The tax man cometh – floating charges, preferential creditors and priorities

Quick read

From 1 December 2020 onwards, HMRC will be treated as a preferential creditor of companies for certain taxes including PAYE, VAT, employee NICs and Construction Industry Scheme deductions. In the event that a company enters administration or liquidation, HMRC's claim for these taxes will rank ahead of any floating charge holder.

This reflects recent changes made to the Finance Act 2020.

The impact on floating charge holders

If a borrower enters administration or liquidation, any monies secured by a floating charge will be repaid only once certain tax debts are paid to HMRC (and after other higher-ranking creditors – this remains unchanged).
This could significantly reduce the realisations available to a floating charge holder and increase the risk of a shortfall in recovering the debt.
While there is provision for regulations to be made limiting the amounts which will be given preferential status to a particular time period, no such regulations have, as yet, been made.
This means that although the legislation came into effect on 1 December 2020, there is no limit specified in the Finance Act 2020 on the age or the amount of the debt owed to HMRC that will be subject to the changes. The legislation will therefore apply retrospectively to tax debts owed prior to 1 December 2020, where a company enters an insolvency process on or after 1 December 2020.
HMRC’s preferential status will apply over all floating charges, whether created before or after 1 December 2020.
A borrower's tax liabilities are now of much more significance to both existing and new lenders, where the lender has (or intends to) take security by way of a floating charge. The increased risk to lenders may lead to an increase in the costs of borrowing.

From 1 December 2020, the ranking of creditors in the insolvency waterfall will be as follows:

fixed charge holders
costs of the insolvency (it's worth noting that a new moratorium procedure was introduced by the Corporate Insolvency and Governance Act 2020 – if a company enters into administration or winding-up proceedings within 12 weeks of the end of a Part A1 moratorium, any unpaid moratorium debts or pre-moratorium debts (where the company does not have the benefit of a payment holiday for these) will benefit from super-priority; these debts will be paid after those which are owing to fixed charge holders, but before administration or liquidation expenses)
ordinary preferential creditors (most notably, certain claims from employees)
second preferential creditors (claims for certain taxes from HMRC such as VAT, PAYE, employee NICs and Construction Industry Scheme deductions)
prescribed part (recently increased from a maximum £600,000 up to £800,000 for floating charges created on or after 6 April 2020)
floating charge holders
unsecured creditors (including all other taxes – eg corporation tax)
shareholders.

Deferred VAT payments due to coronavirus

In the light of the economic impact of the coronavirus pandemic, the UK government and HMRC introduced measures to allow companies to defer payment of VAT until 31 March 2021.
Many companies affected by coronavirus will have deferred their VAT payments under this scheme. This is particularly concerning given the lack of a cap or limit on the size or age of the tax debts eligible for preferential status.

Considerations for lenders

Review the tax liabilities of a borrower as part of your due diligence and consider including tighter covenants in the loan terms in relation to payments by the borrower to HMRC, such as requiring borrowers to reserve cash for future tax liabilities.
Structure financing arrangements to reduce your exposure to an HMRC preference.
Consider the risk of any purported fixed charge you hold being deemed a floating charge and ways to perfect your security.
Consider an adjustment to pricing to reflect the increased risk and if the benefit of any changes to your lending terms will commercially outweigh the effect any changes might have on your competitiveness in the market.