In this article we provide an resource on some of the key issues that we are dealing with at the moment in the world of insolvency:
- Moratorium for individuals facing personal financial difficulties
- Most common questions from directors about the personal impact on them of company insolvency
- MVL resource – tax-efficient way for shareholders to draw money when they close a company
- HMRC preference in Post 1 December 2020 insolvencies
Breathing space for individuals facing personal financial difficulties
In Scotland, individuals facing creditor enforcement action in respect of personal debt can apply for a moratorium. Directors of limited companies that have provided personal guarantees for company debt where that company has gone into insolvency can apply for a moratorium.
The key points are:
- A moratorium gives individuals 6 months of breathing space to take time to consider their options. It stops creditors from taking enforcement action to recover the money owed to them.
- Pre-COVID the moratorium period was only 6 weeks. It was extended in order to reduce stress and protect the mental health of those worried about personal insolvency in these uncertain times.
- The aim is to protect those individuals who have been adversely impacted as a direct result of COVID 19 whose personal finances should return to normality after COVID-19.
- There is no cost to commence a moratorium. Information is public and it is likely to affect an individual’s credit rating.
- During the moratorium interest and charges still accrue and individuals are still liable for their debt.
FAQs from Directors about the implications on insolvency on them personally
We know that some of your clients may be in a difficult financial situation and below we list some of the most common questions that we get asked by directors about the impact on them personally should their company go into insolvency.
- A director of a company that is in liquidation, can still be a director of other companies at the same time/ can take on new directorships/set up new companies.
- The information will be publicly available on Companies House until such time as the company is removed from the register, usually three months after the end of the liquidation, but it should have no effect on a director’s personal credit rating and they can still hold positions in public office.
- In most circumstances, a new company can carry out a similar business as the insolvent one, but the director needs to ensure that they have addressed whatever caused the liquidation. A new company cannot trade using the same or similar name unless specific requirements are met.
- A director will normally not be personally liable for any of the company debt unless they have provided personal guarantees. If they have personally guaranteed company debt, those creditors will look to them personally for repayment.
- If there is an overdrawn directors’ loan they will be required to pay this back.
- They may be personally liable for debts incurred by wrongful trading. This is where company debts have increased in a period when the director ought to have known that there was no reasonable prospect that the company would avoid insolvency. Wrongful trading was temporarily suspended until 30 September 2020 but is now back in force.
- In any insolvency procedure, the insolvency practitioner has to investigate the conduct of the directors and submit a report to the government on adverse conduct. If there is adverse conduct this may lead to directors being unable to act as directors for a set number of years. Some of the areas that have to be reported on:
- Keeping adequate books and records
- Keeping tax returns and payments up to date
- Preferring certain creditors over others
- Has the director benefited excessively?
- Giving away company assets for less than they are worth
- Taking customer deposits when it is known that the goods or service will not be provided
- Trading whilst insolvent
- Not co-operating with the liquidator
Certain specific circumstances may have an impact on the position above. Any individual facing individual or corporate insolvency should speak to an insolvency practitioner.
Members’ Voluntary Liquidation (MVL) resource
We have been dealing with a flurry of MVLs in recent weeks as shareholders wanted to bring their companies to a close. This was due to concerns that the tax position would change and bring capital gains tax in line with income tax and perhaps further reduce Business Asset Disposal Relief (which is what Entrepreneurs’ Relief is now known as).
The cancellation of the Autumn Statement has removed that spectre for now but I think everyone knows that there will be tax hikes in the next budget. There is always a spate of MVL enquiries in the lead up to every budget and although we can usually turn things around pretty quickly, it’s not always possible. Planning is key. To help you assist your clients we set out below a reminder of the key provisions for Business Asset Disposal Relief, which helps with an efficient liquidation appointment and the key stages of the MVL itself.
Business Asset Disposal Relief
Where net assets in a company are greater than £25,000 Business Asset Disposal Relief applied after a Members’ Voluntary Liquidation means that less capital gains tax is paid when someone sells or disposes of all or part of their business. The taxation paid is 10% on any gain (after deduction of the tax-free allowance).
Broadly, the key conditions for an individual to qualify for this relief are that:
- The company must have traded
- The individual owns at least 5% of the company
- The individual is an employee or officer of the company
- The shares have been held for 12 months prior to ceasing to trade
- Three year period from cessation of trade for relief to be applied
- NOTE the relief will not apply if the individual starts doing the same trade again within 2 years (Targeted Anti Avoidance Rules)
We don’t provide individuals with tax advice or complete their personal tax returns for them as part of the MVL engagement. Either you do that or our tax team can.
- All liabilities paid, including the final corporation tax
- All VAT returns made and final PAYE returns if there were employees
- VAT – if the company is VAT registered, deregister. The VAT on liquidation fees can still be reclaimed
- All assets realised – we can distribute some assets directly (called “in specie” distributions)
- Overdrawn director loan accounts do not need to be repaid but can be distributed in specie. For the purposes of s455 tax, this counts as repayment
- If the preference is to place the company into liquidation before all assets are realised and liabilities settled, we can do this, but there will be an additional fee for this
Key stages of MVLs:
- The accounts need to be completed and tax returns finalised
- A letter of engagement is drawn up between us and the client specifying the fixed fee and each parties responsibilities
- We prepare the paperwork to place the company into liquidation
- One of the documents is a statutory declaration of solvency which is signed by a majority of directors in front of a notary public. This can be done virtually
- Following appointment, we will make a significant distribution of the funds held by the company following receipt of the funds from the company’s bank to the shareholders
- We attend to all remaining statutory matters and seek final clearance from HMRC
- Following clearance, a final distribution is made and we take steps to dissolve the company
Certain HMRC debts will be preferential in any business insolvency from 1 December 2020 onwards
HMRC will have preference in any insolvencies from 1 December 2020 onwards. The relevant taxes are VAT, PAYE, CIS, employees NI and student loan deductions i.e. taxes that a business effectively collects on behalf of HMRC. This applies to both corporate and personal insolvencies.
Currently, HMRC ranks as an unsecured creditor. Post 1 December 2020 any of these outstanding taxes will have preferential status. This means that HMRC will get a bigger share of the pot at the end of an insolvency than they would if the insolvency happened before 1 December 2020. The additional share comes at the expense of floating charge holders and unsecured creditors.
The amount of the preference for each tax is unlimited in time or value. With current COVID VAT deferrals, the amount could be significant. Many businesses will have Time to Pay arrangements in place. Some businesses have never had such a large outstanding balance to HMRC.
Who does this impact?
1. Businesses that are approaching renewals of facilities coming up/currently seeking funding
Banks and funders are now becoming a lot more interested in what tax a business has deferred before providing or renewing credit. So expect them to ask clients for confirmation of amounts outstanding from HMRC and future cashflows. If a funder will have to stand behind HMRC in the rankings in an insolvency, and HMRC have deferred substantial amounts outstanding, then a funder will be reluctant to provide funding. Provision of well-structured cashflows that clearly show how the HMRC debt will be repaid and commentary around the sensitivities will be key.
2. Companies where there is a floating charge, large HMRC balance and the borrower is in default
The lender may be considering taking steps to appoint an administrator prior to 1 December in order to protect their position.
3. Directors that have personal guarantees
If a director has provided a personal guarantee to a lender then they should have a think about what the impact is of this change on the amount that they are guaranteeing, because any of the relevant amounts outstanding to HMRC will be paid out of the floating charge.
For directors considering new funding and being required to give a personal guarantee, they should make sure they know what they are guaranteeing because the position between 30 November and 1 December could be materially different.
4. Unsecured creditors
There is a view that unsecured creditors don’t get much. HMRC provided some data that put it at 4p in £ on average. It’s debatable to what extent a supplier takes into account potential dividend rates when assessing credit risk. The current level of HMRC arrears a potential customer has is not public and many companies will have greater liabilities than the last set of lodged accounts indicates. It is certain that unsecured creditors will receive less in post-December 2020. We have one case that a 30p in £ dividend to unsecured creditors would be completely wiped out by the HMRC preference had the appointment been on 1 December 2020.
A simplified example: A director has provided the bank with a personal guarantee in respect of an overdraft of £25k. The bank also holds a floating charge. There are book debts of £75k. There are creditors totalling £100k of which HMRC represents £50k. There are no employees. The company enters liquidation and at the end of the liquidation net realisations after liquidation costs and fees are £50k.
- If the company enters into insolvency on 30 November 2020. The bank ranks first under the floating charge. The bank is repaid in full and the unsecured creditors get the remaining £25k split between them which results in a 25p in the £ dividend. This means HMRC get a dividend totalling £12,500.
- If the company enters insolvency on 1 December 2020. HMRC ranks first because of its new preferential status, meaning they get £50,000 in full. There is no money returned to the bank and no money returned to the unsecured creditors. The bank now requires the director to pay the £25,000 personally guaranteed overdraft.
If the director in this scenario had provided any personal guarantee to any other suppliers they will have to meet a larger portion.
The policy aim of this is so that more of the taxes paid in good faith by employees and customers go to fund public services, rather than being used to fund trading. This was all pre COVID and was originally supposed to come into effect in April 2020. It was delayed at that time to prevent lenders placing companies into administration to protect their positions. It is at odds with the government encouragement to defer VAT payments in early COVID in order so businesses could fund trading and surely it is just as likely that there will be a similar rush coming up to the 1 December 2020. It is entirely possible that this will be extended again.