Paying HMRC before insolvency – directors' risks and what you need to consider

When cash is tight, and HMRC arrears start to build, directors often prioritise bringing tax arrears up to date before anything else. That instinct is understandable given HMRC’s enforcement powers, and in many cases sustained pressure from HMRC is one of the clearest signs that a business is under strain.

Since 1 December 2020, HMRC has ranked as a secondary preferential creditor for certain taxes collected and held by businesses, including VAT, PAYE income tax and employee National Insurance Contributions (NICs). That affects how funds are distributed in a formal insolvency, but it does not mean directors and justify paying HMRC ahead of other creditors before an insolvency process begins.

This is where the position is often misunderstood. In some situations, prioritising HMRC at that stage (before the formal insolvency process has begun) can actually increase rather than reduce director risk.

HMRC preferential status what is means before insolvency

• HMRC’s preferential status affects how money is distributed after an insolvency process starts, but it does not give directors permission to favour HMRC beforehand. Directors are required to consider the interests of creditors as a whole.

Courts and insolvency practitioners will closely examine what decisions were made before insolvency – the rationale behind payments, the company’s financial position and the extent to which decisions were properly thought through and recorded.

Why paying HMRC before insolvency can be challenged

During financial distress, directors often believe that paying HMRC demonstrates responsible behaviour. In reality, risks arise where the business was already insolvent, or where insolvency was unavoidable. In those circumstances, payments made to relieve pressure, delay insolvency, or buy time can come under scrutiny.

• Those payments do not sit in isolation and may be questioned alongside the broader picture, including decisions to continue trading, whether some creditors were treated more favourably than others and whether the directors properly considered the interests of the wider creditor body.

There is no automatic exemption from scrutiny just because HMRC was paid.

Common misconceptions around paying HMRC

In practice, directors often make payment decisions on the basis of incorrect assumptions that feel reasonable at the time, such as:

· “HMRC are preferential, so paying them must be right.” - Preferential status does not remove scrutiny of pre‑insolvency conduct.
· “They were threatening action, so I had no choice.” - Creditor pressure alone does not always justify selective payment.
· “If HMRC gets paid in the end, no one is worse off.” - Other creditors may be materially worse off because funds were diverted earlier.
· “This shows I acted responsibly.” Courts focus on outcomes and timing, not intentions.

Directors duties when insolvency is likely

The legal position is more nuanced than simply asking whether HMRC was paid. In BTI 2014 LLC v Sequana SA [2022], the Supreme Court confirmed that where a company is insolvent, or insolvency is probable, directors must consider the interests of creditors as a whole. Where insolvency is inevitable, creditor interests become paramount.

• Once insolvency is probable, directors should focus on the interests of creditors as a general body, not on the demands of any single creditor – and payments to HMRC are not treated differently in this respect. Selective payments may be scrutinised alongside potential preference issues under the Insolvency Act and wider wrongful trading or misfeasance allegations if losses to creditors increase

That is why these cases are often judged in hindsight after an insolvency appointment, by reference to the company’s financial position, the information available at the time, and the quality of the directors’ decision-making records.

Directors should also be aware HMRC can, in limited circumstances, issue a Personal Liability Notice in respect of certain unpaid tax liabilities. These are not routine and do not arise merely because tax remains unpaid. Broadly speaking, personal liability only arises where there has been fraud, neglect or deliberate wrongdoing. Directors who act honestly, reasonably and in accordance with their duties, will not usually be personally liable for the company’s HMRC debts.

What directors should consider before paying HMRC

In practice, the most effective protection for directors is early, informed decision-making. That usually means getting independent advice before arrears escalate or selective payments become a pattern.

• Before paying HMRC ahead of others, directors should usually ensure that they have up-to-date management information, including short-term cashflow and creditor position. It also means having documented rationale for why any payments are in the interests of creditors as a whole. Where financial pressure is increasing and funding, forbearance or a Time to Pay arrangement is no longer stabilising the business, professional advice becomes particularly important.
• Taking those steps helps directors to show that payment decisions were informed, deliberate and properly recorded and that they have considered rescue, restructuring or orderly wind-down options before value is lost/

Seeking advice early is not an admission of failure. It is often one of the clearest indicators that directors recognised risk early and responded responsibly.

Balancing HMRC payments with wider creditor interests

HMRC’s preferential status has changed the distribution landscape in insolvency, but it has not changed the need for directors to exercise careful judgment beforehand. Paying HMRC may be the right step in some situations, but it should not automatically be treated as the default. Where insolvency is a real possibility, the question is not simply whether HMRC should be paid, but whether the decision can be justified by reference to the interests of creditors as a whole.