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Protecting taxes in insolvency: bad for UK business?

As the Government prepares legislation for ‘protecting taxes in insolvency’, a return of Crown Preference, is UK insolvency industry law about to take a backwards step? And will it actually damage business rescue?

The “Protecting your taxes in insolvency” proposal is presented as a way to claw back lost tax revenue after a business collapse, and increase tax income. However, industry specialists are warning that any gains for the public are likely to be short term.

Fears are that increasing the risk for lenders will reduce business investment. So more businesses, including viable concerns, may face closure. The long-term impact of which could negatively impact UK business and result in low tax revenue figures. Therefore, defeating the original government objective.

Are the concerns of insolvency experts justified? Or will the government’s plan work with no ill-effect for UK business?

The return of Crown Preference

The incoming legislation follows through on proposals outlined in the Autumn 2018 Budget to make HRMC a secondary preferential creditor.

Meaning HMRC will now get paid directly after secured creditors (primarily financial institutions). This effectively signals a return of ‘crown preference’ and increases the likelihood taxes will be collected if a business does close down.

However, it will also leave less money in the pot for the floating charge holders and the unsecured creditors.

“Protecting your taxes”

The government argument is that it has a responsibility to the public purse and, since the enactment of the Enterprise Act 2002, the losses to the Treasury from insolvency have increased dramatically. So, they believe steps to protect lost tax income must be made.

Official government estimates suggest that the crown preference U-turn will generate around £185 million in taxes a year that could go towards public spending.

The insolvency law changes April 6th, 2020

Under the proposed changes, from 6 April 2020, “when a business enters into insolvency, more of the taxes paid in good faith by its employees and customers, which are temporarily held on trust by the business, will go to fund public services, rather than being distributed to other creditors.”

Employee and customer taxes affected

This applies to certain taxes paid by a business’s employees and customers, including VAT, PAYE, Income Tax, employee national insurance contributions (NICs). These will be held in trust by the business when it enters insolvency.

No change to business taxes in insolvency

The rules will remain unchanged for taxes in owed by businesses themselves, such as employer NICs and corporation tax.

A new order of priority for corporate insolvency repayments

Below is a simplified hierarchy showing how the order of priority repayments break down

  1. ‘Fixed charge’ secured creditors (Creditors with lending secured against a definable object)
  2. Insolvency process costs (this may include any rent during the insolvency process, wages or office fees)
  3. Preferential creditors, which include:
    • occupational/state pension scheme contributions;
    • Some wages owing to employees (up to 4 months prior to insolvency);
    • money owed to the Financial Services Compensation Scheme;
    • From April 6th 2020: HMRC will be a preferential creditor
      Taxes collected and held by businesses on behalf of other taxpayers
      (i.e. VAT, PAYE Income Tax, NICs, construction industry scheme deductions)
  4. Secured ‘floating charge’ creditors (Creditors with lending secured against a class of object (but not specific items | Asset-based lending (ABL) is a form of floating charge.)
  5. Unsecured creditors (Almost all remaining creditors such as customers, trade creditors, and pension schemes – HMRC is currently an unsecured creditor through the Pension Protection Fund.)
  6. Shareholders

Funding risk to UK business?

Reintroducing crown preference will have a direct impact on the security of many UK business. Especially those who use floating charge lending, for example, asset-based lending (ABL), which make up a large percentage of the SME market.

For many small businesses, ABL offers previously unavailable funding options which can be based on asset performance as well as debtor value. Without access to this funding, many businesses could close.

ABL changes to impact small business

By placing HMRC higher in the creditor hierarchy during business insolvency ABL will not be repaid until HMRC confirms it has been paid in full.

Which makes ABL to business far riskier. Driving fees up and availability down. Meaning many businesses that can be rescued could now face closure.

Stuart Frith, the president of the Insolvency and Restructuring trade body R3, has strongly criticised the upcoming change, saying: “‘Floating charge’ lending includes common types of lending, like asset-based lending. If things go wrong, a lender won’t get their money back – it’ll go to the Treasury instead. It’s simple: the greater the risk of lending, the less lending there is likely to be. This makes it harder to fund rescues, and limits lending options for healthy businesses.”

Interestingly, the government consultation paper acknowledges the changes will “affect financial institutions”, but does not believe they will “have a material impact on lending, and the Office for Budget Responsibility made no adjustment to its forecast as a result of this measure”.

Retail sector amongst those at risk

And since floating charge lending is often used in the retail sector for expanding stock levels, it is very likely that the repercussions will be felt by many retailers.

Frith adds: “Little thought seems to have gone into how many businesses would fail if their lending facilities were withdrawn or reduced.”

Short-sighted and short-term: business rescue will suffer

In short, the incoming change to collecting taxes in insolvency is extremely unpopular. Businesses and professionals from the finance and insolvency world have expressed their disappointment with the change and the negative impact it may have on UK PLC.

And the timing of the proposal could not be worse. With looming no-deal Brexit, all businesses in the UK are stockpiling and preparing for the unknown future.

So, while the UK Treasury may claw back a little more tax each year from failing businesses, as a direct result of the change more business could fail. Therefore, missing out on taxable income in later years.

The business rescue problem is amplified by the resulting tighter access to business finance. Higher business failure does not mean more HMRC revenue, as there will be fewer growing businesses to generate tax receipts, and higher redundancy payouts for the Government to cover.

What about your taxes in insolvency?

If you owe HMRC and other creditors and are worried about these proposals, please contact Maxwell Davies for professional advice.

If you are worried about business insolvency we can answer all your questions, even help rescue your business.

Initial consultations are free.

You don’t know what we can do until you ask!

 

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