Published on 15 October 2010 by Tony Groom

Owing Her Majesty’s Revenue & Customs (HMRC) more than £150,000 for overdue VAT and PAYE when your turnover is less than £3 million is not uncommon in 2010.

A second, more extreme example of HMRC arrears was a labour services company that owed more than £100,000 having taken on staff but failed to pay PAYE while it grew to a turnover of £1 million. HMRC’s reliance on the P35 annual return to reconcile their receipts with PAYE deductions has made it easy for companies to build up PAYE arrears that eventually catch up with them.

The leniency of HMRC, whose light touch approach to collecting Revenue arrears since the recession began has helped the cash flow of many companies, has also made it easier for them to accrue both VAT and PAYE arrears. But the lack of a recovery has left companies in arrears burdened with debt they can’t easily repay.

Companies in this position have a number of options, but a real challenge is when to do something about it. If ignored, the liability can build up and the underlying business problems can escalate to a point where the company can find it more difficult to recover.

While directors are normally aware of the problems, and in particular of the liability in respect of Revenue arrears, they may not be aware of their options, assuming: “I know my business better than anyone else and if I don’t know the solution, then no one else will.”

There are three financial solutions to consider when dealing with HMRC arrears. They are immediate payment, a Time to Pay (TTP) arrangement or a Company Voluntary Arrangement (CVA). However, all too often one of these is implemented without considering other issues that perhaps need to be addressed at the same time.

The build up of PAYE arrears and VAT arrears is an indicator that the business is no longer profitable or that it doesn’t have sufficient working capital. The underlying issues can be identified by a business review and preparation of forecasts. It is obvious that an unprofitable company cannot achieve a payment plan while also covering ongoing payments. Less obvious is the restructuring and reorganisation that may be needed to achieve a viable business, one that is profitable with adequate working capital and positive cash flow.

The solutions to the two examples at the beginning of this article were very different and followed a business review that revealed factors that were not at first obvious but had a bearing on the final rescue solution. The company turning over £3 million was able to raise a modest loan that funded the purchase of cheaper stock from overseas, which in turn increased profitability. A TTP was agreed with HMRC to repay the £150,000 over 10 months.

The other company was in a more serious state as it was not profitable and it had serious working capital issues with taking credit and factoring its book debts. The terms of the factoring were so onerous that the annual fee was similar to the amount borrowed. This company was cut back to a smaller company by withdrawing from unprofitable customer segments. It was able to terminate its factoring arrangement by removing the need for working capital by focussing on the domestic market with payment on delivery. The creditors, who mainly comprised of the Revenue arrears, agreed a CVA.

Surviving the pressure of PAYE and VAT arrears generally involves more than just fixing the financial problem.  Instead, with the help of a business rescue adviser, the underlying issues were identified and workable solutions were put in place.