Crown Preference changes in favour of HMRC on 1 December 2020
Firstly, for many businesses the initial question is, “what is Crown Preference”? Put simply, it is where HMRC “rank” for certain taxes owed by a company in the event of a corporate insolvency.
At the moment, where a company becomes insolvent, HMRC rank (mainly) in the same place as unsecured creditors such as suppliers to the insolvent company and to funders who have a floating charge over the wider pool of assets of the company. From 1 December 2020, that changes so that HMRC will rank ahead of unsecured creditors in relation to tax debts which are collected by the company for others such as VAT, PAYE Income Tax, CIS, Employee NIC and student loan repayments.
So from 1 December 2020, HMRC will be more likely to be able to recover amounts of certain taxes which are owed from the assets of an insolvent company than under the current rules. This means that unsecured creditors will therefore be likely to recover less than under the current rules.
Why does this matter more than it might have done previously?
These changes have been talked about for approximately two years. Why might they be more important now than when they were initially discussed?
Most businesses now have deferred VAT. Deferred VAT was an automatic outcome of the COVID-19 measures in quarter two of 2020. For some businesses, the deferred VAT is substantial. Equally, many businesses will have Time to Pay arrangements in place to defer, e.g. PAYE and NIC. And tax deferrals may continue to accrue throughout Q3 and Q4 2020 as businesses try to recover in uncertain times.
In most cases, the businesses will have deferred VAT which is not due for payment until March 2021. So if you are supplying goods or services to a company, if that company becomes insolvent after 1 December 2020, then you are likely to recover even less in the insolvency than you currently could today. HMRC will rank ahead of you in relation to the VAT they have automatically deferred.
Therefore, unsurprisingly, the banks and funders are now becoming a lot more interested in what tax a business has deferred before providing or renewing credit. If a funder will have to stand behind HMRC in the rankings in an insolvency, and HMRC have deferred substantial amounts of the very taxes that the amended Crown Preference applies to, then a funder will (rightly) be reluctant to provide funding.
Our Corporate Finance Associate Partner, Lee Humble, has written about the impact on the lending market. As a practical point, if you are seeking funding, be able to show the lender how any deferred tax (in particular VAT) will be paid. Also, for example, have you set aside or ringfenced the funds to pay the VAT in March 2021?
Equally, if you are a supplier to a business, have you thought about what tax they have deferred? Trade creditors will rank behind HMRC for more tax debts from 1 December 2020 and as discussed above, HMRC have been either automatically, or by agreement, deferring the taxes for many businesses that the amended Crown Preference applies to. If you have a significant exposure to a company you have been supplying and which becomes insolvent after 1 December 2020, there may be little left after HMRC have had their change to recover their debts owed.
HMRC acknowledged in their policy document summarising the changes that trade suppliers would be impacted by the change. HMRC currently estimate that unsecured creditors recover 4 pence per pound owed in an insolvency – and more of that will now go to HMRC. Therefore, whats left for trade creditors will typically be less than 4 pence.
What might you think about doing to protect your business if you are supplying businesses where tax covered by the changes to Crown Preference may have been deferred? Here are some housekeeping ideas you might want to consider:
- Ask for proof of current tax balances with HMRC. These can be seen on HMRC’s online taxpayer accounts which are operated by companies and should be able to give a real time view (albeit as has been proved recently in a high profile case, screenshots can be amended and so may not tell the entire truth)
- Keep your debtor days short and your exposure to any one client as low as possible – this is of course just good housekeeping
- Monitor risk ratings and any judgements against the company as shown on credit rating databases, for example
- Debtor insurance does exist and may be possible (but equally may be hard to obtain in the current environment)
Good housekeeping will help to minimise your risk as HMRC seek to minimise theirs using the new changes to Crown Preference.