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Tuesday 3 September 2013

Hidden risks of funding Phoenix companies (part 2) – HMRC deposits


Background


In April 2012 HMRC were given new powers to require employers to provide security in relation to PAYE and National Insurance. Previous to this their power was limited to VAT, Insurance Premium Tax and environmental taxes. This security would be provided in the form of a cash deposit or a bond backed by a recognised financial institution and the amount is calculated based upon the amount of tax at risk.

HMRC exercises these rights only on occasions where it considers that there is a serious risk of non-payment and specifically avoids using these powers on businesses that are trying to meet their obligations for example through a time to pay arrangement.

It is rare for HMRC to require a deposit but where directors of insolvent companies have avoided significant sums of money there is an increased risk that one may be required. Whilst such a request can be appealed the director concerned would have to show a strong case that the risk to HMRC is minimised.

If the company fails to meet the security requirements and it continues to trade the directors commit a criminal offence.

Issues for lenders


Whilst it is rare for HMRC to take action to seek security, where funding a Phoenix there is an increased risk as it is likely that the directors will have left behind significant HMRC debt. Only in cases where HMRC believe there is a continued risk will they seek security however if they do so it can have a significant impact on the cash flow of the business and in some circumstances result in a failure of the phoenix company.

Lenders to phoenix businesses should factor in this possible risk that HMRC may request a deposit and understand the impact it may have on the cash flow and viability.

 
 Establishing the risk that security may be required


It can be difficult to establish the extent of this risk but a lender should seek to find out as much as they can about the circumstances of failure:

  • Level of HMRC debt in the failed business; both VAT and PAYE/NI;
  • Over what period this debt accrued;
  • Whether HMRC suffered disproportionately compared to other creditors;
  • The reasons for the failure of the business and how culpable the directors are; and
  • Whether there is a history of failure for the directors concerned

These factors will together provide an indication as to the risk of such a request from HMRC and the likelihood of being able to successfully appeal.

Establishing the amount of security


From a cash flow perspective it is important to sensitise the cash flow forecasts of the phoenix business and the amount of headroom it has in its facilities. Assuming that these do not include a provision for security to HMRC the headroom will help determine the impact that a request for a deposit will have on trading.

The level of security required will be determined by the perceived risk to HMRC and is likely to depend on a number of factors;
  • Whether the phoenix is accounting for and paying VAT on a quarterly or monthly basis
  • The normal level of VAT and PAYE liability at any one point in time; and
  • The level of loss to HMRC in the failed business

Overall


It is difficult to establish the precise risk that HMRC will require a phoenix company to pay deposit or provide security but it is important that lenders understand the impact and consequence of such a situation. Advisors can provide an indication of the risk, impact and potential exit strategy that can be used as part of the credit decision.


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