HMRC Crown Preference: A UK director and creditor's guide

HMRC Crown preference — the historic position whereby unpaid taxes ranked ahead of other creditors in insolvency — was abolished by the Enterprise Act 2002. From 2003 to 30 November 2020, HMRC ranked alongside ordinary unsecured creditors for all unpaid taxes, sharing pari passu in any unsecured creditor distribution. The Finance Act 2020 partially reversed that position, creating a new "secondary preferential creditor" category that applies from 1 December 2020 onwards.

This is not a return to the pre-2003 full Crown preference. The new regime is materially narrower in several respects:

• ›It applies only to specified trust taxes (VAT, PAYE income tax, employee NICs, CIS deductions, student loan deductions) — not to corporation tax, employer NICs, or other HMRC own-account taxes.
• ›It is a secondary rather than ordinary preferential category — employees still rank ahead of HMRC for ordinary preferential debts (unpaid wages up to £800 per employee plus accrued holiday pay).
• ›HMRC's claim continues to share in the prescribed part for non-preferential claims, but does not displace the prescribed part itself.

That said, the change is operationally consequential. For most trading companies, VAT and PAYE/employee NIC arrears are substantial — a typical SME with quarterly VAT of £30,000–50,000 and monthly PAYE/NIC of £10,000–20,000 can carry HMRC trust-tax arrears of £100,000–£500,000+ when entering procedure. All of that ranks ahead of floating charge holders — a substantial reallocation of recovery away from lenders to the Exchequer.

Finance Act 2020

The principal authority is sections 98 and 99 of Finance Act 2020. These provisions amend Schedule 6 to the Insolvency Act 1986 to introduce the secondary preferential debt category for HMRC. Royal Assent was given on 22 July 2020; the provisions came into force on 1 December 2020 (delayed from the originally intended 6 April 2020 effective date as part of the UK Government's early Covid-19 business support measures).

The HMRC Debts: Priority on Insolvency Regulations 2020

The Insolvency Act 1986 (HMRC Debts: Priority on Insolvency) Regulations 2020 (SI 2020/983) supplement Finance Act 2020 by specifying the "relevant deductions" within scope. The Regulations confirm:

• ›Secondary preferential status applies to insolvency procedures commencing on or after 1 December 2020.
• ›Specified relevant deductions: PAYE income tax, employee NICs, CIS deductions, student loan deductions.
• ›VAT is dealt with separately as the principal trust tax of HMRC's claim.

Schedule 6 to the Insolvency Act 1986

Schedule 6 to the Insolvency Act 1986 is the operative provision setting out preferential debt categories. The Finance Act 2020 amendments inserted the new secondary preferential category into Schedule 6, which now distinguishes between:

• ›Category 1 — Ordinary preferential debts: principally employees' unpaid wages (up to £800 per employee for the four months before the relevant date) plus accrued holiday pay, certain pension contributions, and the Financial Services Compensation Scheme.
• ›Category 2 — Secondary preferential debts: HMRC trust taxes (VAT, PAYE income tax, employee NICs, CIS deductions, student loan deductions).

Within each category, claims rank pari passu (proportionately) where assets are insufficient to pay the category in full. Category 1 is paid in full before Category 2 receives anything; Category 2 is paid in full before floating charge holders or unsecured creditors receive anything (other than the prescribed part).

This is the most operationally important section. The line between preferential and unsecured is precise and has material recovery consequences. The conceptual line is the trust tax principle — amounts the company has collected from third parties (customers paying VAT, employees having PAYE/NIC deducted, subcontractors having CIS deducted) on HMRC's behalf, intended to be passed on to HMRC. Where a company becomes insolvent holding such amounts, the policy view is that those amounts should not be available to the company's general creditors — they are not really the company's money.

Conversely, taxes that are HMRC's own revenue claim against the company — corporation tax on the company's profits, employer NICs which are an employer cost — are simply commercial debts the company owes HMRC. The policy view is that they should rank with other commercial debts, not be elevated.

The line is conceptually clean but produces specific operational consequences. A company's overall "debt to HMRC" in a Statement of Affairs may comprise both preferential and unsecured components; the IP and creditors must distinguish them when assessing recoveries. Misclassification — by HMRC or by the company — is reviewable and is a relatively common point in larger insolvencies where HMRC's claim is substantial and includes mixed components.

The post-1 December 2020 creditor priority waterfall in UK corporate insolvency runs as follows. In typical SME insolvencies, the waterfall stops at category 5 or 6 — unsecured creditors receive only their share of the prescribed part (typically a small fraction of their claim) and floating charge holders receive a reduced recovery after Categories 1 and 2 have been paid.

Floating charge holders — typically banks, asset-based lenders, and invoice finance providers — are the principal economic losers from the change. Pre-1 December 2020, floating charge holders ranked ahead of HMRC for unpaid VAT, PAYE, and NICs. Post-1 December 2020, floating charge holders rank behind HMRC for those amounts.

The impact varies by company:

• ›For companies with substantial VAT and PAYE/NIC arrears at the point of insolvency, the value leakage to HMRC can be material. A company with £200,000 of preferential trust-tax arrears reduces floating charge recoveries by £200,000 directly.
• ›For companies with minimal trust-tax arrears (current VAT and PAYE compliance), the impact is modest.
• ›Sectors with elevated peak trust-tax holdings — manufacturing companies with large VAT cycles, businesses with substantial PAYE due to large workforces — face greater exposure.

The lender response has been observable in market behaviour:

• ›Repricing of asset-based and invoice finance facilities to reflect increased risk.
• ›Tighter origination standards, particularly around tax compliance evidence.
• ›Reserves required against trust-tax holdings in some asset-based facilities.
• ›More frequent monitoring of borrower tax compliance during facility life.
• ›Greater focus on fixed-charge security where commercially achievable, since fixed charges retain priority over HMRC.

The prescribed part — the ring-fenced portion of floating charge realisations set aside for unsecured creditors — was increased to a cap of £800,000 for floating charges granted on or after 6 April 2020 (up from £600,000 for earlier charges). The increase coincided with the Crown preference change.

HMRC has a specific interaction with the prescribed part:

• ›HMRC's secondary preferential claims rank above the prescribed part — they are paid before the prescribed part is calculated.
• ›HMRC's non-preferential claims (corporation tax, employer NICs, penalties, interest) share in the prescribed part alongside other unsecured creditors.

This produces what commentators describe as HMRC's "second bite of the cherry" — HMRC takes the trust taxes ahead of floating charges, and then takes a pro-rata share of the prescribed part for its remaining non-preferential claims.

The combined effect can be material. A company with £150,000 of preferential trust-tax debt and £100,000 of unsecured corporation-tax debt sees: the £150,000 paid first from floating charge realisations; HMRC then taking a pro-rata share of the prescribed part for the £100,000 alongside trade creditors and other unsecured creditors. In a small-to-medium insolvency, HMRC may receive 70–90% of total estate distributions across the two routes.

Refinancing and asset-based lending

Asset-based and invoice finance providers have repriced facilities to reflect Crown preference exposure. Pricing impact varies by sector and borrower trust-tax profile, but typical changes include:

• ›Increased margin reflecting reduced expected recovery on insolvency.
• ›Tighter advance rates against floating charge collateral.
• ›Reserves against estimated peak trust-tax holdings.
• ›Tighter compliance covenants requiring evidence of tax compliance.
• ›Earlier intervention triggers — lenders monitor borrower tax compliance more actively given the reduced cushion if insolvency occurs.

Pre-pack administration pricing

Pre-pack administration transactions — where the business is sold immediately on appointment of administrators, often to connected purchasers — are particularly affected. The pricing of the pre-pack must reflect what the business is worth in the alternative scenario (typically winding-up petition followed by compulsory liquidation), which itself depends on the Crown preference position.

• ›HMRC's preferential claim reduces the floating charge realisation expected in liquidation. Where a floating charge holder is the principal lender, this affects the lender's willingness to support a pre-pack at any given price.
• ›HMRC's preferential status increases HMRC's negotiating leverage in pre-pack scenarios. HMRC has a stronger position in alternative outcomes, which makes HMRC's support easier to obtain on reasonable structural terms but harder to obtain on aggressive ones.
• ›Pre-pack valuation evidence (typically required by SIP 16) must reflect the priority position — the alternative outcome value calculation cannot ignore the secondary preferential category.

CVA proposals

Company Voluntary Arrangements are the principal restructuring procedure for trading companies seeking to bind unsecured creditors to a payment plan. Crown preference materially affects CVA viability:

• ›HMRC's preferential debts cannot be compromised in a CVA without HMRC consent (preferential debts are protected). The trust-tax arrears must be paid in full or with HMRC's specific agreement to compromise.
• ›HMRC will compare the CVA proposal against the alternative liquidation outcome — which now includes HMRC's strong preferential position. Where liquidation would produce a higher recovery to HMRC than the CVA proposal, HMRC will typically vote against the CVA.
• ›CVA proposals therefore typically require a meaningful 'CVA premium' to HMRC over the liquidation comparator — through accelerated payment of preferential debts, contributions from connected parties, or other structural enhancements.

The HMRC-engagement strategy on CVA proposals is materially more important than pre-2020. HMRC's vote (often determinative given the size of HMRC claims relative to the unsecured creditor pool) cannot be assumed without specific structural design.

If you are a director

For directors of distressed companies, Crown preference affects:

• ›Procedural choice. Where Crown preference would severely reduce floating charge recoveries, secured creditors may be more aggressive in pursuing enforcement than they would have been pre-2020. Early engagement with both HMRC and the lender is materially more important.
• ›Personal guarantee exposure. Where directors have personal guarantees to floating charge holders, the reduced lender recovery in liquidation increases the gap that the personal guarantee covers — often producing larger personal exposure than directors anticipate.
• ›Restructuring economics. CVA and other restructuring procedures must reflect the HMRC priority position. The "easy" route of compromising HMRC unsecured debt no longer exists for trust taxes.
• ›Director-conduct. The Crown preference position affects what the company would have done at various points if it had taken proper professional advice — and therefore affects director-conduct analysis where the company's solvency was deteriorating.

If you are a floating charge holder

For floating charge holders — lenders, asset-based finance providers, invoice financiers — Crown preference requires:

• ›Proactive monitoring of borrower tax compliance throughout the facility life, not just at origination.
• ›Early intervention where tax arrears are accruing, before the position becomes unsalvageable.
• ›Realistic estimation of recovery in the worst-case scenario, including substantial peak trust-tax exposure where applicable.
• ›Strategic decision-making about whether to pursue enforcement, support restructuring, or facilitate consensual workout — each route now has different economics under the Crown preference regime.

If you are an unsecured creditor

For unsecured creditors — trade suppliers, landlords, professional services providers — Crown preference reduces the prescribed part available because HMRC's preferential claims are paid first. Practical implications:

• ›Recoveries in unsecured creditor distributions have reduced post-2020. The prescribed part remains available but is reduced in many cases by HMRC's preferential claims absorbing more of floating charge realisations.
• ›The economic case for proof of debt and active engagement in proceedings is reduced for many smaller unsecured creditors — though the position is still meaningful for substantial creditors.
• ›CVA proposals require closer scrutiny — the 'CVA premium' over liquidation may be smaller than directors and IPs estimate, particularly where HMRC's preferential position dominates the alternative outcome.

If you are a director, lender, or stakeholder in a distressed scenario where the Crown preference position is material to decision-making, the first step is a conversation with a licensed practitioner. The conversation will assess the realistic recovery position for each creditor class, test alternative procedural routes (CVA, administration, pre-pack, CVL), evaluate the implications for personal-guarantee holders and other interested parties, and identify the strategic priorities. There is no charge for the initial consultation and no obligation arising from it. Confidentiality is absolute.

At IQ Insolvency, every restructuring engagement is led by a licensed insolvency practitioner from the first conversation. The IP works with specialist tax and restructuring counsel where the matter requires it, and engages directly with HMRC and other principal stakeholders throughout the procedure. No call centres. No handoffs. One licensed practitioner, start to finish.

Related reading covers the umbrella HMRC framework, the principal trust-tax pillars, and the procedural routes most affected by the Crown preference position.