It is going to be much more difficult to restructure businesses with HMRC a preferential creditor from 1 December 2020.

HMRC are set to become preferential creditors from 1 December 2020. HMRC will become secondary preferential creditors after employees. The taxes included are VAT, PAYE and National Insurance and Construction Industry scheme deductions. This is likely to have a negative impact on businesses that need to restructure. It will make it more difficult to do a deal with creditors. Here’s why.

1. All relevant HMRC debt is preferential

When HMRC was last a preferential creditor, the amounts that they could claim as preferential were capped at 6-12 months of liability. Under the new rules, there is no such cap. HMRC is often a significant creditor. Moving their debt into the preferential category means that in order to successfully restructure the debts of a business HMRC arrears will need to be paid in full before unsecured creditors can see a dividend. This could be a very sizable barrier to a restructuring. It is not clear if HMRC will accept less in order to help restructure the business.

2. HMRC debt is much higher because of COVID

Remember the VAT that was deferred from March to June 2020 until March 2021? Well, that will become a preferential creditor from 1 December 2020. This combined with the likely level of HMRC arrears building up is going to mean that HMRC is a bigger creditor.

3. CVAs may be impossible to agree

A CVA may be more difficult for creditors because HMRC’s debt will need to be dealt with before ordinary creditors get paid. Previously, assuming no bank debt and the business continuing to trade there would typically only be one class of creditors – the non-preferential unsecured creditors ( trade suppliers and HMRC).

From 1 December 2020 with HMRC becoming a preferential creditor again, there will now be at least two classes of creditors. HMRC as a secondary preferential creditor and the non-preferential unsecured creditors (trade suppliers etc). HMRC will expect to be paid in full before unsecured creditors see any dividend. With HMRC often making up 25- 50% of the total creditors this is going to be tricky. For example, say a business was able to generate £100,000 over a 5 year CVA to pay creditors 40p in the £ on £250,000 of debt of which HMRC was half (£125,000) under the old rules. Under the new rules, HMRC’s debt of £125,000 would need to be paid first. This will leave nothing for non-preferential creditors.

If HMRC’s debt was £50,000, then this would be paid first, leaving £50,000 to be divided between the rest of the creditors £200,000 giving a dividend of just 25p instead of 40p