In its response to the consultation “Protecting your taxes in insolvency”, the NI Tax Committee argues that there is no case for re-establishing Crown Preference for tax debt in an insolvency. HMRC’s consultation, which closed last week, proposes to re-establish Crown Preference for certain tax debt (broadly PAYE, VAT and Construction Industry Deductions). Crown Preference was originally removed in 2003. Read the response to the consultation:

Introduction

The Northern Ireland Tax Committee of Chartered Accountants Ireland is pleased to have the opportunity to comment on the above consultation launched on 26 February 2019. Information about Chartered Accountants Ireland and the Northern Ireland Tax Committee is provided on the previous page.

We wish to comment on the current consultation and would be happy to discuss any aspect of our comments herein and to take part in any further consultations/initiatives in this area.

Tax Consultation Framework

According to Section 6 of the consultation document, this consultation is being conducted in line with the 2011 “Tax Consultation Framework”1. This framework sets out five stages of tax policy development. The first stage “Setting out objectives and identifying options” is a critical element of the development of and changes in UK tax policy. Stage one of the Framework is identical to stage one of the Government’s 2010 publication “Tax Policy Making: a new approach”2 which the Government reaffirmed its commitment to in 2011.

However the current consultation is taking place at stage two of the consultation process with stage one having been completely skipped. No options for reform have been presented. Rather, this is the first consultation on this matter. It is immediately seeking views on the detailed policy design presented and has not considered in detail either the case for change or the impact that this change will have on the provision of finance to small business, the vital work of business rescue and the impact on unsecured creditors all of which we consider further below.

The case for change

The Enterprise Act (“EA”) 2002 removed HMRC’s status as a preferential creditor. At that time the White Paper “Insolvency – A Second Chance”3 said that the removal of Crown preference was “more equitable” and it was being introduced to redress the balance between different categories of creditors where a restructuring was in prospect. In particular, the change was being introduced to provide a higher realisation for unsecured creditors.

In addition, the Research Paper4 to the Enterprise Bill set out that the Government also aimed to “encourage risk-taking and facilitate company rescue when things go wrong”. It argued that when “fundamentally viable businesses are lost there are consequences for creditors, employees and the wider economy.” Both of these statements still stand today.

It is not clear to us therefore that the proposal to reintroduce Crown Preference for certain tax debt is based on a strong case for change. The abolition of Crown Preference was premised on encouraging enterprise; this proposal is likely to have the opposite effect.

The justification for this change is solely based on loss of revenue to the Exchequer; however the impact on the Exchequer was also a consideration when Crown preference was originally abolished. At that time, the benefit to creditors and business rescue outweighed that loss of revenue. This has not changed in 2019.

In December 20185, the Department for Business, Energy and Industrial Strategy rejected proposals which would see a change in the hierarchy of creditors on insolvency, to the benefit of consumers, on the basis of the wider economic impact that would result from such a change. It seems unusual that the Government has taken this view where consumer protection is concerned but does not take a similar view in respect of the current proposal.

Floating charge holders

Whilst Financial Institutions will remain ranked above HMRC in the creditor hierarchy for fixed charges they hold over assets, this will not be the case for Financial Institutions with floating charges.

Floating charges allow a business to access finance by securing the charge using current assets and are often used as a more flexible and easier to access form of debt as they allow the business to continue as normal, trading with and even selling the assets. Floating charge lending, including asset-based lending and invoice discounting, will essentially become as risky as unsecured lending for the finance provider.

The reinstatement of Crown Preference will rank floating charges sixth (previously fifth) and will make floating charges more difficult to secure as they will be less attractive to Financial Institutions. By definition, this will make access to finance for small and medium sized businesses more difficult business and more risky for Financial Institutions. Where Financial Institutions are assuming more risk, they will naturally want to see that additional risk reflected in the rates they charge pushing up the cost of borrowing.

The proposal could also result in issues around the quantification and calculation of the amounts in respect of which HMRC has preferential creditor status, particularly in scenarios where the debt (and related interest and penalties) is not recent. This will mean increased costs and further uncertainty around the assets remaining for floating charge holders and unsecured creditors.

The current legislation established the rules which create third preference in respect of ‘prescribed part creditors’. Essentially this ring fences and creates a fund used by the insolvency officer holder to pay a dividend to non-preferential unsecured creditors. The reinstatement of Crown Preference for certain tax debt will also reduce the funds available to prescribed part creditors.

The ring-fenced amount currently stands at a maximum of £600,000. However there are proposals to increase this to £800,0006. This, coupled with HMRC’s return to preferential status for some tax debt, will mean floating charge holders will not only rank behind HMRC as preferred creditor but the balance of floating charge assets will be further reduced by the increase in the prescribed part.

Overall, reinstatement of Crown Preference will result in less funds being available to floating charge holders and unsecured creditors including the company pension scheme, consumers and suppliers.

The proposal is likely to be particularly harmful to B2B vendors. This particular concern is on the increase as a result of recent high-profile insolvencies such as Carillion, Dawnus and Debenhams with many suppliers and consumers left significantly out of pocket as a result of these business failures.

SME lending

We support the overall objective of protecting taxpayers’ money, but are mindful that the unintended consequence of this proposal is that many small and medium-sized enterprises will find it more difficult and more expensive to borrow.

Many lenders and insolvency practitioners have already submitted evidence to HMRC warning that the change will drive up small business loan costs.

As set out in the consultation document, bank lending to small and medium enterprises (SMEs) alone was £57 billion in the 12 months to July 2018. This demonstrates how vital lending to the SME sector is. SMEs form a hugely important part of the UK economy, accounting for 99.9 per cent of all private sector businesses and 60 per cent of all private sector employment7. The effective provision of finance to UK SMEs is crucial to the UK’s economic performance.

There is currently evidence8 that SMEs, due to the current period of uncertainty as a result of Brexit, are using external finance to put in place contingency plans or are reducing their finance requirements as they delay longer term investment and expansion decisions.

In addition, data from The Insolvency Service9, shows that small business insolvencies rose in the first quarter of 2019, with 4,187 firms becoming insolvent. An additional 484,00010 UK businesses are considered to be in significant financial distress. This is 16% of all UK businesses.

The estimated maximum yield to the Exchequer is a mere £185 million a year, compared to the £622.8 billion in taxes collected by HMRC in 2018/1911. Yet the consultation proposal will result in Financial Institutions and Finance Companies being less willing to lend, particularly to businesses already in financial distress which could be in a position to be turned around with fresh funding. The long term economic damage of the proposal therefore greatly outweighs the Exchequer gain.

According to the consultation document, the impact on lenders is not expected to be material and the loss to lenders is expected to be a very small fraction of total lending compared to the increased Exchequer receipts. However this is a narrow view which ignores why Crown Preference was abolished in the first place.

The UK’s business rescue culture is therefore more likely to end up costing the public purse more in lost income and higher expenses than it will save as a result of partial Crown Preference being re-established and from April 2020.

Miscellaneous

The consultation proposal will apply to insolvencies commencing from 6 April 2020. However the tax debt that will be subject to preferential status from that date is not merely that which arises after 6 April 2020 but all tax debt going back years and including interest and penalties. This could be as much as 21 years. This essentially means that the proposal will have retrospective impact which is simply unfair and provides HMRC with security where one is not legally established. The current proposal is therefore not just a return to Crown Preference for certain tax debt but is an extension of it.

The proposal, assuming there is a strong case for change, should therefore be amended to only cover tax debt in the year before insolvency as it was prior to the EA 2002. This should not include interest and penalties.

We note that the consultation proposal does not currently apply to Northern Ireland as insolvency law is a devolved function of the Northern Ireland Assembly. The comments herein equally apply to any future proposals to extend tax debt preferential status to Northern Ireland insolvency.

Conclusion

We look forward to engaging in further consultation in future on this matter. In the meantime, in the context of the foregoing, as a minimum we believe that the following three key recommendations merit serious consideration:-

1. The Government should first revert to stage 1 of the consultation process which should address the wider economic impact of the proposal;
2. Should the Government decide to proceed with the proposal, this should be scaled back to only include tax debt in the year prior to insolvency. Crown Preference should only be available up to an upper cap to be consulted on in future with stakeholders;
3. Given the economic uncertainty the UK is facing as a result of its planned departure from the EU, the consultation proposal, assuming there is a strong case for change, should be delayed until at least two years after the UK leaves the EU.

Freedom of Information

We note the scope of the Freedom of Information Act with regards to this submission. We have no difficulty with this response being published or disclosed in accordance with the access to information regimes. This response will be published on our own website in due course and will be available to all of our members and the general public.

We look forward to discussing this issue in more detail in the coming weeks and months. Finally, do not hesitate to contact Brian Keegan (brian.keegan@charteredaccountants.ie) or Leontia Doran (leontia.doran@charteredaccountants.ie) of this office should you require anything further.

Yours sincerely,

Alan Gourley, Chairman

Northern Ireland Tax Committee

Chartered Accountants Ireland

1 HM Revenue & Customs, HM Treasury Tax Consultation Framework, March 2011

2 HM Revenue & Customs, HM Treasury Tax Policy Making: a new approach, June 2010

3 Department of Trade and Industry, Insolvency – A Second Chance, July 2001

4 House of Commons Library, Research Paper 02/21 Enterprise Bill, April 2002

5 Department for Business, Energy and Industrial Strategy, Law Commission Report on Consumers Prepayments on Retail Insolvency, December 2018

6 Department for Business, Energy and Industrial Strategy, Insolvency and Corporate Governance: Government Response, August 2018

7 House of Commons Treasury Committee, SME Finance, October 2018

8 British Business Bank, Small Business Finance Markets 2018/19, February 2019

9 The Insolvency Service, Company Insolvency Statistics, Q1 January to March 2019, April 2019

10 https://www.begbies-traynorgroup.com/news/business-health-statistics/484000-businesses-in-significant-financial-distress-as-uk-economic-uncertainty-grows, April 2019

11 HMRC Tax and NIC Receipts, April 2019