What does HMRC Secondary Preferential Status mean for creditors?

As of 1st December 2020, HMRC became a secondary preferential creditor in insolvency processes. Before, they were unsecured creditors and positioned at the bottom of the hierarchy for repayment.

Creditors get repaid in a specific order set by insolvency law. This alteration has significant effects on certain creditor groups. Unsecured creditors usually get a small return in an insolvent liquidation, lowering their chances of receiving any dividend.

So, what does HMRC’s secondary preferential creditor status mean for other creditors, and why has HMRC’s position changed in this manner?

HMRC are involuntary creditors

Unlike suppliers and other creditors, HMRC cannot choose their business partners or impact a trading relationship like other creditors. This makes them involuntary creditors.

HMRC is often the biggest creditor in a liquidation process, facing significant potential losses in taxes. These taxes might remain unpaid for months or even years, as preferential tax debts have no time limit.

So, what has occurred to alter their position in the creditor hierarchy?

Why are HMRC now secondary preferential creditors?

HMRC previously held preferential creditor status, which was revoked when the Enterprise Act 2002 took effect on 15th September 2003. This change redirected funds that would have earlier benefited public services through preferential creditor claims, now typically repaying other creditor groups in a liquidation process.

In an attempt to enhance public funds, their preferential creditor status has been reinstated, though it now comes after employees’ preferential claims. Moreover, it applies only to the repayment of specific taxes that a company collects on behalf of HMRC.

This includes:

• VAT
• PAYE
• Employee National Insurance Contributions (NICs)
• Construction Industry Scheme (CIS) deductions

Corporation tax is directly paid by a company. If there are debts related to corporation tax, HMRC would be classified as an unsecured creditor for the owed amount. While this advancement in the hierarchy of repayment in liquidation benefits certain taxes, it also exposes other creditor groups to higher risks of loss.

What is the hierarchy for repayment in insolvency?

Creditors are categorised, and here is a general overview of the order of repayment:

• Secured creditors with a fixed charge
• Preferential creditors – company employees
• Secondary preferential creditors – HMRC only, in respect of above-mentioned taxes
• Prescribed part – a sum set aside for unsecured creditors
• Secured creditors with a floating charge
• Unsecured creditors

The appointed office-holder must fully repay each creditor group before proceeding to the next.

Read More:

• What happens when HMRC want to visit my business
• What is a HMRC field force officer and what are their rights
• Understanding HMRC security bonds for VAT, PAYE, and NI
• What is the role of the HMRC Fraud Investigations Service (FIS)?
• What happens to your limited company if you ignore HMRC?

What does HMRC’s Secondary Preferential Status mean for other creditors?

1. Lower returns

Secured creditors with a floating charge and unsecured creditors face the prospect of reduced returns in a liquidation process because of the updated HMRC creditor status. As noted earlier, unsecured creditors, in particular, usually receive minimal returns from insolvent liquidation, and this change by HMRC worsens their situation.

2. Reluctance to lend

Lenders with a floating charge over a company’s asset class, like stock, might hesitate to lend to businesses as the value of their security diminishes. If there is widespread reluctance to lend following HMRC’s creditor status, it could increase financial strain for companies with weak cash flow and impede overall business growth. 

3. More personal guarantees

To reduce their lending risk, lenders might increasingly request personal guarantees, especially if they find themselves lower in the hierarchy. This adds extra strain on companies and directors, especially when securing funding is vital.

4. Potential rise in insolvencies and job losses

Additional constraints on business lending and requests for personal guarantees may lead to more insolvencies and job losses as businesses face challenges in obtaining crucial funding. Creditors in the business supply chain are also prone to experiencing the repercussions of their trading partner’s insolvency, posing a risk of financial decline in other businesses.

For further information on HMRC creditor status and its implications for your business, please get in touch with our team at Vanguard Insolvency. As insolvency specialists with offices across the country, we can provide you with a free same-day consultation.