As lockdown restrictions are eased, businesses are beginning to reopen and start the recovery process. However, it is likely that “business as usual” is still a long way off for many, and it is inevitable that there will be casualties on the way, with recent reports suggesting that as many as two thirds of SME businesses will not be able to pay their deferred tax liabilities in six months’ time.

As such, there is likely to be an increase in the number of businesses entering into insolvency and consequently an uplift in processes such as pre-pack administrations, which are seen as an attractive means of releasing a business from the burden of its debt, involving a quick sale of the business and assets of an insolvent Company into a new legal entity, and it is often the case that Directors of the failed business acquire the trade and assets under a new company name – a so called ‘phoenix company’.

But there are strict rules that govern the use of this process, and HMRC may demand greater levels of security for such businesses.

Where HMRC have experienced a loss of tax through non-payment or the company pre-insolvency had a poor history of paying its tax liabilities, HMRC can issue a security bond – essentially a deposit.

A pre-determined amount, HMRC can ask you to pay a security bond if they believe there is a risk that you will not be able to pay your tax on time. If requested, a security bond must be paid prior to a new company being granted a VAT registration number following a pre-pack administration – this way HMRC are able to settle any outstanding liabilities using the bond, should a company fail to pay its tax liabilities when they fall due.

Security bonds cover several taxes and can be issued for significant amounts. From a VAT perspective security bonds are typically calculated at a multiple of a business’s VAT liability in a reporting period, which can create serious issues and affect a business’s ability to trade.

Issues can also arise through the method of financing the bonds, which can in turn impact working capital levels and potentially cause longer term cash flow problems from the outset.

Given the level of support provided by Government to businesses hit by the Coronavirus pandemic it is inevitable that, at some stage, HMRC will be looking at all their options to protect the Crown and using all of the tools available to them to do so, which may see an increase in the number of requests for security bonds being provided.

The return of Crown Preference – a further strengthening of the position

In addition to security bonds there will also be the reintroduction of Crown preference, coming into force in December 2020, meaning HMRC will no longer be ranked as an unsecured creditor, but instead be elevated to preferential creditor status in Business Recovery and Insolvency procedures in respect to certain taxes such as VAT, PAYE income tax and employees national insurance contributions.

Whilst this may not appear to impact businesses and directors on the face of it, it may impact the levels of finance available to phoenix companies and reduce the potential levels of working capital available from funders due to preferential creditors ranking in priority to floating charges, which are ordinarily obtained by funders to protect their lending exposure.

We do not yet know the true extent as to how this will impact funding routes, however if you believe that a formal insolvency process for your business is unavoidable the timing of that process may prove crucial when taking into account the potential funding made available to the successor business.

But what does this mean for security bonds?

In these unprecedented times, more than ever, cash is key, and with the the reintroduction of Crown preference potentially impacting available working capital for phoenix companies, as well as the heightened risk of security bonds being sought, forward planning is fundamental.

As a result, it is also crucial that any HMRC debt is calculated accurately to mitigate any security bond calculations and avoid any negative impact on the funds available for distribution to creditors, including those who hold a floating charge.

The Indirect Tax team at Smith Cooper has significant experience in advising businesses in insolvency and can advise on the options available.

HMRC are likely to initially raise a security bond notice of requirement advising of the amount due. On receipt you do have several options available if you are not in position to pay the amount in full.

These include an outright challenge and appeal against HMRC’s decision to raise a notice of requirement, negotiating a time to pay arrangement or negotiating the amount due.

If you have received a notice of requirement or would like more information on issues associated with security bonds, please do not hesitate to get in touch with one of our specialists so we can discuss your situation and evaluate the options available to you.

In the meantime, if you’d like further information regarding securities in respect of VAT, you can access the governments guidance by clicking here.