The return of Crown preference from 1 December 2020

What are the new provisions?

For almost 20 years, the Crown has been an unsecured non-preferential creditor in respect of all sums owing to it. However, in respect of certain insolvency processes where the relevant date is on or after 1 December 2020[1], certain debts owing to HM Revenue and Customs (“HMRC”) are to be included in a category of secondary preferential debts, such that HMRC will be entitled to repayment of these debts from the estate of the insolvent company ahead of both floating charge creditors and unsecured non-preferential creditors.

The tax debts granted secondary preferential status are value added tax (VAT) and a relevant deduction[2]. A relevant deduction is defined in the legislation[3] and includes:

• Pay as you earn (PAYE);
• Employee National Insurance contributions;
• Deductions on account of tax from contract payments; and
• Student loan repayments.

HMRC will remain an unsecured non-preferential creditor for all other tax debts, such as corporation tax and employer National Insurance contributions.

HMRC’s preferential status is not subject to a financial cap or a specified period prior to the relevant date when the liabilities need to have been incurred to rank as preferential, although the Treasury may put forward Regulations specifying limits if it chooses to do so[4].

What is a secondary preferential debt?

Preferential debts are debts paid after debts secured by a fixed charge and the remuneration and expenses of the insolvency practitioner, but before debts secured by a floating charge and all other ordinary unsecured creditors. However, within the category of ‘preferential debts’ there are both ‘ordinary’ and ‘secondary’ preferential debts[5].

Ordinary preferential debts are debts an insolvent company owes in relation to certain payments due to (i) employees and (ii) the Financial Services Compensation Scheme (“FSCS”) or deposits that would otherwise be covered by the FSCS.

Secondary preferential debts currently include certain deposits owed to depositors that are not otherwise protected by the FSCS. From 1 December 2020, the debts due to HMRC detailed above will also constitute secondary preferential debts.

Ordinary preferential debts rank above secondary preferential debts and secondary preferential debts rank equally among themselves, meaning that if there are insufficient funds to pay all secondary preferential debts in full, they will be paid pro rata.

What are the implications of the new provisions?

As a secondary preferential creditor, HMRC’s debts will rank ahead of floating charge holders and unsecured non-preferential creditors, which will reduce the realisations available for distribution to these categories of creditor on an insolvency. In relation to floating charge holders, this applies even where the floating charge was created before 1 December 2020. It is therefore likely to become even more important for lenders to satisfy themselves that they have sufficient fixed charge security to cover the outstanding debt. In order to have the degree of control necessary for a charge to be fixed, as opposed to floating, this may see extra restrictions being placed on the grantor of the security (but this is often not a viable option for businesses).

HMRC may therefore receive a distribution from an insolvent company’s estate via two routes: (i) as a secondary preferential creditor in respect of the debts noted above; and (ii) as an unsecured non-preferential creditor in respect of all other debts.

A summary of the payment waterfall on insolvency (in respect of insolvencies where the relevant date is on or after 1 December 2020) is set out in the table below.

[1] Section 98(7) of the Finance Act 2020, by reference to the meaning of ‘relevant date’ pursuant to section 387 of the Insolvency Act 1986. Relevant date relates to when the relevant entity goes into the insolvency process, for example administration or liquidation, as opposed to taking a step leading to it.

[2] Section 98(2) of the Finance Act 2020 introducing a new Paragraph 15D in Schedule 6 of the Insolvency Act 1986.

[3] Section 98 (2) of the Finance Act 2020 introducing a new Paragraph 15D in Schedule 6 of the Insolvency Act 1986 and the Insolvency Act 1986 (HMRC Debts: Priority on Insolvency) Regulations 2020.

[4] Section 99(1) of the Finance Act 2020.

[5] Schedule 6 of the Insolvency Act 1986.