Preferential Creditors

CHAPTER 40

February 2006

PART 5

40.76 Definition of preferential debts

(May 2008)

Preferential debts are unsecured debts which, by statute, are to be paid in priority to all other unsecured debts: see Chapter 36A, paragraphs 36A.23 and 36A.57-36A.64 and 36A.106-36A.109.In addition, where debts are paid out of assets subject to a floating charge, preferential debts are paid in priority to claims secured by any floating charge-holder, it should be noted however, that the first source of funds payable to the preferential creditors will be the insolvent's general assets.

Preferential debts rank equally among themselves and should be paid in full, unless the assets are insufficient to meet them, in which case they abate in equal proportions between themselves.

 

40.77 Insolvency Act 1986, Schedule 6

The categories of preferential debts for all forms of insolvency are listed in Schedule 6 to the Insolvency Act 1986. The EA2002, which applies to all cases where the petition for a winding-up order or bankruptcy order was presented on or after 15 September 2003, has significantly reduced the types of creditors to whom preferential status is available, with HM Revenue and Customs being most affected. The categories of preferential debts are detailed at paragraphs 40.80 to 40.96.

 

40.78 The relevant date

The ' relevant date' referred to in Schedule 6, when determining the existence and amount of a preferential debt, depends on the particular insolvency procedure involved, and whether the insolvent is a company or an individual.The relevant date is defined in section 387.

 

40.79 Categories of preferential debts

Schedule 6 was amended by the EA2002 and categories 1 - 3 were deleted. Consequently categories 1 - 3 do not apply to those cases where the petition for a winding-up order or bankruptcy order was presented on or after 15 September 2003, and debts which would have fallen into categories 1 - 3 are non preferential and will thus rank equally with all non preferential debts.

 

40.80 Category 1: Debts due to the Inland Revenue(EA2002 applies - see paragraph 40.79)

In cases where the insolvency petition was presented before 15 September 2003, deductions of income tax from officers and employees under the Pay As You Earn scheme [note 1] that have been, or should have been made, and deductions made, or which should have been made, from sub-contractors of debtors engaged in the construction industry [note 2], in the 12 months before the relevant date are preferential.

Interest on tax liabilities is an unsecured debt (see also Chapter 77 - Taxation).

 

40.81 Category 2: Debts due to HM Revenue and Customs (EA2002 applies - see paragraph 40.79)

Further information on debts due to HM Revenue and Customs are given in Chapter 77 - Taxation, and Chapter 78 - VAT. The debtor will be registered with HM Revenue and Customs for the collection of these taxes and duties.

VAT, Landfill tax and Insurance Premium tax

The preferential portion of VAT [note 3], Landfill tax and Insurance Premium tax [note 4] is defined in category 2 of schedule 6 as being ‘referable to the period of 6 months next before the relevant date’. All these taxes are usually accounted for in quarterly accounting periods by the submission of returns. VAT can be accounted for on a monthly or annual basis depending on the turnover of the business. It will frequently be the case that the relevant date does not fall at the end of an accounting period. The amount of the preferential debt will therefore be calculated as a proportion of several returns. The accounting reference periods for the various taxes are set out in the relevant legislation.

 

40.82 VAT Group registration

Where two or more companies are treated as a group for VAT purposes, all members of the group are liable jointly and severally for any tax due from the representative member. [note 5] The Commissioners will normally make a claim first against the representative member of a VAT group. However, if that company is unable to pay the debt in full, the Commissioners will make a claim against the other members of the group for the remaining debt. To the extent that the representative company’s debt is preferential, it will also be treated as a preferential claim in the insolvency of any of the other members of the VAT group. The VAT claim in the insolvency of each member of the group will be preferential to the extent that the tax is referable to the six-month period (as defined in relation to the insolvency of the particular member of the group). The limitation is that the Commissioners cannot recover in total more than the amount of tax due from the representative member.

 

40.83 Excise duty on Beer

Beer becomes liable to duty when it is produced or imported although it can be moved between registered premises or to excise warehouses without payment of duty - this is known as duty suspension. Packagers of beer may apply to be registered for beer duty if they wish to package beer in duty suspension. The preferential portion of excise duty on beer is any amount due from the debtor at the relevant date and which became due within a 6-month period before that date.

 

40.84 Air passenger duty

Air passenger duty was introduced by the Finance Act 1994 and came into effect on 1 November 1994. Air passenger duty is levied on the carriage from UK airports of chargeable passengers on chargeable aircraft. It is paid by the operator of the aircraft. The preferential portion of air passenger duty is any amount due from the debtor at the relevant date and which became due within a 6-month period before that date.

 

40.85 Betting, bingo, gaming and lottery duty

General betting duty is a duty on the total money staked on off-course bets made with a bookmaker or the Horserace Totalisator Board (the Tote). The duty is paid by the bookmaker or the Tote. From 1 January 2002 general betting duty was replaced by a gross profits tax to be paid by the bookmaker at a rate of 15 per cent on gross margins, which are defined as the difference between the stake laid with the bookmaker and the winnings they pay out.

Pool betting duty applies to bets made by way of pool betting with a promoter based in the UK or made at fixed odds by way of coupon betting in the UK. The promoter of the betting is responsible for paying the duty.

All bingo played on premises licensed for gaming by the local gaming licensing committee is liable to duty. Other bingo is liable to duty unless it is:

  • members' club bingo,

  • non-commercial bingo,

  • small scale bingo (generally bingo played at travelling fairs and amusement arcades),

  • domestic bingo, or

  • machine bingo.

The duty is paid on a percentage of the total weekly stake money paid to bingo promoters by players as payment for their cards plus a percentage of the amount by which the total value of prizes won in the same week's bingo exceeds the weekly stake money, less duty (often referred to as added prize money). The promoter of the bingo is responsible for paying the duty.

Gaming licence duty is paid by anyone concerned in organising, managing or providing a commercial gaming club. Duty is calculated on a percentage of gross gaming yield.

Lottery duty is collected only from the operator of the National Lottery; the individual shops that sell lottery tickets do not pay lottery duty. It is therefore highly unlikely that there will ever be an insolvency where there is a claim for lottery duty.

The preferential portion of the debt for betting duty, bingo duty, gaming duty and lottery duty is the amount due from the debtor at the relevant date and which became due within the period of 12 months before that date.

 

40.86 Category 3: Social Security contributions (EA2002 applies - see paragraph 40.79)

Class 1 National Insurance contributions are paid by employees and their employers. Class 2 and Class 4 contributions are paid by the self-employed.

All sums which on the relevant date are due from the debtor on account of Class 1 or Class 2 contributions [note 6] and which became due from the debtor in the 12 months before the relevant date are preferential.

All sums which on the relevant date have been assessed on and are due from the debtor on account of Class 4 contributions [note 6] being sums which are due to HM Revenue and Customs (rather than to the Secretary of State or a Northern Ireland department), and are assessed on the debtor up to 5 April before the relevant date, but not exceeding, in the whole, any one-year’s assessment are preferential.

 

40.87 Category 4: Contributions to Occupational Pension Schemes

Any sum which is owed by the debtor and is a sum to which Schedule 4 to the Pension Schemes Act 1993 applies (contributions to occupational pension schemes) is preferential. (See Chapter 61 Pension Schemes for further information relating to types of pension schemes).

 

40.88 National Insurance Fund Claim

The administrator of a pension scheme can, within certain limits, make a claim on the National Insurance Fund in respect of any pension scheme contributions unpaid by the employer at the date of the employer's insolvency [note 7]. This applies to unpaid contributions to personal pension schemes as well as occupational schemes, and the amount of the claim can include both unpaid employer's contributions and employees' contributions deducted from pay but not paid into the scheme. The claim has to be made by the administrator of the scheme to the Employment Relations Directorate of BIS (Redundancy Payments Service (RPS)). Where the RPS make a payment in respect of unpaid scheme contributions, the Secretary of State will have a subrogated claim in the liquidation for the amount of the payment, part or all of which may be preferential.

 

40.89 Category 5: Remuneration etc of Employees

Wages

So much of any amount which-

  1. is owed by the debtor to a person who is or has been an employee of the debtor [note 8], and
  2. is payable by way of remuneration in respect of the whole or any part of the period of 4 months next before the relevant date,

as does not exceed so much as may be prescribed by order made by the Secretary of State [note 9] is preferential.

 

40.90 Holiday pay

An amount owed by way of accrued holiday remuneration [note 10], in respect of any period of employment before the relevant date, to a person whose employment by the debtor has been terminated, whether before, on or after that date is preferential.

 

40.91 Advances for wages and holiday pay

So much of any sum owed in respect of money advanced for the purpose of paying wages or holiday pay as has been applied for the payment of a debt which, if it had not been paid, would have been a debt falling within the debts in paragraphs 40.89 and 40.90 is preferential.

 

40.92 Reserve Forces (Safeguard of Employment) Act 1985]

So much of any amount which-  
  1. is ordered (whether before or after the relevant date) to be paid by the debtor under the Reserve Forces (Safeguard of Employment) Act 1985, and
  2. is so ordered in respect of a default made by the debtor before that date in the discharge of his obligations under that Act,

as does not exceed such amount as may be prescribed by order made by the Secretary of State [note 9] is preferential.

Schedule 6.13 and 6.14 provide further interpretation of the above provisions.

 

40.93 Subrogation of claims - Secretary of State

If an employer becomes insolvent, certain debts owing to employees may be paid by the Secretary of State for BIS from the National Insurance Fund (NI Fund) [note 11]. The most common of these debts are arrears of pay, holiday pay and pay in lieu of notice.

The insolvency provisions enable the Secretary of State, within the prescribed limits [note 12], to pay the specified debts due to employees in an insolvency, whether the debts are preferential or not.

When the payments have been made, the Secretary of State assumes the rights of each employee and becomes a single creditor of the employer. The priority of the Secretary of State's claim depends on the priority of each payment made to the employee. Once payment in full has been received from the NI Fund, the employee has no further rights in the insolvency in respect of that element of his/her claim.

If elements of his/her qualifying claim have not been paid, or only partly paid, the employee retains the right to claim the balance in the insolvency [note 11], and that payment must be recovered and repaid to the NI Fund before any payment is made to the employee. Chapter 76, Employment Law, provides further information on employment law generally, insolvency of the employer at paragraphs 76.27 to 76.42 and, at paragraph 76.2, the definition of an employee.

 

40.94 Subrogation of claims - Other third party

Where a creditor's claim includes sums advanced to the company or bankrupt for the purposes of paying employees' remuneration and holiday pay (see paragraphs 40.89 and 40.91) that claim will rank preferentially to the extent that the advances were used for the purpose of paying employees' remuneration and holiday pay and the employees' own preferential claims have been reduced as a result.

Such advances are often made by banks through the operation of an overdraft facility. It is not necessary for the person making the advance to know a particular advance was for the purpose of paying employees' remuneration, provided he/she was aware that some of the advances he/she was making were for that purpose. Thus in the case of a bank overdraft, the bank need not show it was aware which cheques were for the payment of remuneration provided it realised some were (which will nearly always be the case). In the case of a bank overdraft, it will be necessary to ascertain which of the advances for remuneration constitute part of the final overdraft. The debits making up the final balance must therefore be identified [note 13].

The person making the advance is only entitled to claim preferentially to the extent that the advance has been used to pay a sum which would otherwise itself have been preferential as remuneration, i.e. net pay after stoppages. If the employee himself/herself is owed the amount, which is the maximum which can rank preferentially (or more), none of the sums paid out of the advance would have ranked preferentially and the person making the advance can therefore have no preferential claim. The maximum preferential claim he/she can have is the lower of:

  • (i) the amount he/she advanced for the purpose of paying the employee's remuneration and actually used for that purpose; and
  • (ii) the maximum preferential claim for remuneration less the employee's actual preferential claim for remuneration.

 

40.95 Priority of payment between creditors under Category 5

The Secretary of State for BIS is, in relation to the claims to which he/she is subrogated, entitled to priority over other preferential claims of the employee (see paragraph 40.89 and 40.90). The preferential claims of persons who have made advances for the purpose of paying remuneration (see paragraph 40.91) are not claims of the employee or due to them by way of subrogation to the employee's claims and therefore the Secretary of State does not enjoy priority over them.

 

40.96 Category 6: Levies on Coal and Steel Production

The European Coal and Steel Community Levy (E.C.S.C) is raised by the European Coal and Steel Community on the producers of coal and steel by reference to their output. Any levies payable by the few independent producers in the UK are negligible and therefore claims for such sums will be extremely rare.

Any sums due at the relevant date from the debtor in respect of-

  1. the levies on the production of coal and steel referred to in Article 49 and 50 of the E.C.S.C Treaty, or
  2. any surcharge for delay provided for in article 50(3) of that Treaty and Article 6 of Decision 3/52 of the High Authority of the Coal and Steel Community are preferential.

 

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