In the 2018 Budget, then chancellor Philip Hammond announced that HMRC’s preferential creditor status in insolvencies would be restored. Neil Dingley of Moore Stephens explains how this will affect insolvency processes from 1 December 2020.

What is preferential debt?

The Insolvency Act 1986 gained Royal Assent on 25 July 1986. Schedule 6 to this Act set out the different types of debt which were to be classed as ‘preferential’, ie those which were to be paid ahead of ordinary unsecured creditors.

Under Schedule 6, the Inland Revenue (as was) could claim preferentially for 12 months outstanding PAYE and NIC, and HM Customs & Excise could claim preferentially for 6 months outstanding VAT. This remained good law until the enactment of the Enterprise Act 2002, at which point the Inland Revenue and HM Customs & Excise lost their preferential status.

In 2005, the Inland Revenue and HM Customs & Excise were combined into a single department, HM Revenue & Customs (HMRC), and in October 2018 it was announced that HMRC’s preferential status will not only be restored but extended to encompass any and all outstanding PAYE NIC and VAT at the date of insolvency.

The Finance Act 2020 legislation was recently enacted to give HMRC its preferential creditor status, taking effect from 1 December 2020. This legislation more or less returns the insolvency creditor process to the pre-Enterprise Act 2002 era.

Why has HMRC received preferential creditor status?

These changes were made principally to enable HMRC to collect more tax from insolvent companies and individuals. Some estimates say the move could raise around £195 million annually.

This will naturally benefit HMRC but is potentially detrimental to ordinary unsecured creditors and holders of floating charges, who will only be entitled to be paid after HMRC’s PAYE NIC and VAT liabilities have been paid in full.

How will the changes affect insolvency practitioners going forward?

From 1 December 2020, insolvency practitioners and solicitors, especially those who issue winding up and bankruptcy petitions, will have to educate and manage the expectations of those clients on whose behalf petitions are issued.

It’s important to remember that not all debts owed to HMRC will have preferential status. However, those debts that are preferential, unlike pre-Enterprise Act 2002, will not be time barred. This will result in further reduced funds being available to pay dividends to unsecured creditors. Not only that, when preferential debts are increased, this will also inevitably result in a reduced prescribed part (S176A Insolvency Act 1986) in those cases where this applies.

Whilst issuing petitions was never a guarantee of clients getting their money back, under the new regime there is every likelihood of the dividend prospects to floating charge and unsecured creditors being diluted because of the increased reach of HMRC’s preferential status.

About the author

Neil Dingley is Restructuring and Insolvency Partner at Moore Stephens - Stoke on Trent and has a background in information technology and accountancy.

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Find out more

Insolvency Act 1986 (Legislation)

Enterprise Act 2002 (Legislation)

Finance Act 2020 (Legislation)

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Publication updated: 2 December 2020