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Potential damage to company finance and business rescue?

Jonathan Taylor - May 26th, 2020


The Finance Bill 2019-21 had its second reading in Parliament on 27 April, closely watched by the insolvency and restructuring profession due to the inclusion of 2 proposed policies which may damage business lending and hinder business rescue:

  • Plans to grant HMRC preferential status in insolvency procedures from December this year; and
  • Measures to make directors personally liable for a company’s tax liabilities where HMRC considers avoidance or evasion has taken place, or where there is evidence of ‘phoenixism’ (‘tax abuse using company insolvencies’).

During a time of unprecedented economic crisis, when access to finance and support for struggling businesses will be more important than ever, many believe these proposals will significantly impede the ability to rescue businesses and save potentially viable companies during Covid-19 pandemic.

HMRC preferential status represents a significant challenge to the UK’s business community, as it risks increasing the difficulties businesses face when seeking access new finance / funding.

As well as having a detrimental impact on business and economic growth, restricted lending will make it harder to rescue businesses, increasing the knock-on effect of the insolvency of one business on other companies and individuals. Business investment, returns to creditors, and confidence in the UK’s corporate framework all stand to be damaged as a result.

In insolvency procedures, creditors are repaid in accordance with a structured, statutory hierarchy. Because an insolvent business is very unlikely to be able to repay all its debts, the lower a creditor is down the hierarchy, the less of their money they are likely to see back. Under the Government’s plan, some HMRC debts such as PAYE, employee National Insurance Contributions (NICs), and VAT, will move ‘up’ the hierarchy. Other tax debts, such as Corporation Tax or employer NICs, will remain an unsecured debt, lower down the hierarchy.

This plan reverses changes made by the Enterprise Act 2002, which removed HMRC’s preferential status and established tax debts as an unsecured debt in insolvencies. This Act was designed to encourage investment and entrepreneurialism and has long been considered a success.

Impact on pensions, suppliers, customers and lenders

The creditors most affected by the changes are those leapfrogged by HMRC: ‘floating charge’ creditors (who lend against a changing asset, such as stock) and unsecured creditors (such as the company pension scheme, some employee claims, and the company’s suppliers or customers – including SMEs and consumers). The extra money HMRC gets as part of the proposed reform will be coming from what would otherwise be repaid to these other creditors.

Unlike the pre-2002 approach, tax debts will now qualify for preferential status regardless of when they arose. Previously, only tax debts arising in the 12 months prior to insolvency benefitted from preferential status. The lack of a time ‘cap’ for HMRC’s claim means other creditors could get even less back in insolvencies than they did before the Enterprise Act 2002.

The impact on business rescue and funding

The squeeze on ‘floating charge’ lenders could have a big impact on business rescue and funding. Floating charge lending is a very common form of business finance, particularly for SMEs and sectors like retail. With lenders facing the possibility of not seeing any of their money back if a company becomes insolvent, they will be less willing to lend, particularly to those companies already in financial distress but who may be able to turn themselves around with fresh funding.

This is bad news for UK businesses, which need reliable access to finance to operate. The removal of HMRC’s preferential status in the Enterprise Act 2002 contributed to the growth of floating charge lending in the first place.

Tax abuse using company insolvencies

The Government’s ‘tax abuse and insolvency’ policy, included under “Clause 97: Joint and several liability of company directors“, will make directors personally liable for tax debts in situations where they are suspected of abusing the insolvency framework in order to avoid paying taxes. This could apply to directors with a track record of corporate insolvency, or where the director’s company is facing, or in, an insolvency procedure.

While R3 understands the issue which the Government is seeking to address, we are concerned that, without strict guidance to accompany the legislation, there is a risk that it may be applied much more widely than originally intended.

The impact on individuals, restructuring experts and the UK’s corporate framework

The implications of the policy are significant: it breaches the principle of ‘limited liability’ which lies as the heart of the UK’s corporate framework. As such it must be handled with care and used sparingly. For example, while an individual will have a right to review the decision by HMRC to use the power, the individual will not initially be able to challenge the existence or amount of any tax liability for which they are being held responsible. It is also worth noting that the Government already has a number of powers to pursue tax debts which are far stronger than those possessed by other types of creditor.

Drafting issues

Crucially, the legislation does not define a number of important terms which are necessary to ensure the effectiveness and correct applicability of the policy. These include terms such as ‘potential insolvency’, and ‘serious possibility’ of avoidance. Perhaps most concerning is the lack of a definition of ‘participator’ which, due to other legislation, expressly includes shareholders and lenders who may well not have any control of the company in question but who could now become liable for the actions of the directors.

R3 mentioned in debate

Some of the profession’s concerns around HMRC’s proposed new creditor status were aired during the Finance Bill’s second reading debate in Parliament on April 27. Alison Thewliss MP (SNP) quoted directly from R3’s September 2019 stakeholder letter to the Chancellor when highlighting the potential consequences this proposal could have for businesses, consumers and the wider economy to the Minister, as well as colleagues speaking from their own homes across the country  due to the social distancing restrictions.

We await further discussion of these and other MPs’ and stakeholders’ concerns on this and other issues when the Bill reaches the Committee Stage of its journey in a few weeks’ time.

Source: R3 – Association of Business Recovery Professionals