Protecting Tax in Insolvency Introduction The current priority of debts in an English insolvency are determined by reference to the Insolvency Act 1986, which provides for preferential status in respect of certain debts including, for example, employee remuneration and occupational pension schemes. This status ensures that these preferred debts are paid after creditors holding fixed security/proprietary interests and expenses of the insolvent estate but in priority to all other creditors including floating charge holders. Preferential debts are divided into “ordinary” preferential debts and “secondary” preferential debts, with the former (including employee and pension debts) having higher priority than the latter. Summary of Changes On 11 July 2019, HM Revenue & Customs (“HMRC“) released draft legislation amending the Insolvency Act 1986 to provide for secondary preferential creditor status to HMRC in respect of certain taxes as from 6 April 2020. Equivalent changes are also proposed to the Scottish insolvency rules. The key principle behind the changes being that taxes paid by a person to the debtor (where such amount is held on behalf of HMRC) should remain payable to HMRC, rather than to creditors. In light of the overarching principle, the increased preferential creditor status is limited to VAT, and “relevant deductions”. A relevant deduction is, broadly, one which the relevant debtor was required to make (i) from a payment to another person and account to HMRC, (ii) the payment is creditable against the other person’s tax liability and (iii) the deduction is of a kind specified in regulations. Whilst the regulations have not yet been released, it is anticipated that the scope of taxes (in addition to VAT) will be extended to PAYE, employee NICs, student loan deductions and Construction Industry Scheme deductions. The new regime is not expected to be extended to corporation tax or employer NICs, in respect of which HMRC will remain unsecured creditors, unless the tax liability is claimed as an expense of the insolvent estate. It is expected that interest and penalties arising on any taxes due will remain as unsecured liabilities of the business (including any interest and penalties on those taxes in respect of which HMRC will have preferential status). Industry Responses Earlier this year, the Government entered into consultation on the scope of these rules. The responses were generally mixed. Whilst many practitioners could understand the rationale behind the change, there was concern that HMRC often fails to use the full extent of its existing debt-collection powers, and this new approach could increase the risk of HMRC becoming a major petitioning creditor in some cases. There were also concerns around the additional risks floating charge holders would bear as a result of this change. Although the scope of taxes is relatively narrow, VAT and employment taxes typically represent a larger share of outstanding tax liabilities in an insolvency than corporation tax and employer NICs.
By Akin Gump LLP