The Budget 2020: The insolvency and restructuring wishlist
04 March 2020
- Read R3's Budget submission to the Chancellor here.
The forthcoming Budget on 11 March will likely contain a range of headline-friendly projects, from heavily-trailed measures to increase infrastructure spending to 'level up' areas of the North, to changes to taxation which are sure to prompt much debate.
Among all the attention paid to the more eye-catching proposals that Chancellor Rishi Sunak will unveil, we want to ensure the concerns of our members in the insolvency and restructuring profession are also heard. Our Budget submission sets out our views on two key issues which may well be tucked away in the Budget 'Red Book' rather than announced with fanfare by the Chancellor at the Despatch Box: the Government's plans to grant HMRC 'preferential status' in insolvency procedures from April this year, and measures to make directors personally liable for a company's tax liabilities where HMRC considers avoidance or evasion has taken place, or where there is evidence of 'phoenixism'.
HMRC's position as a creditor in insolvency procedures
As we have previously set out, granting certain types of tax debts a preferential status in insolvencies - originally announced without warning in the 2018 Budget - will create a significant challenge to the UK's business community, by making it harder for businesses to access working capital finance. If debts owed to HMRC 'leapfrog' finance provided on a floating charge basis - which is commonly used by businesses to fund their stock levels - then those who provide it will, understandably, be more cautious, and will be required to take more security from customers as a consequence, pushing up the cost of this type of finance for businesses.
Allowing HMRC to move near the top of the creditor 'waterfall' reverses changes made by the Enterprise Act 2002, which removed HMRC's preferential status and established tax debts as an unsecured debt in insolvencies. This Act was designed to encourage investment and entrepreneurialism and has long been considered a success. Rowing back on its changes is a retrograde move from the Government, and will harm business rescue as well as growth prospects for many UK companies, and will increase the knock-on effect of the insolvency of one business on other companies and individuals. Business investment, returns to creditors, and confidence in the UK's corporate framework all stand to be damaged as a result.
While it is difficult to model the policy's precise impact on business lending, UK Finance estimates that the policy could hit lending by up to £1.5 billion.
Unsecured creditors (that is, the company pension scheme, some employee claims, and the company's suppliers or customers, including SMEs and consumers, among others) will also be hit hard by the Government's plan. The extra money HMRC will be paid under the proposed reform will be coming from what would otherwise be repaid to these other creditors.
In order to prevent damage to UK business rescue and lending, pension schemes, supply chains, and consumers, the Government should drop its plans.
At the very least, the Government must scale back the scope of its proposals. To provide certainty about the size of HMRC's preferential claims, the Government should cap the age of tax debts eligible for preferential status (currently unlimited); and, to ensure the policy is fair and that its administrative impact is minimised, HMRC's preferential claim should not outrank floating charges created before April 2020. Greater HMRC engagement in insolvency procedures would also be a more effective way of increasing post-insolvency tax returns - HMRC's lack of engagement can already cause delays in insolvency procedures, and more tasks for HMRC may mean more delays, exacerbating the impact of the proposal on other creditors.
'Tax Abuse and Insolvency'
The Government's 'tax abuse and insolvency' policy (read R3's consultation response here) will make directors personally liable for tax debts in situations where they are suspected of abusing the insolvency framework in order to avoid paying taxes. This could apply to directors with a track record of corporate insolvency, or where the director's company is facing, or in, an insolvency procedure.
While R3 understands the issue which the Government is seeking to address, we are concerned that, without strict guidance to accompany the legislation, there is a risk that it may be applied much more widely than originally intended.
The implications of the policy are significant: it breaches the principle of 'limited liability' which lies as the heart of the UK's corporate framework. As such it must be handled with care and used sparingly. It is also worth noting that the Government already has a number of powers to pursue tax debts which are far stronger than those possessed by other types of creditor.
While officials appear to have taken on board some of R3's feedback on earlier versions of the proposals, we have some remaining concerns.
For example, while an individual will have a right to review the decision by HMRC to use the power, the individual will not be able to challenge the existence or amount of any tax liability for which they are being held responsible.
Additionally, the legislation will allow HMRC to make individuals liable for corporate tax debts if (among other criteria) they have links to a number of corporate insolvencies in the recent past - a description which could encompass turnaround specialists, who are often taken on as short-term directors of distressed businesses. It would obviously be unfair for turnaround and restructuring advisors to be included within the scope of the legislation. The good news is that the Government has indicated that the policy will not be applied to turnaround specialists, but nevertheless the wording of the legislation and subsequent guidance will be key to ensuring this commitment can be honoured.
Finally, among the criteria which need to be met before the power can be used are requirements that there is a "serious risk" of insolvency, or a "serious possibility" that a tax liability may not be paid. These terms are somewhat vague and are open to interpretation.
Whatever else it contains, the Budget is bound to have a major, if underappreciated, impact on the UK's corporate insolvency and restructuring framework. We hope the Government will listen to the concerns of R3's members, and ensure that the measures the Chancellor introduces in the Budget do not damage the UK's strong culture of business rescue and entrepreneurialism.
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