The majority of people in the UK want to pay the right tax at the right time because they believe that it is the right thing to do and appreciate that tax revenue funds public services for everyone, writes Michael Kashis, Managing Partner and Head of our Corporate & Commercial team.
HMRC provides a flexible range of support for those who would like to pay on time but find it hard to do so. It’s essential that any business that is struggling to pay what they owe contacts HMRC, with support available through the Business Payment Support Service.
Where a company or individual becomes insolvent, the taxes paid by employees and customers, which the insolvent business was temporarily holding, do not always go to funding public services as intended. In such cases, they often go towards paying off debts owed to other creditors.
The Treasury recently published this briefing explaining how taxes paid by employees and customers will be protected in an insolvency procedure commencing after 1 December 2020.
1. Why do insolvent businesses hold on to tax that has been paid by employees or customers?
In a normal trading business, certain taxes due from employees and customers are withheld by the business and then paid over in one lump sum periodically to HMRC by the business, acting as an intermediary.
For example, Income Tax and National Insurance contributions (NICs) owed by individual employees are paid in this way. An employee first pays the taxes to their employer, through deduction from wages or salaries, and later the employer passes all of their employees’ deductions to HMRC. This system works well to reduce administrative burdens on individual employees.
However, where an employer becomes insolvent, it may be holding funds due to HMRC at the time of its insolvency. Without special protection these funds would be used to pay other creditors, rather than HMRC as intended.
2. What’s happening now?
The government announced after the Budget 2018 that it would be seeking to protect these types of taxes temporarily held by insolvent businesses. Legislation was enacted in the Finance Bill 2020 to give preference to certain debts due to HMRC in the event of insolvency.
3. How will it work?
The provisions apply to debts in insolvency procedures commencing after 1 December 2020. In all formal insolvencies a licensed insolvency practitioner must be appointed. Insolvency practitioners have statutory obligations to realise the assets of the insolvent business and pay those realisations to creditors in an order set out in legislation.
Broadly, asset realisations are paid out to the following classes of creditor in this order:
- secured creditors with a fixed charge (after costs of realisation)
- insolvency practitioners’ fees and expenses
- preferential creditors
- secondary preferential creditors
- prescribed part creditors
- secured creditors with a floating charge
- non-preferential creditors
- shareholders (for insolvent companies) or individual (for personal insolvency cases)
For insolvency procedures starting after 1 December 2020, certain sums due to HMRC but held by businesses when they enter formal insolvency rank as secondary preferential debts in the order of priority.
This means they are paid ahead of secured creditors holding a floating charge (for example banks) and ahead of non-preferential creditors (for example suppliers).
4. What debts to HMRC are included?
Only certain specified HMRC debts are included. These are:
- Value Added Tax (VAT)
- debts that relate to the following taxes:
- Pay As You Earn (PAYE) Income Tax
- employee National Insurance contributions (NICs)
- students loan repayments
- Construction Industry Scheme deductions
Where the business is required to deduct these taxes from payments they make to another other person and pay those deductions to HMRC and the payment to HMRC is credited against the liabilities of the other person.
Coronavirus Job Retention Scheme
PAYE/NIC (employee contribution) deductions that were withheld by a business from funds claimed from the Coronavirus Job Retention Scheme fall within the preferential claim.
These debts are only preferential if the insolvent business entered a formal insolvency procedure on or after 1 December 2020. For businesses that did enter insolvency on or after that date, the full amount of the specified debts which arose prior to the date of insolvency is payable as a secondary preferential debt.
5. What debts to HMRC are not included?
Only the debts specified above are included. This is not an exhaustive list, they are just examples. That means many of the amounts due to HMRC are not included within our preferential claim, such as:
- amounts which are not held on behalf of other taxpayers, for example, Climate Change Levy, Corporation Tax, employer NICs etc
- any penalties and interest, for example those which have arisen as a result of late payment, late returns or incorrect returns
- loan charge in form of notional payments under PAYE regulations
- excess payments under the Coronavirus Job Retention Scheme that are paid to businesses in error. Overpayments relating to Coronavirus Job Retention Scheme are therefore non-preferential debts
6. How will HMRC implement this change?
The biggest change will be in how insolvency practitioners appointed in formal insolvencies deal with the funds they realise. They will need to ensure the debts listed above are paid to HMRC in advance of other creditors, in accordance with the statutory order. Insolvency practitioners already pay preferential debts as part of their existing processes, where realisations are sufficient to do so.
Our role will be to ensure claims for outstanding debts due to HMRC that we send to insolvency practitioners clearly reflect which elements are preferential and which are non-preferential. Many sums owed to HMRC will be unchanged in their status, and so will remain payable lower down the priority order.
HMRC will continue to engage with insolvency practitioners to ensure that claims processing is efficient. Where an insolvency practitioner has not received a claim and considers an urgent claim is needed so that HMRC can receive an imminent dividend, they should contact HMRC as below including ‘Urgent – HMRC claim required’ in the title. If you have any query on the implementation of this measure, please contact our insolvency helpdesk.
7. Will HMRC’s approach on voting change as a result of being a preferential creditor?
Where HMRC is a creditor we can vote on matters in insolvency proceedings, in the same way as all other creditors. We will continue our current approach of voting where we have a stake in the outcome of the vote and consider that our vote is necessary to achieve that outcome.
As HMRC’s public statement on voluntary arrangements makes clear, HMRC will reject a voluntary arrangement which proposes to exclude or modify the preferential treatment of any creditor, including HMRC.
What does this mean for 2021?
Commercial lawyers and Insolvency practitioners will help clients by continuing to file any outstanding tax returns as promptly as possible after the insolvency commences. This will ensure HMRC’s claims in the insolvency are accurate and timely. HMRC aims to respond to correspondence in line with service standards.
Employees of insolvent businesses can sometimes not be paid by their employer. Certain unpaid sums due to employees rank as preferential creditors in the order of priority. HMRC’s secondary preferential claims are paid after these preferential amounts are paid to employees, thus protecting the entitlements of unpaid employees of insolvent businesses.
There is further protection for employees because in certain circumstances the Redundancy Payments Service will pay employees sums they are owed by their employer.
The above is accurate as at 14 December 2020. The information above may be subject to change during these ever-changing times.
The content of this note should not be considered legal advice and each matter should be considered on a case by case basis.