HMRC as a secondary preferential creditor

In any UK insolvency where the relevant date is on or after 1 December 2020, HMRC ranks as a secondary preferential creditor for VAT and for tax the business deducted from other people: PAYE income tax, employee National Insurance, student loan deductions and Construction Industry Scheme deductions. These debts are paid after employees’ preferential claims but ahead of the prescribed part, floating charge holders and ordinary unsecured creditors. Corporation Tax, employer National Insurance, penalties and interest remain unsecured.

Which HMRC debts are secondary preferential?

The rule sits in paragraph 15D of Schedule 6 to the Insolvency Act 1986, inserted by section 98 of the Finance Act 2020 as “Category 9: Certain HMRC debts”. It covers any amount owed to HMRC at the relevant date in respect of:

• value added tax; and
• a relevant deduction, meaning a deduction the debtor must make from a payment to another person, where the amount paid to HMRC is credited against that other person’s liabilities and the deduction is of a kind specified in regulations.

The Insolvency Act 1986 (HMRC Debts: Priority on Insolvency) Regulations 2020 (SI 2020/983) specify four deductions:

• Construction Industry Scheme deductions under section 61 of the Finance Act 2004;
• employee (primary) Class 1 National Insurance deducted under paragraph 6(1)(b) of Schedule 4 to the Social Security (Contributions) Regulations 2001;
• PAYE income tax deducted under regulation 21 of the Income Tax (Pay As You Earn) Regulations 2003;
• student loan deductions under regulation 50 of the Education (Student Loans) (Repayment) Regulations 2009.

Unlike the old Crown preference, which limited preferential VAT to the six months before the relevant date and PAYE to twelve months, paragraph 15D has no look back period. HMRC’s policy paper says the full amount of the specified debts that arose before the insolvency is payable as a secondary preferential debt. HMRC also says that employee PAYE and National Insurance withheld from Coronavirus Job Retention Scheme funds falls within the preferential claim.

Which HMRC debts stay unsecured?

Anything that is not VAT or one of the four listed deductions ranks with ordinary unsecured creditors. HMRC’s policy paper gives examples:

• taxes that are not held on behalf of other taxpayers, such as Corporation Tax, employer National Insurance and Climate Change Levy;
• penalties and interest, including those for late payment, late returns or incorrect returns;
• the loan charge in the form of notional payments under the PAYE regulations;
• Coronavirus Job Retention Scheme grants overpaid to a business in error.

HMRC’s claim to the office holder should therefore show two figures: a preferential element and a non preferential element. Advisers reviewing an estimated outcome statement should check that the split has been made, because the two parts may produce very different returns.

Where does HMRC sit in the order of payment?

Section 386 of the Insolvency Act 1986 divides preferential debts into two tiers. Ordinary preferential debts are those in paragraphs 8 to 15B of Schedule 6, which include occupational pension contributions and employees’ unpaid remuneration and holiday pay. Secondary preferential debts are those in paragraphs 15BA, 15BB and 15D, so HMRC shares the second tier with certain bank deposits above the Financial Services Compensation Scheme limit.

HMRC’s policy paper summarises the broad order in which realisations are paid:

1. secured creditors with a fixed charge, after costs of realisation;
2. insolvency practitioners’ fees and expenses;
3. ordinary preferential creditors;
4. secondary preferential creditors, including HMRC;
5. prescribed part creditors;
6. secured creditors with a floating charge;
7. non preferential creditors;
8. shareholders, or the individual in a personal insolvency.

Section 175 confirms that in a winding up secondary preferential debts rank equally among themselves after ordinary preferential debts, and abate in equal proportions if there is not enough to pay them in full. Under section 175(2)(b), preferential debts are paid out of floating charge assets where the free assets are insufficient.

How does this affect lenders and the prescribed part?

Section 176A requires a liquidator, administrator or receiver to set aside a prescribed part of the company’s net property for unsecured creditors. Net property is what would otherwise go to floating charge holders, so it is calculated after preferential debts. A larger HMRC preferential claim therefore reduces both the floating charge holder’s recovery and the prescribed part.

The Insolvency Act 1986 (Prescribed Part) Order 2003 sets the prescribed part at 50% of the first £10,000 of net property and 20% of the rest. The cap was raised from £600,000 to £800,000 from 6 April 2020 by SI 2020/211, but the old cap still applies where the property is available to a first ranking floating charge created before that date. The office holder may disapply the prescribed part where net property is below £10,000 and the cost of a distribution would be disproportionate.

For lenders, the practical effect is that a company’s arrears of VAT and PAYE now sit ahead of the bank’s floating charge. Lenders may look more closely at a borrower’s tax position and ask for evidence that VAT and PAYE are up to date.

When does the rule apply?

Section 98(7) of the Finance Act 2020 says the change does not apply where the relevant date is before 1 December 2020. The relevant date is set by section 387 of the Insolvency Act 1986 and depends on the procedure:

Procedure	Relevant date
Creditors’ voluntary liquidation	The date the winding up resolution is passed
Compulsory liquidation	Appointment of a provisional liquidator or, if none, the winding up order
Administration	The date the company entered administration
Company voluntary arrangement (not in administration)	The date the arrangement takes effect
Bankruptcy	The date of the bankruptcy order, or the first appointment of an interim receiver

A liquidation that follows straight on from administration generally uses the date the company entered administration.

Does it apply to CVAs, sole traders and the rest of the UK?

Yes. Section 4(4) of the Insolvency Act 1986 prevents a company voluntary arrangement from paying a preferential debt otherwise than in priority to non preferential debts, or ordinary preferential debts otherwise than ahead of secondary ones, unless the creditor concerned agrees. HMRC states that it will reject a voluntary arrangement that proposes to exclude or modify the preferential treatment of any creditor, including HMRC. A CVA proposal that treats HMRC’s VAT and PAYE arrears as unsecured is therefore unlikely to succeed. See company voluntary arrangements.

Schedule 6 applies to individuals as well as companies, and section 328 gives secondary preferential debts the same ranking in bankruptcy, so a self employed trader’s unpaid VAT is preferential in their bankruptcy. Section 98 of the Finance Act 2020 made matching changes for Scotland, where these are “secondary preferred debts” under the Bankruptcy (Scotland) Act 2016, and for Northern Ireland.

How might the numbers work?

Illustration only. A company enters creditors’ voluntary liquidation. After the liquidator’s costs, floating charge realisations are £200,000. The bank’s floating charge was created after 6 April 2020 and the bank is owed more than the realisations. Claims include:

• employees’ preferential wages and holiday pay: £20,000;
• HMRC VAT: £60,000, and PAYE income tax and employee National Insurance: £25,000;
• HMRC employer National Insurance £10,000, Corporation Tax £30,000 and penalties £2,000;
• trade suppliers: £150,000.

The employees are paid £20,000 first. HMRC’s secondary preferential claim of £85,000 is paid next. Net property is £95,000, so the prescribed part is £5,000 plus 20% of £85,000, which is £22,000. The bank receives £73,000. The £22,000 prescribed part is shared between the suppliers and HMRC’s £42,000 unsecured claim. Before December 2020 the whole £127,000 owed to HMRC would have ranked as unsecured, with more going to the bank and the prescribed part.

What mistakes do directors and advisers make?

• Treating VAT and PAYE as working capital when cash is tight. These sums are now the first thing paid after employees, and directors who keep trading while arrears build may face questions about wrongful trading.
• Assuming all tax is preferential. Corporation Tax, employer National Insurance, penalties and interest are not.
• Applying the old six and twelve month limits. Paragraph 15D covers the full amount owed at the relevant date.
• Leaving returns unfiled. HMRC asks insolvency practitioners to file outstanding returns promptly so that its claim, and the preferential split, is accurate.
• Ignoring the option of a Time to Pay arrangement while the business is still viable.

For the wider order of payment in a winding up see creditors’ voluntary liquidation, compulsory liquidation and administration.

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Related Accountapedia entries

• The order of priority for paying creditors in liquidation
• The prescribed part for unsecured creditors
• Fixed and floating charges
• Directors as creditors of their insolvent company
• What an insolvency practitioner does

Sources

• legislation.gov.uk: Act 1986 c. 45, schedule 6
• legislation.gov.uk: Act 2020 c. 14, section 98
• legislation.gov.uk: SI 2020/983
• GOV.UK: Hmrc as a preferential creditor
• legislation.gov.uk: Act 1986 c. 45, section 386
• legislation.gov.uk: Act 1986 c. 45, section 175
• legislation.gov.uk: Act 1986 c. 45, section 176A
• legislation.gov.uk: SI 2003/2097
• legislation.gov.uk: SI 2020/211
• legislation.gov.uk: Act 1986 c. 45, section 387

Reviewed by Christine Anderson, Broker, Solar Protect. Last reviewed 8 October 2026. Part of Accountapedia, the Solar Protect guide to UK tax and accounting. This page is general information, not personalised advice.