HMRC become preferential creditor

How does HMRC’s move to preferential creditor impact directors?

Authored by Andy Wood

Andy Wood

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Approximate read time: 3 minutes

The return to preferential creditor status of HMRC has overnight increased the exposure of directors who have given personal guarantees to funders/suppliers to their companies and very few directors were made aware of the change that came into effect on the 1st December 2020. Are you one of those directors?

On the 1st December 2020, HMRC regained their preferential creditor status which they relinquished back in 2003. The result is that monies deducted from employees wages (PAYE/NIC), collected from customers by way of VAT or unpaid Corporation Tax which has not been paid over to the government at the point of insolvency, will effectively rank first in the queue, after fixed charge creditors, where monies realised in the insolvent estate are to be paid out to creditors.

How will the change affect your company debts and what is the personal impact on directors?

The statutory order in which an insolvency practitioner is required to distribute surplus funds realised after agreed professional fees is as follows;

  • Fixed Charge Holders
  • Preferential Creditors
  • Floating Charge Holders
  • Unsecured creditors

The majority of personal guarantees provided by directors are in relation to floating charge holders. The bank debt for example will be a floating charge, unless there is typically a company property within the balance sheet which would act as a fixed charge in general to the Bank.

In simple terms without confusing matters with the Prescribed Part rules, which allows a small portion of realisations to be reserved for unsecured creditors, may produce the following outcome in insolvency;

Surplus realisations after agreed costs – £100,000

Bank debt secured by standard floating charge debenture and backed up with a directors personal guarantee – £80,000

HMRC monies owed (PAYE/NIC and VAT) – £65,000

Unsecured creditors (suppliers, utilities, business rates etc) – £200,000

Employees Redundancy (Arrears of wages/holiday pay paid up to date) – £90,000

How would funds have been distributed pre- 1st December 2020?

The order of distribution would have been;

Surplus Realisations – £100,000

Less: Bank (£80,000)

Surplus to Unsecured creditors – £20,000

Unsecured creditors – (£355,000)

Shortfall to unsecured creditors – (£335,000)

In this scenario, the Bank would be repaid in full and no call would be made by the bank on the directors personal guarantee. HMRC would receive on a pro rata basis as an unsecured creditor, 5.6 pence in the £ which totals £3,662.

How would funds have been distributed if the same business had entered insolvency on or after 1st December 2020?

The order of distribution under the new rules would be;

Surplus Realisations – (£100,000)

Less HMRC (Preferential creditor) – (£65,000)

Surplus to floating charge creditor/ Prescribed Part to unsecured creditors – (£35,000)

Less Bank (£80,000)

Shortfall to Bank – (£45,000)

Shortfall to unsecured creditors – (£290,000)

As mentioned above, of the £35,000 surplus after HMRC have received 100 pence in the £, a small portion would go to unsecured creditors, leaving in reality some £50,000 due to the Bank, which would trigger a personal demand against the directors personal assets as a result.

What will be the impact on directors?

Without doubt in the coming months and years, whilst the taxpayer will benefit greatly by an increase collection rate in terms of monies owed to HMRC, this will be subsidised by directors who will have to reach some accommodation with their banks, failing which the worst-case scenario could be personal bankruptcy.

How can we help?

Wilson Field can help by firstly assessing the solvency of your company and where cashflow issues are prevalent explore payment plans with HMRC and/ or other third-party creditors whether that be through an informal or formal arrangement such as a Company Voluntary Arrangement (“CVA”). If this can not be achieved, we can assist with the formal Liquidation process.

In Summary

The change in HMRC preferential status from 1 December 2020 has fundamentally changed the dynamics of the insolvency and restructuring profession, with the potential impact on directors being a greater exposure to unpaid company debts where personal guarantees have been provided. More so than ever is the need for directors to take early advice from Insolvency Practitioners like Wilson Field to maximise the opportunity of navigating a way around such exposures for the benefit of company creditors and company directors with personal guarantee exposures.

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