DMBM605020 – Pre-enforcement: Preparing a case for enforcement: Customers in difficulty

Where a customer is facing financial difficulty, it is vital that we take action swiftly, whether to expedite insolvency proceedings, or force the business to face the realities of its position, thus preventing the debt increasing and reducing HMRC losses.

Whilst normal enforcement action should be taken in respect of unpaid taxes, it is important to note that Security action can only be taken against VAT & Environmental Taxes.

Effective communication between Debt Management, Insolvency Compliance and Securities Local/National Compliance staff is vital in avoiding revenue losses see DMBM580030.

Warning signs

Listed below are examples of factors that may give cause for concern. However, it is important to note that one single sign does not necessarily mean that the trader is about to become insolvent.

General

• Newspaper reports of legal action for recovery of debts, or actions involving heavy penalties
• the trader’s general payment reputation amongst other local traders.

Business

• Major changes of management (buy-outs or take-overs). However, this can also mean that the company is trying to avoid insolvency
• large-scale redundancies - redundancy packages can be expensive
• loss of contracts/falling sales - this can mean pressure on cash flow
• discrepancies in the premises/plant and declared activities - do they match?
• change of address - why has the trader moved? Is the move down-market?
• unexplained change to inputs/outputs ratio on VAT return (e.g. Repayment claim).

Financial

• Cheques returned by the bank, “refer to drawer”
• deterioration in payment pattern - VAT returns are consistently late and regular surcharges are being issued. PAYE payments consistently late or months missed? PAYE returns not submitted in order to hide a debt
• apparently excessive bank overdrafts or loans, compared to assets against which security can be taken
• Time to Pay arrangements are not kept
• restriction of short term credit, or cash on delivery required by suppliers
• signs that the trader has extended credit or is being continually pressed for payment. e.g. are currently liabilities substantially greater than current assets? This can be established by looking at company records
• turning a small problem into a large one by refusing to pay when only a small debt is in dispute
• regular cash flow problems are more an indication that a trader is on the verge of insolvency (e.g. by not getting paid or paying too much). Insolvency can be better defined as an inability to pay debts as they fall due, or where the trader would not be able to pay all liabilities, after assets have been sold
• losses incurred on a regular basis - how can they continue to fund these losses?

If annual accounts are available examine ratios in relation to quick asset test and creditor and debtor days. Would the assets that can be quickly realised (CA-stock / CL) be sufficient to meet immediate liabilities? Are the debtor days (the amount of time it takes customers to pay) increasing? Are the creditor days also increasing? (time taken to pay his suppliers).

The combination of longer debtor days and shorter creditor days is potentially harmful to cash- flow. The trader pays his suppliers on average before getting paid by purchasers. This situation cannot go on indefinitely.

Other signs

Those traders who carry little stock and whose fixed assets are secured by mortgage or debenture (e.g. to a bank) need special attention. They may suddenly cease trading leaving a large tax debt, with no assets.

Although late payment of tax may give grounds for suspicion, prompt payment is not a guarantee of stability; the trader may have other outstanding commitments. Companies with leased property or plant are particularly easy to close down as a lease can be cancelled and rental agreement be terminated.

A business which has gone through a recent ‘sale & leaseback’ of assets or property (which is a last resort for funding), has reached its normal borrowing limit. In particular, the company can no longer borrow against assets as they no longer own the property.