What If I Pay Staff but Not HMRC Before Liquidation?

Paying your staff before paying HMRC when the company is insolvent is not just a moral instinct. It is a legal risk. The liquidator can claw that payment back as a preference, and you personally may have to explain why you chose one creditor over another when you knew the company could not pay everyone.

We understand the impulse. Your staff have families, they rely on their wages, and the idea of leaving them unpaid while HMRC gets its share feels wrong. But insolvency law does not care about fairness in the way you might expect. It cares about arithmetic.

It cares about the statutory creditor priority order, and HMRC is a preferential creditor for certain debts. Paying staff ahead of HMRC can create a preference under section 239 of the Insolvency Act 1986, and it can also form part of a wrongful trading claim against you personally.

Quick Answer: Can You Pay Staff Before HMRC in Liquidation?

If your company is insolvent or approaching insolvency, paying staff their normal wages for work already done is generally defensible. Paying staff bonuses, enhanced redundancy, or accelerated payments that go beyond their contractual entitlement is not.

And failing to pay HMRC debts that have preferential status (PAYE, employee NICs, and VAT collected on behalf of HMRC) while paying other creditors is exactly the kind of conduct liquidators investigate.

The question is not whether you should pay your staff. It is whether the payments you are making are ordinary course payments for work done, or whether they look like selective creditor preference when examined after the fact by a liquidator who was not in the room when you made the decision.

Why HMRC Gets Paid Before Staff in Liquidation

Since December 2020, HMRC regained preferential creditor status for certain tax debts. This means that in any insolvency, HMRC ranks ahead of floating charge holders and unsecured creditors for:

• PAYE income tax deducted from employees’ wages
• Employee National Insurance contributions
• VAT
• Construction Industry Scheme deductions
• Student loan repayments collected through payroll

These are taxes you collected on behalf of HMRC, not the company’s own tax liabilities. Corporation Tax and employer NICs remain unsecured. Our guide to the order creditors are paid sets out the full statutory ranking the liquidator must follow.

The distinction matters because paying an unsecured creditor (including your staff) ahead of a preferential creditor (HMRC for the debts listed above) is a stronger indicator of preference than paying one unsecured creditor ahead of another.

We find that most directors do not realise HMRC regained this preferential status. The change was introduced by the Finance Act 2020 and took effect for insolvencies on or after 1 December 2020. If you are making payment decisions now, you need to understand this hierarchy.

Paying Staff Before HMRC: What Counts as a Preference

Section 239 of the Insolvency Act 1986 defines a preference as a payment or action that puts a creditor in a better position than they would have been in if the company had gone straight into liquidation. The liquidator can challenge any preference made in the six months before the onset of insolvency, or two years if the creditor is a connected party.

For a preference claim to succeed, the liquidator must show that the company was influenced by a desire to put that creditor in a better position. This is where the nuance sits.

Paying your staff their normal monthly wages for work they have actually done is unlikely to be challenged, because you are meeting an existing contractual obligation in the ordinary course of business.

But paying a staff member a lump sum bonus, settling a director’s loan account, making enhanced redundancy payments beyond the statutory minimum, or paying a family member who also happens to work for the company: all of these look different to a liquidator.

We regularly see directors who made payments they considered perfectly reasonable at the time, only to have those payments unwound months later because the liquidator could show they were preferential.

Wrongful Trading Risk When Paying Staff Over HMRC

Preference claims are about individual payments. Wrongful trading is about the bigger picture.

Section 214 of the Insolvency Act 1986 makes directors personally liable if they continued to trade when they knew, or should have known, that insolvent liquidation was unavoidable, and they did not take every step a reasonably diligent person would take to minimise the potential loss to creditors.

Choosing to pay staff instead of HMRC when the company is clearly insolvent is evidence that you were still making discretionary payment decisions rather than placing the company into formal insolvency.

The liquidator will ask: if you knew there was not enough money to pay everyone, why were you still deciding who to pay? That question is harder to answer than most directors expect.

We are not saying you should stop paying staff. We are saying that if you are at the point where you are choosing between creditors, you have almost certainly passed the point where you should be taking professional advice about a formal insolvency process.

Employee Protection When the Company Is Liquidated

Directors often prioritise staff payments because they assume their employees will get nothing in liquidation. That is not the case. The statutory framework provides substantial protection for employees.

The National Insurance Fund. As we explain in our guide to employee rights in liquidation, employees of insolvent companies can claim from the National Insurance Fund for up to 8 weeks’ arrears of pay (capped at £643 per week as of April 2024), up to 6 weeks’ holiday pay, statutory notice pay, and statutory redundancy pay. These claims are handled by the Redundancy Payments Service.

Preferential creditor status for wages. Employees are preferential creditors for up to four months’ unpaid wages (capped at £800 per employee) and accrued holiday pay. They rank ahead of HMRC’s secondary preferential claims and ahead of all unsecured creditors in the distribution.

The protection is not perfect, and the caps mean higher-paid employees may not recover everything they are owed. But it is significantly better than nothing, and it means that paying staff out of company funds before liquidation, at the expense of other creditors, is less justified than directors assume. We explain this to every director we advise, because it usually changes the decision.

What to Do Instead of Choosing Between Staff and HMRC

If you are at the point where you cannot pay both staff and HMRC, here is what we advise:

1. Stop making selective payments. Pay normal wages for work done in the ordinary course. Do not make bonus payments, enhanced redundancy, or director loan repayments.
2. Speak to a licensed insolvency practitioner immediately. You need professional advice on whether the company should continue trading and, if not, which formal insolvency route is appropriate.
3. Document every payment decision. If you do continue to pay staff, record why, when, and on what basis. The liquidator will examine your payment decisions, and contemporaneous records are the strongest evidence that your decisions were made in good faith.
4. Do not assume HMRC will wait. HMRC has extensive enforcement powers, including the ability to issue a winding-up petition for debts over £750. If you are not paying HMRC, they may force the issue before you are ready. Our guide on what happens if you stop paying company debts sets out the creditor action that tends to follow.
5. Tell your staff the position. A Friday afternoon conversation where you explain what is happening and what they can claim is uncomfortable. Not having that conversation and letting them find out from the liquidator’s letter the following Monday is worse. If the company is likely to enter insolvency, your employees are better served by honest communication and guidance on how to claim from the National Insurance Fund than by receiving payments that the liquidator may later claw back.

Company Debt connects directors with licensed, regulated insolvency practitioners who can assess your position and help you make payment decisions that are defensible. If you are choosing between creditors, get liquidation advice now, not after the liquidator starts asking questions.

FAQs on Paying Staff Before HMRC in Liquidation