FINANCE ACT 2020 – HMRC SECURES SECONDARY PREFERENTIAL STATUS…

20th August 2020

…BUT PROSPECT OF JOINT & SEVERAL LIABILITY FOR A RANGE OF STAKEHOLDERS IS AN UNWELCOME SURPRISE!

The Finance Bill 2020 received Royal Assent on 22 July 2020 and became the Finance Act 2020.  Within it, among other things, are two key pieces of legislation that are of particular interest.  Firstly, as has been previously reported, and something that we commented on back in October 2019 is the confirmation that HMRC will have secondary preferential status in insolvencies from December this year.  Secondly, and something which was not foreseen, was the introduction of provisions that can make a wide range of stakeholders – and not just directors – jointly and severally liable for the tax debts of an insolvent company.

HMRC preferential status

The Finance Act amends the Insolvency Act 1986 such that for insolvencies commencing on or after 1^st December 2020, HMRC will have secondary preferential creditor status for certain taxes due from an insolvent business.  These include VAT, PAYE (including student loan repayments), Employee NICs and CIS deductions.  HMRC will remain an unsecured creditor for direct taxes such as Corporation Tax and Employer NICs.  The intention is that more of the taxes paid in good faith by a company’s employees and customers will go to fund public services, rather than be distributed to other creditors.

This will place HMRC, in respect of the relevant taxes, in front of ordinary unsecured creditors (which is where such claims would normally sit) but still after primary preferential creditors such as some employee claims.  Crucially, in corporate insolvencies, this will place HMRC in front of floating charge holders and the prescribed part (the ring-fenced amount set aside for unsecured creditors).

As highlighted in our article last year, because HMRC will rank ahead of the holders of floating charges, a common form of security for all banks (including the growing number of alternative lenders), those funders will find themselves in a less-secure position in the event of an insolvency – this could have some serious implications:

• Funders may be less willing to lend if their risk of loss increases
• Funding costs may increase as compensation for increased risk

The consequences of this for British businesses could also be severe, especially at a time when SMEs are dealing with the massive disruption caused by Coronavirus:

• Business owners’ ability to access new finance may become restricted
• This could lead to good businesses being unable to grow, or be adequately financed
• It could lead to struggling businesses becoming unable to access much-needed additional funds, thus forcing them to fail and enter an insolvency process
• Existing lending may be reduced or could fall into default if covenants have to be recalculated to take account of a diluted security position which may also lead to currently healthy businesses entering insolvency

While there would be a greater return to HMRC from an insolvency process, the trade-off is that unsecured creditors and pension funds will receive less.  This could also have a number of implications:

• The reduction in returns from insolvencies could lead to increased numbers of business failures
• The risk of lower returns may mean that unsecured creditors are less likely to support rescue packages that, ordinarily, would be supported – again, leading to greater levels of business failure

There are some serious risks for lenders if the value of their available security is diluted and, whilst banks need to lend money in order to make money, it is perfectly understandable that it could become harder for business owners to access that capital.  If new funding is harder to come by, then that cannot be welcome news for the owners of UK businesses at a time when many are in a precarious position.

Provisions for joint and several tax liability

The Finance Act 2020 provides for a person to be jointly and severally liable for amounts payable to HMRC by companies and LLPs in certain circumstances involving insolvency or potential insolvency.  This includes directors and shadow directors, managers and shareholders.  Furthermore, based on the way the legislation is written, it also extends to lenders.

From 22^nd July 2020, HMRC can issue a joint liability notice to make an individual personally liable with the company for outstanding tax liabilities.  Such a notice can generally be issued in the following three scenarios:

• Tax avoidance and tax evasion cases
• Repeated insolvency and non-payment cases
• Cases involving penalty for facilitating avoidance or evasion

And where:

• The company is subject to an insolvency procedure, or there is a serious risk that it will be
• The person was responsible for the company’s conduct, enabled or facilitated it, or benefited from it
• There is likely to be a tax liability arising from the avoidance or evasion
• There is a serious possibility some or all of that liability will not be paid

The legislation also sets out certain conditions that all need to apply in repeated insolvency and non-payment cases for a notice to be issued. They are that:

• Two or more companies to which the person is connected have become insolvent in a period of five years immediately prior to the issue of the notice (and had an unpaid tax liability or failed to submit a relevant return)
• Another company (“new company”) carries on the business of the insolvent companies
• The individual has a relevant connection with the new company in the five year period
• One of the failures had HMRC liabilities over £10k and which was greater than 50% of the unsecured creditors (or where the Company has not submitted returns in order for the debt to be quantified)

For those engaged in the facilitation of tax avoidance or evasion, the conditions are that:

• A relevant penalty has been imposed on a company by HMRC, or Tribunal proceedings to impose one have begun
• The company is subject to an insolvency procedure, or there is a serious risk that it will be
• There is a serious possibility some or all of the penalty will not be paid

Because HMRC will decide whether the criteria for a joint liability notice have been met, there is a risk of inconsistency in approach – there is also only limited scope for an individual to appeal if they receive such a notice.

It has previously been reported that HMRC were only looking to target taxpayers who had tried to artificially reduce their tax bill via an insolvency process however, because the legislation is wide-ranging, there is a risk that it could also apply to people who were not directly involved with the running of the company and had no knowledge of any wrongdoing, particularly in the case of groups of companies.  It is therefore vital to consider this in any potential restructuring or company rescue.

In summary, this new legislation is likely to have serious consequences for companies and their directors, as well as directors in an individual capacity and so, should any of your clients have any issues resulting from this then don’t hesitate to speak to your local Leonard Curtis contact or via this link https://www.lcbsg.co.uk/locations/.