Individual Voluntary Arrangements with HMRC as Creditor: Tax Debt, Voting Rights & Prohibited Terms

HMRC is now the single largest creditor in a significant proportion of individual insolvency cases in England and Wales. Its approach to individual voluntary arrangements (IVAs) is governed by a published creditor policy, the Insolvency Act 1986 and the Finance Act 2020 restoration of Crown preference. Advisers who understand HMRC’s voting criteria, the ring-fenced position of PAYE, the prohibited IVA modifications and the options when HMRC blocks can make the difference between a viable arrangement and a bankruptcy petition. This guide covers the full statutory and practical framework.

Why This Matters

Tax debt is the fastest-growing category of individual insolvency in England and Wales. Self-employed sole traders accumulating income tax and NIC arrears, directors of companies wound up with personal guarantees and VAT liabilities and individuals with significant offshore tax obligations all find themselves facing HMRC as a major or dominant creditor when they seek to restructure through an IVA. In many of these cases, HMRC’s vote is determinative: if HMRC holds more than 25% of the total debt by value, it can veto the arrangement single-handedly. Understanding HMRC’s published creditor criteria and the legal constraints on both HMRC’s conduct as a creditor and the terms of the IVA itself is therefore essential.

What Is an Individual Voluntary Arrangement?

An IVA is a formal, court-supervised debt solution for individuals under Part VIII of the Insolvency Act 1986 (ss 252–263H). The debtor (through a licensed insolvency practitioner acting as nominee) proposes an arrangement to their creditors setting out the terms on which they will pay a composition of their debts, typically a fixed monthly contribution over five years, with the remainder of the debt written off on completion.

The procedure is:

1. Nominee’s report: The IP prepares a report under s 256 IA 1986 assessing whether the proposal should be put to creditors.
2. Creditor decision procedure: Since the Insolvency (England and Wales) Rules 2016 replaced the old creditors’ meeting with a written decision procedure (deemed consent or virtual meeting), creditors vote on the proposal by correspondence in most cases.
3. 75% majority required: The proposal is approved if creditors representing 75% or more of the total provable debt by value vote in favour. If creditors representing more than 50% in value (but less than 75%) vote in favour, there is a “modified majority” that does not bind dissenting creditors.
4. Binding effect: Once approved, the IVA binds all creditors who were entitled to vote, whether or not they voted (s 260(2) IA 1986). This is the key protection for the debtor, even a dissenting creditor (including HMRC) is bound if the 75% majority is obtained.
5. Supervisor role: On approval, the IP becomes the supervisor of the IVA, managing payments and reporting to creditors.

Which Tax Debts Can Be Included in an IVA?

In principle, all unsecured provable debts that exist at the date of approval can be included in an IVA. For tax debts, this includes:

• Income tax (self-assessment arrears, understated tax following HMRC investigation);
• Capital gains tax (assessed or undeclared gains);
• Class 2 and Class 4 National Insurance contributions (self-employed NIC arrears);
• VAT (where the debtor is personally liable, including assessments following deregistration or VAT fraud findings);
• HMRC penalties and interest arising from the foregoing.

The critical caveat is that the IVA can only include debts that exist and are provable at the date of approval. Tax liabilities not yet assessed but arising from non-compliance discovered after the IVA commences cannot be included in the arrangement, they will need to be met from income outside the IVA contributions or, if not met, may form the basis for the supervisor applying for the IVA to fail.

Post-commencement penalties, for example, penalties for failures occurring after the IVA approval date, are not included and must be paid as they arise. This is a practical risk for clients under ongoing HMRC investigation when an IVA is proposed: if the investigation leads to a penalty assessment after the IVA commences, that penalty will be outside the arrangement.

PAYE and the Trust Problem

The most contentious category of tax debt in IVA negotiations is PAYE deducted by the debtor from employees’ wages (as an employer) but not remitted to HMRC. HMRC’s consistent position is that such funds were never the employer’s money to begin with: they were deducted from employees in the employer’s capacity as a collection agent and held on trust for HMRC. An employer who spent or retained these funds was, on HMRC’s analysis, misappropriating trust assets.

The practical consequence is that HMRC will strongly resist including unremitted PAYE in an IVA on the same terms as ordinary unsecured debt. HMRC’s position is reinforced by the Finance Act 2020 restoration of Crown preference: from 1 December 2020, PAYE and employee National Insurance deductions that were collected from employees but not remitted to HMRC are preferential debts in insolvency, ranking ahead of the claims of floating charge holders and unsecured creditors (see the related guide on HMRC as preferential creditor). In an IVA, preferential debts must be paid in full before any distribution to ordinary unsecured creditors, they cannot be included in the composition.

In Revenue and Customs Commissioners v Bhatti [2015] EWCA Civ 1175, the Court of Appeal considered HMRC’s position as a creditor in the context of a CVA (company voluntary arrangement), but the principles are equally applicable to IVAs. The Court confirmed that HMRC is entitled to vote against and veto an arrangement where it has a genuine basis for treating its debt as arising from trust obligations or fraud and that this does not constitute an improper exercise of the creditor’s vote.

HMRC as Preferential Creditor: The Ranking Problem for IVAs

Since 1 December 2020, certain HMRC debts are preferential in insolvency: PAYE, employee NICs and Construction Industry Scheme deductions collected from subcontractors but not remitted. In bankruptcy, these would be paid ahead of floating charge holders and ordinary unsecured creditors. In an IVA, the treatment of preferential debts is nuanced.

An IVA can include preferential debts, but HMRC will insist that preferential debts are treated at least as favourably as ordinary unsecured debts and, in many cases, will require that they be paid in full (or at a higher rate) before the composition dividend is applied to ordinary unsecured debts. A proposal that treats PAYE and employee NICs as ordinary unsecured debt, offering, say, 20p in the pound alongside income tax and commercial creditors, will almost certainly be rejected by HMRC.

Practitioners preparing IVA proposals in cases where HMRC holds PAYE or employee NIC arrears should model the proposal on the basis that those amounts will need to be paid at 100% (or close to it) and only the income tax, CGT and personal NIC arrears will be subject to the composition. This substantially reduces the practical debt relief available from the IVA in cases with significant PAYE arrears.

HMRC’s Voting Policy

HMRC has published guidance for insolvency practitioners on its approach to voting in individual voluntary arrangements (available through HMRC’s insolvency practitioner guidance and the Insolvency Service’s published statements of practice). HMRC will generally vote in favour of an IVA where:

1. The return is better than bankruptcy: The proposed dividend to unsecured creditors must demonstrably exceed the estimated return in the event of bankruptcy. HMRC will commission or accept an independent estimation of the bankruptcy return, and the IVA offer must be clearly better, typically by a meaningful margin, not just fractionally.
2. Equal treatment of creditors: HMRC’s debts (to the extent unsecured) must be treated no less favourably than the debts of other unsecured creditors. A proposal that offers commercial creditors a higher rate of return while offering HMRC a lower rate will be rejected.
3. Ongoing compliance: The debtor must be up to date with all current tax filing and payment obligations during the IVA or must have an agreed plan to become compliant. An IVA proposal from a debtor who is accumulating fresh liabilities during the arrangement period will not attract HMRC support.
4. No prohibited terms: The proposal must not contain any of the prohibited modifications described below.
5. No fraud or deliberate concealment history: Where the tax debt arose from deliberate fraud, systematic concealment or persistent non-compliance, HMRC is less likely to vote for an IVA, both as a matter of policy and because the trust-assets argument applies more forcefully.

HMRC will generally vote against where:

• The IVA offers less than the estimated bankruptcy dividend;
• The debtor has a prior failed IVA, unless there are compelling reasons;
• The tax debt includes significant PAYE arrears that HMRC treats as trust assets;
• The debtor has a history of serial insolvency used to defeat HMRC;
• Criminal proceedings are pending in relation to the tax debt.

The 75% Threshold and HMRC’s Blocking Power

The 75% approval threshold under s 260(1)(b) IA 1986 (as modified by the 2016 Rules) means that any creditor holding more than 25% of the total provable debt by value can single-handedly block an IVA. In practice, HMRC frequently holds this blocking stake, particularly where:

• The debtor is a self-employed sole trader or former contractor whose creditors are predominantly HMRC;
• The debtor owes significant income tax, CGT and NIC arrears accumulated over several years without assessment;
• Commercial creditors are secured or have been partially repaid, leaving HMRC as the dominant unsecured creditor.

Where HMRC holds the blocking stake, the IVA is effectively impossible without HMRC’s consent. The practitioner’s role in these cases is to negotiate the terms of the proposal with HMRC’s insolvency unit before the formal decision procedure is invoked. Pre-approval engagement with HMRC, presenting detailed bankruptcy comparisons and evidence of the debtor’s compliance intention, significantly improves the probability of a positive vote.

Prohibited IVA Modifications (Sch 4A IA 1986)

Schedule 4A of the Insolvency Act 1986 sets out terms that are prohibited in individual voluntary arrangements, regardless of creditor approval. For HMRC, the most significant prohibited modifications are:

• Restricting HMRC’s investigation powers: An IVA cannot prevent or restrict HMRC from exercising its powers under Schedule 36 Finance Act 2008 to issue information notices and require the production of documents. Any term purporting to give the debtor an immunity from HMRC information requests is void.
• Restricting discovery assessments in fraud cases: An IVA cannot prevent or restrict HMRC from making or recovering discovery assessments where the tax was lost through the debtor’s fraud. HMRC’s ability to assess and recover in fraud situations is ring-fenced.
• General statutory duty restrictions: An IVA cannot contain terms that would prevent HMRC from carrying out its statutory duty to collect and manage taxes.

These prohibitions mean that an IVA is not a shield from ongoing HMRC investigation. A debtor who proposes an IVA while under a live HMRC investigation cannot include terms requiring HMRC to cease or suspend that investigation as a condition of the arrangement. Any IVA that purports to do so is void to that extent and a supervisor who allowed such terms to operate would be acting unlawfully.

Challenging a Failed Vote

Section 262 IA 1986 provides that a creditor, the nominee or the debtor may apply to court to challenge the outcome of the IVA decision procedure on two grounds:

1. Unfair prejudice: The IVA as approved unfairly prejudices the interests of a creditor (used by a dissenting creditor who was outvoted but says the terms are prejudicial to them specifically).
2. Material irregularity: There was a material irregularity at or in relation to the decision procedure.

In the context of HMRC vetoing an IVA, these provisions are less directly applicable (the IVA has not been approved, so there is nothing to challenge under s 262). However, if HMRC’s vote was for the IVA (and it passed) but HMRC subsequently attempts to re-open settled debts in breach of the arrangement, the IVA supervisor can apply to court to enforce the arrangement’s binding effect.

More relevant is the question of whether HMRC’s decision to vote against can itself be challenged. HMRC exercises a public function as a statutory body when voting as a creditor. In principle, a decision to vote against an IVA on grounds that are legally impermissible, for example, on the basis of HMRC’s own convenience rather than any legitimate creditor interest, could be challenged by judicial review. In IRC v Wimbledon Football Club Ltd [2004] EWCA Civ 655, the Court of Appeal considered the analogous position in company voluntary arrangements and confirmed that HMRC’s creditor vote is subject to a general duty of good faith. A vote cast in bad faith or for an improper purpose could in principle be subject to judicial review, though in practice the threshold is high and such challenges are rare.

Alternatives When HMRC Blocks

Where HMRC vetoes an IVA, the following alternatives should be considered:

Renegotiate and Resubmit

A revised IVA proposal can be submitted. If HMRC’s objection was to the quantum or terms rather than a fundamental bar (such as fraud), improving the offer, higher monthly payments, a lump sum from a third party or a longer duration, may secure a positive vote on resubmission. HMRC’s DMB team will usually indicate what it would need to see to vote in favour.

Time to Pay Arrangement

HMRC has a statutory duty to consider Time to Pay (TTP) arrangements for taxpayers who cannot pay their liabilities in full. A TTP is an informal agreement to pay arrears in instalments, typically over 12 to 36 months, though longer periods are possible in appropriate cases. It is not insolvency and does not bind other creditors, but it may address the HMRC portion of the debt while the debtor manages other creditors separately. For the analysis of HMRC’s TTP approach, see the related resource on HMRC Time to Pay.

Statutory Demand and Bankruptcy

Where HMRC has vetoed the IVA and the debtor cannot meet the liability, HMRC may issue a statutory demand as a precursor to presenting a bankruptcy petition. The debtor has 18 days to apply to set aside the statutory demand (r.10.4 Insolvency Rules 2016). Grounds for setting aside include a genuine dispute as to the underlying liability or an IVA proposal pending that is likely to be successful, though where HMRC has already voted against, the latter ground will be difficult to establish.

Debt Relief Order

For lower-value debts (currently below £30,000 of qualifying debt, with less than £75 monthly disposable income and assets under £2,000), a Debt Relief Order (DRO) may be available as a lower-cost alternative to both an IVA and formal bankruptcy. DROs do not require creditor consent and HMRC debts can be included, subject to the eligibility thresholds.

Practitioner Strategy

Engage HMRC’s DMB Team Early

Before preparing a formal IVA proposal, contact HMRC’s Debt Management and Banking (insolvency) team informally. Identify the debt breakdown (income tax, PAYE, NIC, penalties) and obtain clarity on HMRC’s position on the PAYE and trust issue. A preliminary conversation avoids the cost and embarrassment of a formal proposal that HMRC will predictably reject.

Quantify the HMRC Debt Precisely

Obtain a full breakdown of HMRC’s claimed debt. Check for errors: HMRC’s systems can overstate liabilities due to coding errors, duplicate assessments or penalty calculations that include disputed underlying liabilities. Correcting these before the proposal reduces HMRC’s share of total debt and may reduce its blocking stake below the 25% threshold.

Model the Bankruptcy Comparison Carefully

The bankruptcy comparison is the cornerstone of HMRC’s creditor decision. Overestimate it and the IVA looks unnecessarily generous; underestimate it and HMRC will question its accuracy. A robust, independently evidenced bankruptcy comparison using realistic realisations from the debtor’s available assets is essential.

Address Compliance History

If the debtor has a poor compliance history, acknowledge it and evidence the steps taken to resolve it, outstanding returns filed, payment arrangements in place, accountant engaged. HMRC is more likely to vote for an IVA from a debtor who demonstrates genuine commitment to future compliance than from one whose proposal is silent on the question.

Worked Example: Sole Trader with Mixed Creditor Profile

A self-employed plumber (“Client F”) has accumulated the following debts: HMRC income tax and NIC arrears: £48,000; HMRC penalties: £12,000; PAYE arrears (two former employees): £8,000; bank overdraft: £15,000; trade creditors: £17,000. Total: £100,000.

• HMRC’s share: £68,000 = 68% of total debt. HMRC holds far more than the 25% blocking stake.
• PAYE issue: The £8,000 PAYE is preferential since December 2020. HMRC will require this to be paid in full, not at the IVA composition rate. The effective IVA pool therefore needs to cover £8,000 preferentially before applying the dividend to the remaining £92,000.
• Bankruptcy comparison: Client F owns a van worth £8,000 and has a contributory income after living expenses of £900/month. A trustee in bankruptcy would realise £8,000 from the van and could take contributions of approximately £500/month for 3 years (£18,000). Total bankruptcy dividend: £26,000 = 26p in the pound.
• IVA proposal: Client F proposes 60 monthly payments of £800 plus the van proceeds (£8,000) = £56,000 total. After supervisor fees (approximately £8,000), available to creditors: £48,000. Pay PAYE preferentially: £8,000. Remaining to unsecured: £40,000 from a pool of £92,000 = 43.5p in the pound. Substantially better than the 26p bankruptcy dividend.
• Outcome: HMRC votes in favour. The commercial and bank creditors (holding the remaining 32%) also vote in favour. The IVA is approved. Client F’s obligations are consolidated and the arrangement completes after 5 years with the balance written off.

Practitioner Checklist

1. Obtain a full HMRC debt breakdown , income tax, NIC, VAT, PAYE (including split between employee deductions and employer NIC) and penalties.
2. Check HMRC’s share of total debt: if above 25%, HMRC holds the veto and early engagement is essential.
3. Identify PAYE and preferential debt , these cannot be included in the composition and must be paid in full.
4. Prepare a robust bankruptcy comparison showing the estimated return to creditors in bankruptcy vs the IVA proposal.
5. Engage HMRC DMB informally before submitting , present the draft proposal and bankruptcy analysis.
6. Ensure current compliance: outstanding returns must be filed and current liabilities addressed before the proposal is submitted.
7. Check for prohibited modifications (Sch 4A IA 1986), the proposal must not restrict HMRC’s investigatory or assessment powers.
8. Address the ongoing investigation risk: include a contingency for further assessments arising from any live HMRC investigation.
9. Advise on alternatives if HMRC is likely to veto, TTP, DRO, revised proposal or bankruptcy proceedings.

Frequently Asked Questions