Defined benefit (DB) schemes and the Pension Protection Fund (PPF) are set to receive even less in sponsor insolvencies as the Treasury moves the taxman higher up the repayment ladder.
From April 2020, HM Revenue and Customs (HMRC) is to become a ‘preferential creditor' under plans announced in the Budget yesterday (29 October), moving from the ‘unsecured creditor' category it currently shares with the PPF and pension schemes.
The ‘preferential' category is the second rung in the insolvency repayment ladder, ranking only below ‘secured creditors' with fixed charge securities over property, but is two above the ‘unsecured creditor' group, which is the bottom rung.
The effect is such that taxes paid by employees and customers, and temporarily held by companies, will automatically be sent to HMRC before the amount to be distributed to pension schemes and the PPF is calculated, reducing the pool of assets available.
In its Budget documents, the Treasury said around £185m of tax take a year was lost when employers go into insolvency and funds are distributed towards creditors ahead of HMRC.
While it is expected the change to affect financial institutions, however, the government said it anticipated the effect on unsecured creditors, such as pension funds, to be minimal, noting: "Other unsecured creditors - such as suppliers - are usually unable to recover any of their debts and so most will be unaffected. They currently only recover 4% of debts owed on average."
Aon partner Lynda Whitney said covenant advice will have to include this new aspect.
"Putting HMRC ahead of unsecured creditors in insolvency is likely to mean they will also be ahead of pension schemes," she said. "So, a new question we will need to ask in covenant reviews will be: ‘How much do you owe the taxman?'"
Schemes may also need to rethink the securities their sponsor provides them, focusing more on charges over contingent assets.
Earlier this year, secretary of state for work and pensions Esther McVey seemed to suggest the government would review the insolvency hierarchy in the wake of the collapse of Carillion, considering whether pension funds should be higher.
However, a Department for Business, Energy & Industrial Strategy consultation failed to make such a recommendation, instead proposing enhanced stewardship roles for shareholders and stronger investigation powers for the Insolvency Service.
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