HMRC priority: The impact of the new order

6 minute read
01 December 2020

The Insolvency Act 1986 (HMRC Debts: Priority on Insolvency) Regulations 2020 will apply to all business insolvencies that commence on or after 1 December 2020. They provide for certain debts owed to HM Revenue & Customs (HMRC) to become preferential debts in the event of a business entering a formal insolvency. It is important that creditors understand whether they are affected by these changes so that they can decide whether they need to take steps to protect their position.

The relevant debts

The regulations will afford priority status to HMRC in respect of certain taxes that have been collected by a business and are being held by it on behalf of other taxpayers, namely:

  • VAT;
  • PAYE;
  • Employee National Insurance contributions;
  • Student loan deductions; and/or
  • Construction Industry Scheme deductions.

The preference applies to all debts falling within these categories, regardless of when the debt arose.

Note that there are no changes being made to the rules in respect of taxes that a business owes itself to HMRC (such as Corporation Tax and employer National Insurance contributions), which would have a more dramatic effect. However, there will undoubtedly be an impact on creditors whose debts are not afforded preferential status, particularly in respect of businesses that have a large workforce, who make sizeable Construction Industry Scheme deductions, or which collect significant amounts of VAT but account to HMRC on an infrequent basis.

The new priority of payments

The relevant debts described above will become secondary preferential debts alongside retail deposits that are not protected by the Financial Services Compensation Scheme. This means that, in an administration, Company Voluntary Arrangement (CVA) or winding up they will fall to be paid after:

  • fixed charges;
  • applicable moratorium and pre-moratorium debts;
  • applicable contracts entered into or adopted by former administrators (administration only);
  • expenses of the insolvent estate; and
  • ordinary preferential debts (such as pension scheme contributions, wages and holiday pay),

and they leapfrog secured floating charge holder creditors and unsecured creditors, which will comprise key stakeholders in a restructuring and rescue, such as key suppliers and customers and pension scheme creditors.

The change is going to have the effect of reducing the amount of funds available to distribute amongst the holders of lower ranking debts. It will be most keenly felt by:

  • floating chargeholders, particularly since the maximum 'prescribed part' to be set aside for unsecured creditors out of their realisations increased from £600,000 to £800,000 earlier in the year; and
  • unsecured creditors whose prospects of receiving any payment are reduced by taking certain HMRC payments out of this class and giving them priority status.

Wider impact

The Government has explained that the aim of the regulations is to ensure that taxes paid in good faith by third parties, go to fund public services as intended. However, their introduction has not been universally welcomed, with some criticisms being made in the press from bodies such as R3 and the City of London Law Society.;

There are concerns that the change will limit the appetite of lenders to finance on a flexible 'floating charge' basis and restrict access to affordable finance, particularly for the SME market and that overall it will 'increase the impact of corporate insolvencies on pension schemes, trade creditors, consumers and the wider business community'[1].

The commencement of the regulations was postponed from April 2020 at the start of the COVID-19 pandemic. However, if anything, the economic position in the UK is now even more delicate and there have been concerns raised that the move goes against the other efforts by the Government to offer support at this difficult time.

In addition, restructuring professionals are already beginning to see the impact in terms of the viable options for rescue potentially narrowing with this change. We have already seen that HMRC's position in an administration may be better than in a CVA if the outcome in the CVA is not on a par with the outcome in Administration, taking into account the split in the preferential element of HMRC's debt and the unsecured element. As a result, more CVAs could be voted down. The CVA is a key tool for struggling retail businesses in particular and this change could limit the rescue options for those businesses, forcing an immediate insolvency or limiting funding options.

If you would like to discuss how to protect your business against the increased risks arising from this change in the law, please contact one of our Restructuring and Insolvency team whose contact details are below.

This article relates to the law of England and Wales.


[1] Taken from the letter from R3 to the Chancellor on 3 September 2019, co-signed by a number of industry bodies.

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