The UK Government announced 11^th July 2019, through the publication of the Draft Finance Bill, that it is going ahead with the reinstatement of Crown Preference in respect of VAT and PAYE.

This development is particularly disappointing following various representations on behalf of the lending and turnaround management community.

After a meeting in June with both HMRC and HM Treasury with representatives of both UK Finance and the European Chapter of the Secured Finance Network, it appeared that HMRC was at least considering and asking for suggestions pertaining to potential mitigation to the unintended consequences of the proposed legislation.

Various options were proposed during discussions and detailed proposals were submitted along with further information describing the potential negative impact on UK lenders and UK business.

These mitigation recommendations included:

• Capping - Introducing a cap on the total size of the potential HMRC claim – along the lines of the prescribed part. This is obviously the most favourable position as lenders could then be sure of the potential Crown Liability.
• Time-limiting - Introducing a time-limit on the debts to which the new preference would attach.This would reflect the situation prior to the abolition of crown preference. Attendees recommended that three months from the date at which the liability became payable.
• Grandfathering – using the date of the new legislation as the date under which the New Crown Preference would apply. This would be based on the registration date of the floating charge so that only security interests registered after the 6^th April would be subject to Crown Preference.
• Priority - attendees also recommended HMRC reconsider the proposed priority structure whereby the Crown would rank after the floating charge holder, but in preference to other creditors.
• Delay proposed implementation of the measure to enable businesses to digest and deal with the wider economic uncertainty caused by exit from the EU.

Reservation of Title - Whilst recognising that this was likely outside the scope of the implementing legislation (the Finance Act), it was brought to the meeting attendees’ attention that a significant borrowing capacity is undermined by the Existence of Retention of Title

The undoing of the provision of the Enterprise Act, which abolished the original Crown preference position, means that lenders against inventory will need to increase reserves in respect of anticipated unpaid PAYE and VAT to protect themselves in borrower insolvency situations.

Lenders will likely reintroduce the practices established prior to the 2003 Enterprise Act.

Back then it was standard practice to make reserves for three months PAYE NIC Contributions + any arrears and calculated 2 quarters VAT amounts + any arrears.

Both these values can fluctuate (particularly VAT), and because lenders may not be in control of the timing of an insolvency event, there will be a tendency towards over collateralisation.

Also, where lenders have not established a fixed charge security or a true sale over receivables (because of not controlling the proceeds of sale/cash dominion) and are therefore relying on a floating charge security interest, they need to be cognisant of this new legislation.

The legislation, which is expected to become Law in April 2020, will be retrospective. This means that historic Crown Liabilities will be subject to Crown Preference.

This may have severe effects on UK businesses that rely upon inventory finance to finance working capital needs.

This would appear particularly to be counter intuitive from a supposedly “business friendly” UK Government, particularly in light of the impact that Brexit is having, whereby inventory levels have been increasing significantly as business tries to adjust in anticipation of a slowdown in the procurement process.

If this alone was not bad news, it is also intended to increase the Prescribed Part from £600,000.00 to £800,000.00.

The UK Government has stated that the rationale behind the Legislation is to recover an additional £185 million from the estate of insolvent borrowers, when, in fact, the Legislation will more likely increase the number of insolvencies and furthermore increase the total value of unpaid taxes.

The Secured Finance Network will continue to work closely with other parties and specifically UK Finance to attempt to convince the UK Government to move away from this course of action.

Matthew Davies, director of Invoice Finance and Asset Based Lending, UK Finance, said, “We have expressed the concerns of UK Finance’s members about this move and its likely impact on lending to UK businesses of all sizes, and particularly SMEs.  This step degrades the security available to banks and other finance providers and that it is being taken when the economic outlook is already so uncertain is particularly concerning.

“UK Finance and its members support the overall objective of protecting tax revenues, but the estimated tax yield from this measure is likely to be insignificant compared to the impact on lending and economic growth.  It is disappointing that despite the evidence put forward to government regarding the negative impact there have been few changes to the legislation. 

“UK Finance’s members will be monitoring the effects of this measure and will be working hard to mitigate the impact of this retrograde step on the businesses that they support.”