European Funds Comment: Giving Priority to Tax in UK Insolvency Law

27 September 2019

Previous UK governments have brought forward various policies to encourage and facilitate business rescue, to stimulate lending to growth businesses, and to protect unsecured creditors. Perhaps the most eye-catching – and, no doubt, one of the most expensive for government – was the abolition of “crown preference” in 2003, removing the government’s preferential status for unpaid taxes on an insolvency.  Now the government wants to re-introduce an amended version of this rule.  Many believe that the change will hinder access to finance and are calling for a re-think.

Crown preference used to provide that a certain level of unpaid taxes were given priority when a company went into insolvency, ranking ahead of all unsecured and some secured creditors.  That made it more likely that the UK government would be paid what it was owed, but had a predictable impact on the willingness of certain creditors to advance finance.  Indeed, an important justification for the removal of crown preference was to help keep viable businesses afloat:  previously, lenders further down the ranking would demand that insolvency proceedings were started earlier because they were concerned that otherwise they would not be paid.

Most people regarded the 2003 law change as a step forward and, since then, the government has ranked alongside unsecured creditors for any unpaid tax.  The government now benefits – alongside those other unsecured creditors – from something known as the “prescribed part”, which ring-fences a certain part of the assets of the company and gives them priority over some secured creditors.  The maximum amount of ring-fenced assets is set out in the law (and a separate government proposal would increase it), so lenders are able to assess the impact it could have on the recovery they could make.

The UK government says that it has lost a significant amount of revenue from this change in the law and wants to partially reverse it.  To be fair, there is some logic to the government’s position.  It says that some taxes – for example, VAT and employment taxes due from the employee – are effectively collected from third parties on behalf of the government and should be treated more like assets that belong to the government (rather than a debt due to the government).  They say that employees and customers pay that money expecting that it will go to fund public services.  So, for these types of tax, the government is proposing that they should sit ahead of creditors with a “floating charge” – one that attaches to the assets that are not specifically charged – and reckons that it could recover up to £185 million a year. 

In July, the government confirmed that it would press ahead with the proposals, with a few modifications, following a consultation earlier in the year – despite considerable opposition from many respondents.  The plan is to introduce the new rules from April 2020.  The government concedes that “floating charge” holders will lose out, but argues that the loss of up to £185 million a year – a prediction from the independent Office of Budget Responsibility’s “maximum impact” assessment – is a minor issue for a small and medium-sized business loan market that is currently worth £58 billion.

Nevertheless, 11 organisations and insolvency experts – including the UK’s private equity association, the BVCA – recently wrote to the UK government to protest again about the changes, supported by further representations from the City of London Law Society, arguing that they will have a significant impact on access to finance.  They argue that lenders will be more cautious since their security becomes less attractive in the event of default, and many unsecured creditors will also lose out.  Moreover, they say companies would once again be forced into insolvency at an earlier stage, which could see the UK lose potentially viable businesses, especially since the proposed change is (in effect) retrospective.  These organisations have suggested that, if the government does implement this proposal, it should at least limit the age of tax debts that can be reclaimed. 

But, although many experts are concerned that this change could have a negative impact on lending activity – and could, for example, encourage lenders to work harder to take fixed charges, so they continue to rank ahead of the tax authorities – the government seems determined to press ahead, unless (it says) it is presented with further evidence that significant harm will result. 

Given the general uncertainty facing small and medium-sized businesses in the UK at the moment, the reform certainly seems to be ill-timed, even if the underlying principle may seem sound.