In this article, we look at how HMRC obtaining preferential status for certain debts, which is coming into force in December 2020, may potentially mean that defined benefit pension schemes miss out.
As trustees of a defined pension scheme will know, the deficit on the scheme (i.e. the difference between the sum required to purchase an insurance policy to fund all of the members’ benefits in full and the value of the scheme assets) will often mean that the defined benefit pension scheme is one of the largest creditors of a company.
Whilst trustees have used the ongoing valuations to help secure comfort that this deficit is met either through contingent assets, the acceptance of security, or in some instances, parental guarantees, there are still a number of schemes that do not have such comfort. These schemes will therefore have an unsecured claim in the event of insolvency and this claim is often one of the biggest.
When a company enters into an insolvency process, the Pension Protection Fund (PPF) will look to step in and ensure that the members of schemes with an insolvent employer are protected and will fund a proportion of their pension.
The ability of the PPF to fund the benefits of those scheme members whose defined benefit sponsoring employer is insolvent, is partly based on the levy income and partly on any distribution it receives from claims made in insolvent entities. The levy income is received from schemes which may be eligible for entry into the PPF should the employer become insolvent, and the amount paid is linked to the risk of their employer becoming insolvent.
Usually unsecured creditors will receive a distribution out of the Prescribed Part pot, which is based on the company’s net floating charge realisations and is after the payment of preferential creditors. Under current insolvency legislation, preferential creditors are arrears of wages up to £800, holiday pay, and in some instances, unpaid pension contributions.
However, the legislation is changing on 1 December 2020 and will see certain HMRC liabilities be classified as a preferential debt. HMRC will be granted preferential status in respect of VAT and also other deductions which are made by a company on their behalf – employees’ National Insurance and PAYE. Amounts due in respect of these liabilities will only be paid out once all other preferential debts are paid in full, but given that the sums due in respect of PAYE can often be considerable, it will erode the extent to which there will be funds available from which to create the Prescribed Part.
This change in status will ultimately mean that the potential for any return to the pension scheme is significantly reduced, which in itself is worrying, but it is also likely to have the knock on impact that the reliance upon the PPF levy income will increase and schemes will end up paying a higher levy to reflect this risk.
If you are a pension trustee who is concerned about whether you should be considering taking action, please get in touch with our team who will be able to assist you.