There has been talk for some time about changes to how HM Revenue & Customs’ (HMRC) debt status will impact upon companies and directors. The change to HMRC’s status in insolvency procedures has been threatened for a while, as has joint and several liability for directors where there is evidence of tax avoidance and/or tax evasion, so it was no surprise that the Finance Act 2020 has both of these measures included within it. However, what has come as a surprise is the extension of the joint and several liability for directors who have been involved in a number of insolvencies. We take a look at all of these changes here.
HMRC used to have an elevated status in insolvency procedures but the introduction of the Enterprise Act 2002 in September 2003 moved them down the pecking order so that they would rank alongside other unsecured creditors, such as trade creditors. The quid pro quo was the introduction of the ‘Prescribed Part’, meaning that there was a pot of money ring-fenced for this class of creditor, prior to any monies being distributed to the secured lender with floating charge security. At the time, it was a fairly radical step, but it was thought that the introduction of the Prescribed Part would assist with the rescue culture.
In a step that has disappointed many in the insolvency and restructuring profession, from 1 December 2020, HMRC will become a preferential creditor in respect of VAT arrears, PAYE arrears and employees’ National Insurance contributions (employer’s National Insurance contributions and Corporation Tax will remain as unsecured liabilities). This means that HMRC will rank ahead of trade creditors - although they do sit behind employees’ preferential claims (arrears of wages up to £800 and holiday pay). This means that HMRC will effectively have to be paid in full for the preferential elements before trade creditors can expect to see a dividend.
As anticipated, where directors have engaged in tax avoidance or tax evasion, HMRC now have the ability to serve them with a Joint Liability Notice where there is a risk that the tax will not be paid. In particular, this applies where the company (which includes limited liability partnerships) is either already subject to an insolvency procedure or there is a serious possibility that the company will become subject to an insolvency procedure. This in itself should not be a surprise – HMRC have been targeting individuals who have been involved in various schemes for quite a while and this change to legislation serves to assist them in recovering those funds.
What has come as a surprise is the introduction of joint and several liability for individuals who have been directors of a number of companies that have been subject to insolvency procedures. In short, where an individual has been involved in two or more companies in a five year period, prior to the issuing of the Joint Liability Notice, which have been subject to insolvency procedures and is currently involved in a new company which carries on in the same trade or activity similar to the other companies, then they are liable for the tax incurred by the new company as at the date of the Notice and for five years from the date that the Notice is given.
In addition, the limit on the amount of tax outstanding only has to be £10,000 for this to apply although it does have to represent at least 50% of the unsecured creditor pool before the Notice can be issued.
Whilst you may be inclined to think that it will be okay with regards to the previous failures as the companies have since been dissolved, unfortunately the Notice also provides HMRC with an ability to recover any tax liabilities from the previous companies, regardless of whether they are still in existence or not. If the companies have subsequently been dissolved, then the individual will become solely liable for the outstanding sums due as at the date the companies ceased to exist.
The legislation is far-reaching as to whom HMRC are able to target; not only does it target company directors, but it also targets shadow directors and participators (anyone who possesses or is entitled to acquire share capital or voting rights, for example). This means that if a director of a business has placed it into an insolvency process and a new company has started to trade as a consequence, even if that director is not listed as a director at Companies House, if they are still involved in the business as a shadow director or as someone who has shares, then HMRC will be able to target that individual if the other aspects apply (see above). Interestingly, the legislation also covers individuals who have a relevant connection with the business either as director/participator/shadow director or even an individual who is “concerned, whether directly or indirectly, or takes part, in the management of the company.”
The Finance Act 2020 could be described as “having teeth”. It gained Royal Assent on 22 July 2020 and therefore the above changes are now in play. It should be noted that multiple failures, especially where Crown arrears are concerned, have always been a key issue for Government departments; indeed there is a focus on Crown arrears when an insolvency practitioner has to conduct their investigations into the director’s conduct where a company has failed. However, this legislation provides HMRC with a direct route to recover lost taxes and it will be interesting to see how successful it is.
With regards to the preferential status, we expect that this will impact on working capital facilities as lenders look to manage their potential exposure and any business considering its options will need to be aware of this as they review their short to medium cash flow positions. As always, seeking advice sooner rather than later will be vital.