Days of future past: the reintroduction of Crown Preference

United Kingdom

HMRC has launched a consultation on new legislation that will restore (and improve) its status as a secondary preferential creditor for certain tax debts in business insolvencies (the “Consultation”). This was first announced in the Government’s 2018 Autumn budget statement (see Fortune favours the…Crown). HMRC will be “secondary” to existing preferential creditors, such as employees, and ahead of the holders of a floating charge.

The changes are to be introduced in the Finance Bill 2020 (the “Bill”) and will apply to insolvencies commencing on or after 6 April 2020. HMRC’s secondary preferential creditor status will apply for debts relating to PAYE (including student loan repayments), VAT, employee National Insurance Contributions (“NICs”), and Construction Industry Scheme Deductions. The HMRC rationale is that this tax revenue, which has already been paid to, or reserved by, the company with the intention of it being paid to HMRC (but for the insolvency), should be used as always intended, that is to fund public services. The rules concerning debts relating to Income Tax, Capital Gains Tax, Corporation Tax and Employer NICs remain unchanged under the new legislation.

Prior to the changes made by the Enterprise Act 2002, similar Crown Preference rules applied on a time-limited basis. This is not just a reintroduction of Crown Preference but an extension of it. There is no proposal for a time limit with regard to the new regime. Further, given the extent of student debt and the increases in NICs since 2002, in absolute terms it is likely to represent larger sums of money.

At the time of the Enterprise Act 2002, the abolition of Crown Preference was one side of a balance between secured and unsecured creditor interests; the other was the introduction of the “prescribed part” (a reserved amount for unsecured creditors). The reintroduction and extension of Crown Preference does not recognise this balance. It is also intended to increase the limit of the “prescribed part” from £600,000 to £800,000, further reducing the value of a floating charge over business assets.

Impact on other creditors

The value of floating charges will be adversely impacted by the change, as they will rank behind the new Crown Preference debts and suffer the deduction of the increased “prescribed part”. It will also disadvantage other unsecured creditors as there will be less likelihood of a “prescribed part” in the first instance, as that is formed of monies available after the payment of preferential creditors.

It will potentially adversely impact stock-intensive businesses, such as retailers and construction companies, as their ability to use the value of their floating charge assets as collateral for lending will be reduced. HMRC dispute this analysis. On a wider basis, lenders will need to discount the value of cash-flow balances from time to time by the average Crown Preference sums in order to assess the true cash position in any insolvency.

It raises questions around the control of insolvency processes. At present unsecured creditors generally control the approval of proposals and remuneration in administration and liquidation, unless (in administration) there will only be a return to secured and preferential creditors. Secured creditors also have limited approval powers in liquidation. If there will be no return, other than to secured and preferential creditors, will this lead to HMRC having an enhanced level of oversight and control in the management of insolvency cases generally?

The balance of interests in insolvency is always difficult and the fact that a decision was made to abolish Crown Preference 17 years ago does not mean that it is the right decision forever. However, it may be seen as a regressive step in light of the current Government’s aim to become a world-leading restructuring jurisdiction.

Next steps

A number of interested parties are expected to respond before the Consultation ends on 27 May 2019. Details of how to respond to the Consultation can be found here.

A summary of the responses is expected to be published in summer 2019.