The seven lines issued in the recent Budget received little attention but they have the potential to cause an economic armageddon.

“3.87 Protecting your taxes in insolvency – From 6 April 2020, when a business enters

insolvency, more of the taxes paid in good faith by its employees and customers, and temporarily

held in trust by the business, will go to fund public services rather than being distributed to

other creditors. This reform will only apply to taxes collected and held by businesses on behalf

of other taxpayers (VAT, PAYE Income Tax, employee NICs, and Construction Industry Scheme

deductions). The rules will remain unchanged for taxes owed by businesses themselves, such as

Corporation Tax and employer NICs.”

Why?

Adding to the preferential creditor status massively undermines the security which banks rely on when they provide loans and overdraft facilities. When banks provide loans and overdraft facilities they often take security in the form of a floating charge.

The example below shows the distributions to the respective creditor groups now and after April 2020 when the proposed changes come into force.

Statement of affairs of XYZ Limited

                                                     £’000

Assets                                           1,000

Liabilities

Bank overdraft

(secured by floating charge)         (1,000)

Preferential creditors –

employees                                       (90)

HMRC                                             (200)

Trade creditors                               (800)

Position in a formal insolvency now                  

£’000

Assets                                               1,000

Preferential creditors –

employees                                             (90)

Balance available for

creditors                                              910

Balance available for

unsecured creditors via

prescribed part                                         (185)

Balance available for

bank under floating

charge                                                    (725)   

Position in a formal insolvency post April 2020             

£’000

Assets                                          1,000

Preferential creditors

– employees                                     (90)

Preferential creditors –

HMRC                                             (200)

Balance available for

creditors                                       710

Balance available for

unsecured creditors via

prescribed part                             (145)

Balance available for

bank under floating

charge                                          (565)

The bank receives £160,000 less in the insolvency post April 2020!!!

So what?

One of the things that banks rely on is their security i.e. the bank wants to know how much it will be repaid in the event that their customer gets into financial difficulties. In seven fairly bland Budget lines the Chancellor has massively weakened the bank’s position and therefore potentially caused the next economic downturn!

You may see some banks in the coming months looking to reduce their exposure to your clients i.e. by reducing overdraft / loan facilities which may put your clients’ currently healthy businesses under significant distress. Banks may also be more reluctant to facilitate new lends as the value of their security is now worth significantly less.

Will these seven lines in the Budget cause the next economic slowdown? We do not have a crystal ball but if banks do start trying to reduce their exposure to your clients then this is main reason why.