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COVID-19 and the Crown Preference conundrum

Alasdair Freeman, partner at Burness Paull
Alasdair Freeman, partner at Burness Paull

The UK government has in the past month or so adopted a number of extraordinary measures designed to support UK businesses throughout the COVID-19 storm.

One of those which attracted headlines was the deferral of VAT payments otherwise due by businesses between March and June of this year. Those payments can now be deferred until the end of the 2020/21 tax year and will have undoubtedly helped businesses to help manage their cash flow by giving them an interest-free loan facility.

Another recent measure which perhaps did not attract as much publicity (and to be fair there have been plenty of them) was confirmed in the March budget before the full impact of COVID became apparent.

It was announced that HMRC will once again rank in insolvencies as a preferred creditor for VAT – meaning the tax man will rank ahead of secured creditors and unsecured creditors in businesses which fall into a formal insolvency process.

This ‘Crown Preference’ concept used to exist but was removed back in 2003, and meant that HMRC had to claim for unpaid taxes as an unsecured creditor behind any secured creditors and preferential creditors.

However, there was a concern that HMRC (and therefore the public purse) were losing out and, despite widespread concern from restructuring professionals about the impact this might have, the recent budget confirmed the Crown Preference will be reinstated later this year.

Separately an increase to the ‘prescribed part’ in an insolvency process came into force on 6 April – this is money which has to be set aside from the moneys which would otherwise get paid to the holder of a floating charge (usually the bank/finance company) and which is distributed among unsecured creditors. The maximum limit for the prescribed part has increased from £600,000 to £800,000.

What has not been considered is the impact the Crown Preference and the increased prescribed part may have on the wider lending market and access to finance.

Many UK businesses will make use of the option to defer VAT payments until next year, and if businesses then go into insolvency the Crown Preference will by then entitle HMRC to rank ahead of other creditors such as banks and finance lenders who are generally the secured creditors.

This is going to be a problem for the lending community. The protection they thought they had under a security is going to subject to the newly reinstated Crown Preference and to the increase in the prescribed part.

On top of that, the VAT deferrals made under the COVID-19 crisis measures will give rise to an increase on sums due to HMRC and subject to the Crown Preference.

All of this is likely to result in reduced levels of recovery by banks and in turn an increased risk in lending.

Have the banks or the government thought properly about the implications? If lenders see increased risks in lending then this is likely to be reflected in the costs of doing so, and perhaps the need for additional security from customers.

Clearly it would not make sense to introduce measures designed to help businesses survive the coronavirus crisis, and then to introduce another policy which will make it harder for businesses to access finance in the future.

The Crown Preference is to come into effect on 1 December 2020 – let’s hope between now and then there’s some serious reflection on the potential consequences.

Alasdair Freeman, Partner, Burness Paull

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