What do the Insolvency Act 1986 Regulations 2020 mean for law firms?
Mike Stevenson, managing director at Iceberg, says it’ll be difficult for a business’s bank to calculate the amount that may now take priority to their floating charge realisations.
On 1 December, the Insolvency Act 1986 (HMRC Debts: Priority on Insolvency) Regulations 2020 came into effect. This partially restores the Crown’s status as a preferential creditor in the order of distribution in insolvency proceedings.
Prior to 1 December 2020, HMRC had been subordinate to all secured creditors in the event of insolvency. With immediate effect, VAT, PAYE income tax, employee national insurance contributions and student loan deductions (collectively known as preferred priority taxes) are now ‘preferred creditors’.
The current proposal moves HMRC to take priority alongside preferential unsecured creditors, ranking only behind fixed charge security and liquidation/administration expenses and ahead of the floating charge holders, unsecured creditors and shareholders.
What does this change mean for law firms and their banks?
Because there’s no backstop to claims, it’ll be difficult for a business’s bank to calculate the amount that may now take priority to their floating charge realisations.
Many lenders will be taking practical steps to adjust to the new legislation, which may include a review of lending structures to take into account any money owed to HMRC that would take precedence over their charges in the event of insolvency.
As a consequence of this, the value a clearing bank places on its floating charge security could change. For example, the amount it will advance against WIP might potentially be reduced by the amount the firm has outstanding to HMRC in respect of preferred priority taxes.
Some lenders may now also ask for proof that preferred priority taxes are paid up to date. If they’re not, it’s possible that a corresponding reduction in the bank’s facilities may be required.
What solutions are available to law firms facing tax and VAT payments?
With the January deadline for payment of partners’ tax fast approaching, it’s important for law firms to consider the impact of this change in legislation on their business.
This is particularly crucial as the change coincides with many law firms having deferred payments of VAT between March and June 2020 and income tax in July 2020, resulting in record amounts owed to HMRC. Due to the change in legislation, these will need to be paid in full in order to avoid any floating charge security held by a business’ bank being negatively impacted.
However, paying tax payments upfront might not be the right option for many legal practices facing high bills of accrued deferred payments, particularly during these uncertain economic times. Many firms will be focused on prioritising long-term cash security and will want to maintain high levels of liquidity.
A solution available to law firms is to explore a range of financing options available to pay their taxes.
Taking out an unsecured tax loan will not adversely impact on any floating charge security held by a firm in the way that owing money to HMRC as a preferred creditor would.
Entering this type of arrangement means that a law firm can spread payment over 12 months of tax due in January, including any income tax deferred from July, together with and deferred VAT from earlier this year without the risk of a reduction in your overdraft facility.
As a first step, we would advise firms to contact their bank and clarify what the change is legislation means for their account and whether any changes in terms have been applied. Based on this information, firms can then make decisions on how to manage tax payments due early next year.
