Changes to The Return of Crown Preference
On 1 December 2020 the government enacted the Finance Act 2020 (The Act) bringing with it the return of Crown Preference. We are already seeing the wide-ranging ramifications not just for creditors in insolvency proceedings but also for those businesses seeking to borrow money in what is a challenging economic climate.
Floating charge finance has traditionally been a source of funding to companies, and one of the readily available tools for business turnaround. The charging of non-constant assets, for example stock or work in progress, has enabled businesses to borrow where perhaps those businesses did not have traditional fixed charge assets, or those fixed charge assets had already been charged.
What is Crown Preference?
Prior to The Act, HMRC was categorised as “unsecured non-preferential creditor” with regards to sums that were owed to it in insolvency proceedings. Historically, preferential treatment of debt due to HMRC was abolished by the Enterprise Act 2002. On its reintroduction, The Act prescribes certain debts owed to HRMC as “secondary preferential debts”, in respect of which HMRC is promoted in the order of repayment in insolvency proceedings ahead of those with floating charges and unsecured non preferential creditors.
Those debts owed to HMRC categorised as secondary preferential debts include value added tax (VAT), employee national insurance contributions, pay as you earn tax (PAYE), and construction industry scheme deductions.
Prior to 2002 HMRC preference applied to tax debts which were no more than a year old. The current incarnation includes no time bar and provides HMRC with preference over tax debts irrespective of when they were incurred.
Following the implementation of Crown Preference, the order of preference in an insolvency is now:
- Fixed charge holders
- Liquidation/administration expenses.
- Ordinary preferential creditors
- Second ranking preferential creditors (HMRC under crown preference)
- Prescribed part unsecured creditors
- Floating Charge holders
- Unsecured no preferential creditors
What Impact will the return of Crown preference have?
Unsecured creditors or those who hold a floating charge will find that HMRC dilutes the realisable assets available to them in insolvency proceedings – in the case of a company with secondary preferential debt, reducing the amount they receive. Given Crown preference is retrospective, lenders holding floating charges will have seen the value of their security reduce overnight where their borrower has tax debt.
At a time when businesses are struggling and many of those who continue may be looking to refinance or restructure debt, the knock-on effect could well be drastic. One of the consequences of the reintroduction of Crown Preference is the likely reduction of liquidity available to asset-based borrowers as the value of the floating charge as an effective form of security is diminished – this will be especially problematic to businesses that cannot provide fixed charges as a means of security. Those businesses that can still access liquidity will likely see the cost of borrowing rise as lenders look to mitigate the increased risk to their lending.
Further, borrowers could well see lenders paying greater attention to their tax liabilities. This will be of particular concern to those companies that deferred their tax liabilities between 30 March 2020 and 30 June 2020 due to the Covid-19 pandemic. Those companies that deferred their tax payments and have not made provision in the intervening time for payment of such deferred sums, could see their access to quick liquidity reduced due to the fact these tax liabilities have risen in the order of preference. These tax deferrals will also be a concern to creditors in insolvency proceedings who will now see HMRC attempting to recoup significant amounts in deferred VAT which was previously unsecured.
Given the current economic climate only time will tell as to how many businesses requiring liquidity to tie them over during this difficult economic period are denied it due to the greater perceived risk in lending to them, leaving them with no alternative to insolvency.
In the face of this it is imperative that Directors of companies have a far greater understanding of their tax position and fully understand the implications that this position may now have on their access to finance.
This briefing is for guidance purposes only. RadcliffesLeBrasseur LLP accepts no responsibility or liability whatsoever for any action taken or not taken in relation to this note and recommends that appropriate legal advice be taken having regard to a client's own particular circumstances.