Crown Preference - Update from R3

16 April 2019

Although other R3 Thinks posts have previously covered the Government’s proposals, we thought it would be helpful to give a further update now that HMRC is formally consulting on the proposed changes to Crown Preference.

These changes were first announced in last October’s Budget, where the Chancellor revealed that HMRC is to become a ‘secondary preferential creditor’ in corporate insolvencies. This would mean that from 6 April 2020, certain tax debts owed by an insolvent company (including VAT, PAYE, and NICs) would be repaid to HMRC ahead of debts owed to floating charge holders and unsecured creditors.

This is hugely concerning. Successive Governments have attempted to encourage a culture of business rescue – work which has been enhanced by the present Government’s efforts to strengthen the UK’s insolvency framework. All of this will be undermined if this proposal goes ahead.

What’s going on?

The basic gist of the Government’s plan is as follows. When a company enters an insolvency procedure, its debts are repaid according to a statutory hierarchy. The higher up the order, the more likely a creditor is to see at least some of its debts repaid – if any; the lower, down the order, the less likely that a creditor will see their money back. The Government’s plan is to move HMRC debts from near the bottom of the order to near the top.

This is a restoration of something known as ‘Crown Preference’. This was scrapped in 2003 when the Government decided it wanted more money from insolvencies to go back to businesses, lenders, and consumers. The new proposal actually goes further than the old Crown Preference: previously, only tax debts up to a year old enjoyed preferential status; now, any tax debt regardless of how old it is will be bumped up the order.

Impact on access to finance

These plans will have a significant and negative impact on access to finance in the UK. Floating charge funding, where money is lent against a changing asset like stock, is a very common form of finance in some areas of business in the UK, but these creditors will be less of a priority under these proposals. The risk that these lenders will not see any of their money back if a company becomes insolvent means they will be less willing to lend, which is bad news for all sorts of businesses, including those who need funding to carry out a restructure or those who simply need funding to support growth.

At a practical level, the retrospective nature of this proposal means floating charge lenders will have to undertake a detailed historic and ongoing review of the tax positions of the companies to whom they have lent money to check for tax debts which may now outrank their claims. Lenders may also seek to insure themselves against tax liabilities, which will increase the cost of obtaining floating charge financing – another blow to the businesses that depend on this type of finance when they are trying to put together a recovery plan.

Impact on unsecured creditors and HMRC

Moving HMRC up the priority list will also impact on unsecured creditors, including the company pension scheme, some employee claims, and the company’s suppliers or customers. The extra money HMRC gets as part of the proposed reform will be coming from what would otherwise be repaid to these other creditors. The lack of a time ‘cap’ for the new ‘Crown Preference’ means both unsecured and floating charge creditors could get even less back in insolvencies than they did before 2003.

Another key issue this raises is the fact that as a preferential creditor, HMRC will be required to play more of an active role in insolvency procedures. This will require them to vote on approving key parts of the process, creating a risk of a bottleneck – a risk that’s enhanced by the fact that HMRC’s current approach can already cause delays.

Alternative options

The long-term damage this proposal is likely to cause greatly outweighs the gains the Treasury expects to make from it. The Government should drop its plans to restore ‘Crown Preference’, and in doing so, prevent the damage to pension schemes, supply chains, consumers, and business lending this proposal would cause.

If that isn’t an option, the Government must scale back the scope of this proposal. A simple means of doing this would be to cap the size of HMRC’s ‘preferential claim’, restrict the age of tax debts affected, and reduce the amount of engagement required by HMRC in insolvencies. As well as simplifying the plans for this proposal, these three things would also limit the consequences for those it will affect.

Ultimately, the Government would see a better return from insolvencies if HMRC were to engage more actively in insolvency procedures than it does now. That’s a better solution than jumping the creditor queue in insolvencies to generate income for the Treasury at the expense of businesses, stakeholders, and all those involved in business rescue.

Tell us your thoughts

Do you have a view on the Crown Preference proposals? There’s still time to make them known – the Government’s consultation closes on May 27. R3 will be submitting its own response to the consultation, so if you have any comments you’d like us to consider, please email our Public Affairs Manager, James Jeffreys, at [email protected].