Tax Arrears: How They Rank Against a Lender's Security

A business short of cash chooses whom to pay late. Staff are paid, because without them there is no business. Key suppliers are paid, because they can stop supply. The tax authority does not stop anything on the day, so GST or VAT collected from customers and tax deducted from wages are often the first payments to slip. The money has already passed through the business; it is simply not passed on.

The arrears then grow quickly, because each new return adds to them and penalties and interest accrue. Tax authorities in all three markets can agree arrangements to pay over time, and each can also collect directly from the business's bank account: Inland Revenue by a deduction notice, the Australian Taxation Office by a garnishee notice, HMRC through its direct recovery of debts power. A lender who learns of the arrears from the authority's action, rather than from the borrower, has learned something about both.

New Zealand. In a liquidation or a receivership, Schedule 7 of the Companies Act 1993 makes Inland Revenue's claims for GST, PAYE and withholding tax preferential, ranking after the insolvency practitioner's costs and employees' preferential claims. Where the assets free of security are not enough to pay those claims, they are paid out of accounts receivable and inventory ahead of a general security interest over them, though not ahead of a perfected purchase money security interest. Money in the company's bank account counts as an account receivable for this purpose, as the Court of Appeal held in [2013] NZCA 357.

United Kingdom. For insolvencies starting from 1 December 2020, VAT, PAYE income tax, employee National Insurance contributions, student loan deductions and Construction Industry Scheme deductions are secondary preferential claims. They rank after fixed charges, the officeholder's costs and employees' preferential claims, and ahead of the prescribed part and the floating charge. Corporation tax, employer contributions, penalties and interest stay unsecured. Because a charge over book debts is floating unless the lender controls the proceeds in practice, as the House of Lords held in [2005] UKHL 41, the tax usually comes out of the debtors.

Australia. The Commissioner's priority in insolvency ended in 1993. Instead, directors can become personally liable, through director penalty notices, for unpaid PAYG withholding and superannuation guarantee charge, and from 1 April 2020 for GST, luxury car tax and wine equalisation tax. For PAYG withholding and GST, a liability not reported within three months of its due date is locked down (superannuation guarantee has its own, stricter lodgement test), and putting the company into administration or liquidation no longer removes it.

A security guarding contractor, constructed for this page like every figure in it, employs 300 guards and owes its bank US$3.0m under a general security agreement over all its assets. Contracts are lost, it falls behind on tax, and a receiver is appointed. Debtors collect US$2.0m after the costs of collecting them; vehicles and equipment fetch US$0.3m. Employees' preferential claims are US$0.5m. Unpaid GST is US$0.35m and unpaid PAYE US$0.40m. No assets sit outside the security, and every figure is the example's.

In New Zealand and the UK the tax arrears come almost dollar for dollar out of what the bank collects; the UK prescribed part, a share of the floating charge realisations left after preferential claims, set aside for unsecured creditors under a sterling formula with a cap, takes a little more. In Australia the bank keeps the debtors, after employee entitlements, but the tax has not disappeared. If the directors also guaranteed the bank's loan, the tax authority and the bank are now pursuing the same houses.

Employee claims rank ahead of the tax in New Zealand and the UK and, in a labour-heavy business, can be the larger number, so a lender estimating its exposure adds both: unpaid wages, holiday pay and redundancy to the extent the law prefers them, then the preferred tax. In a business with a large workforce and few hard assets, such as labour hire, cleaning or guarding, the two together can absorb most of what the debtors would fetch, which is why the preferential creditors entry is read beside this one.

An agreed arrangement to pay arrears over time is also a borrowing, from a creditor that did not have to be asked twice. A lender counts it in the business's obligations and in debt-like items when the business is valued, and checks that the instalments fit the cash forecast alongside the bank's own repayments.

DEFINED IN ONE PARAGRAPH → · PREFERENTIAL CREDITORS → · EARLY WARNING INDICATORS →

At review, a lender asks for the borrower's statements from the tax authority, not only the accounts, because a balance sheet accrual does not say whether the tax is late. Many facility agreements carry an undertaking to pay taxes when due, and an arrangement with the tax authority may need the lender's consent or at least its knowledge. A lender lending against debtors in New Zealand or the UK often holds back a reserve for preferential claims, so that the advance is sized on what it would actually receive.

In a workout the arrears change the arithmetic of every option. Paying them down protects the bank's recoveries in New Zealand and the UK and the directors' personal position in Australia, where the safe harbour from insolvent trading liability also depends on employee entitlements being paid and tax lodgements being kept up to date. A borrower that raises its tax position early gives the lender time to fund a plan; one that hides it tends to surface it in a receiver's first report.

THE THIRTEEN-WEEK CASH FLOW → · OVERTRADING →