ECSH82785 - Sanctions for non-compliance: financial penalties: financial penalties framework: type 1 (benefits gained) compliance penalties [money service businesses (MSBs), high value dealers (HVDs) and art market participants (AMPs)]

Introduction

This guidance is to assist the decision maker (DM) calculate Type 1 Penalties (Compliance Penalties) for MSBs, HVDs and AMPs only. There is a separate framework, known as Scale Charge Framework, which relates to Accountancy Service Providers (ASPs), Estate Agency Businesses (EABs), Letting Agency Businesses (LABs) and Trust or Company Service Providers (TCSPs) Type 1 Penalties.

Type 1 penalties are subject to a sanctions administration charge capped to a maximum of £2,000.

There are two key components for this framework A and B.

Component A strips away, or disgorges, income received that relates to the contraventions of the MLRs. In determining the amount income received, the DM needs to take into account any financial benefit gained and/or any losses avoided. This embeds the important principle that no one should benefit from non-compliant activity.

Component B is intended to act as a deterrent for the business in contravention, and any other businesses who make similar contraventions. 

There are 3 stages to component B

  • Stage 1 is the calculation of the penalty, based on the disgorged amount calculated at component A.
  • Stages 2 and 3 are the considerations of whether the penalty calculated at stage 1 is appropriate and whether reductions should be applied.

When considering potential reductions (in Stage 2), as well as the appropriateness of the overall final penalty (in Stage 3), this will only relate to the amount established in Stage 1: the overall penalty amount cannot be lower than that the amount calculated in component A. The reason for this is that a penalty that is issued, as a minimum, should remove any financial benefit (including losses avoided) from non-compliant activity.  

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Stage

Description

Fixed or variable amount

Component A

Disgorgement of benefits

Identify any financial benefit gained from non-compliant activity

Fixed amount

Component B

Stage 1 – Penalty Calculation

Higher Tier Penalty (200% of Component A value) or Lower Tier Penalty (100% of Component A value)

+100% or +200% of Component A

Component B

Stage 2 - Behavioural Reductions

Consideration or reducing Stage 1 based on co-operation and behaviour

Variable

Component B

Stage 3 - Appropriateness

Whether Stage 2 penalty is too low or too high and whether other sanction(s) should be used instead or additionally

Potential adjustment to penalty calculated at end of Stage 1 and 2

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Issue penalty

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Total payment due is Component A + Component B

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Prompt payment discount of 25% (applies only to Component B)

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An overview of the stages of the calculation

Component A– Removal of benefits gained from contraventions or the Money Laundering Regulations (MLRs)

This is a non-negotiable element. Once identified the DM cannot adjust amount as part of the overall penalty calculation unless evidence comes to light to adjust the basis: the stripping of benefits gained from non-compliant activity is core to the principle that no-one should gain from non-compliant activity.

HMRC will not allow a business to benefit from breaching regulations. 

The DM should establish the income gained and / or losses avoided from the contraventions. Component A of the framework ensures that all income gained by non-compliant activity is reflected in the total penalty. This calculation will vary, depending on the specific circumstances of the business, and below are some examples of how this may be calculated.

The benefit gained will be income before taking account of any costs to the business, such as bank charges.

If the contraventions relate to systemic issues, such as a business’s risk assessment, policies, controls or procedures, it is likely the entirety of the transactions will be in contravention, therefore all income gained will be liable for the Component A calculation.  When testing transactions and customer due diligence, if contraventions are found within a percentage of the transactions / customer due diligence, if an appropriate sample, this percentage can be apportioned to the entirety of the business. 

For example

Breaches found in 40% of customer due diligence tested.

Appropriate amount of customer due diligence tested to consider it is a fair representation of the entire business.

  • 40% of transactions to be used as basis for calculating benefits made from contraventions.
  • if business has varying fees, calculate the average of this, considering what are the most common value for transactions fees.

Different scenarios for identifying the benefits made includes

  • Money transmitter – identifying income from the commission rates / charges for the transactions concerned
  • Currency exchange / Forex – identifying the income received
    • if transactions are timed/delayed, compare rate at buying compared to rate at selling
    • if not sold yet, use rate on that day 
    • if it is lower, treat the rate as £0.00 profit, this will ensure the value being calculated at Component A is not reduced and the business will be considered as ‘breaking even’
  • Cheque cashing – income from the difference in value of cheque and what business has paid to the customer
  • High Value Payments (cash) – difference between the sold price of the goods (or expected selling price) and the price the products were bought for
  • AMPs - the income received for the services they have provided, or goods sold

Losses avoided

As well as calculating income received, the DM should also include in Component A any losses avoided at this stage. Examples of losses avoided may include

  • Not having a Compliance/Nominated Officer in place.
    • the average salary for the Compliance / Nominated Officer (CO/NO), proportionate to the size and nature of the business.
    • please note, there may be a National average and a London average, as well as consideration regarding the size of the business and relevant salaries within the business in concern 
    • dependent upon the size of the business, it may not be necessary to employ a dedicated CO/NO, but there must be a Nominated Officer for the business, even if they undertake numerous roles. If this could be done as part of another role, a calculation should be done based on a proportion of the typical salary of a CO/NO in that sector or a proportion of the salary of another manager in the business to act as a NO based on the amount of time it should have taken them to ensure the business was compliant

  • Failure to complete politically exposed person (PEP) checks, how much would it have cost to undertake the checks (assuming using a system which charges for PEP checks, or how much cheaper the system is because when developing, PEP checks were not included)
    • if this is not initially clear, attempt to (if possible) calculate how much money would be saved in regard to time/salary for a relevant staff member to complete those checks.

  • If outsourcing customer due diligence to a third party, but not utilising them correctly / fully, what was the cost for the money saved not paying the third party, for aspects of customer due diligence that was required?
  • Not correctly undertaking customer/enhanced due diligence which requires an additional expense.
    • cost these additional checks would have incurred should be included in component A calculation.

Component B

Stage One – Penalty (Higher Tier or Lower Tier)

The next stage of the penalty framework is to establish whether the penalty is to be categorised as a higher or lower tier penalty.  This will influence how much penalty will be added to the recovery of the benefits made / losses avoided from contraventions, identified in Component A. The seriousness of the contraventions (the nature and duration of the non-compliance) will determine whether the business should receive a higher or lower tier penalty.  Contraventions with high severity will be categorised as a Higher Tier Penalty and, conversely, less severe contraventions will be categorised as a Lower Tier Penalty. 

When deciding whether the penalty is to be categorised as higher or lower, the deciding officer should consider

  • Are the contraventions widespread across the relevant business activity?
  • Are the contraventions extensive / has the individual / business breached numerous regulations and to what degree were these regulations breached?
  • Did the failings continue for a substantial period before being addressed?
  • Does the individual / business have a history of non-compliance with HMRC, and been warned or sanctioned before? (We may want to consider compliance wider than the MLR as we do when deciding fit and proper such as tax compliance and furlough fraud)
  • How has the individual’s/business’s risk of money laundering and/or terrorist financing been affected by the non-compliance?
  • What other negative impacts are there due to the contraventions?

Whilst there is no ‘one size fits all’ for determining whether a penalty should be classified as Higher Tier or Lower Tier, a reasonable approach would be to classify a penalty as Higher Tier if the answer to at least two of the questions above suggests that the non-compliance is / was significant. There may be cases, however, where contraventions are so significant that although only one of the above is met, the failing is so severe as to warrant a Higher Penalty. In some cases, there may be additional questions not detailed above which would assist in making the decision to classify the penalty as being either Higher or Lower.

Lower Tier Calculation

If a penalty is to be categorised as a Lower Tier, the stage 1 penalty value should be the same as the Component A disgorgement figure. 

If the Component A disgorgement = £100,000, then the Stage 1 penalty will = £100,000

Total value of the fine = £200,000

Higher Tier Calculation

If a penalty is to be categorised as a Higher Penalty, at Stage 1, the value established at Component A should be doubled.

For example:

If the Component A disgorgement = £100,000, then the Stage 1 Penalty will = £200,000

Total = £300,000

Stage Two – Behavioural reductions

This stage involves consideration of whether the Stage 1 amount should be reduced to reflect the behaviours of the business. 

Reductions must not be applied to the Component A disgorgement figure.

There are three considerations to make at this stage, they are

  • Did the business make an unprompted disclosure, see ECSH82825, of their non-compliance (maximum 50% reduction to the penalty) or did this come to light as a result of any HMRC or other agency activity or intervention (or the imminence of one);
  • Was the non-compliance due to carelessness, see ECSH82830, (25% reduction) or deliberate, see ECSH82835, (no reduction); and
  • Did the business co-operate, see ECSH82845, with HMRC to establish the facts and establish the non-compliance (25% reduction)

Stage Three – Appropriateness review

When issuing a financial penalty, the DM must ensure that any penalty is effective, proportionate, and dissuasive. The appropriateness review is the documented consideration that DMs must make, explaining how both the penalty is appropriate and why the amount being imposed is appropriate. All of the relevant factors of the case must therefore be taken into account and documented within the appropriateness review, along with consideration of the relevant factors within regulation 83(1) MLR 2017. Failing to ensure that the penalty is appropriate, or accurately recording all factors and considerations, may lead to the penalty, if challenged, being reduced or set aside.

The appropriateness review is the final stage of the application of the penalty framework, which reviews the penalty already calculated at stages 1 and 2 of component B and allows for the penalty to be adjusted up or down, if appropriate.

In helping to ensure that penalties are consistent and appropriate, the DM should consider the following factors:

Severity of the contravention(s)

Are the contraventions so severe, that it would be more proportionate to issue a penalty higher than the value calculated at the end of Stage 2 (assuming criminal referral has already been ruled out).

Financial Strength

The financial strength of the business/person being penalised must be considered; it should not be the intention of a penalty to liquidate the business. However, we should not rule out issuing a large penalty, if the penalty is appropriate to the situation, especially in the most severe cases of non-compliance.

When considering financial strength of the business, HMRC should, where appropriate, consider the following:

  •    Gross profit
  •    Net assets
  •    Any other debts owed to HMRC/other law enforcement agencies.

Generally speaking, if the penalty calculated at Stage 2 exceeds three years' worth of gross profit, serious consideration should be made as to whether the business will be able to repay the penalty and its amount reduced. This consideration should bear in mind other factors, such as the nature and extent of the breaches and the business' attitude to compliance, as well as the fact that HMRC can allow trader ‘time to pay’ any penalties over an extended period. There is no strict penalty cap for these sectors.

Proportionality

The proportionality of the overall package of sanctions must be considered. For example, whether the combined impact of cancellation, penalties and action against the directors is disproportionate.

How do our actions affect the financial viability of the business and its ability to pay the penalty?

Suspending or cancelling the registration may result in reduced income for the business (depending on the proportion of their business which undertakes unregulated activity), therefore the ability for the business to pay the penalty may be adversely affected.

Considering the factors listed above, should we adjust the penalty to reflect this?

When considering the overall package of sanctions, we may want to consider whether the penalty should be imposed upon individuals responsible for the business’ compliance as well or instead of the business as a whole. Where this is done, the overall proportionality of the full range of measures should be considered, both in terms of proportionality to the contraventions and impact on the business and individuals.

Comparisons to penalties for similar/linked businesses issued under this framework.

For example:

  • MSB A has funds at risk of £10 million and profits made equate to £50,000.
  • MSB B has funds at risk of £45 million and profits made equate to £70,000.
  • MSB A is a customer of MSB B.
  • MSB A and MSB B display same behaviours and have same behavioural reductions.
  • MSB A penalty at Stage 2 is £125,000.
  • MSB B penalty at Stage 2 is £175,000.
  • A decision must be made whether MSB B who has over 4 times the amount of funds at risk should receive only marginally larger than that of MSB A, their customer. We do not necessarily need to follow precedents/comparisons slavishly, but we should consider legal, reputational and other risks of taking a very different approach and whether these can be defended.

Early payment reduction

If the penalty is paid within 30 days of the date of the penalty notice, an early payment reduction is applied. The early payment reduction is 25% of the penalty aspect only, that is, Component B, not to Component A. Neither the disgorgement of benefits nor the sanctions administration charge should be reduced for prompt payment. For example

  • Business owes £12,500 (£5,000 disgorgement of benefits, plus £7,500 penalty)
  • Business pays within 30 days of receiving notice.
  • Business due to pay: £5,000 disgorgement of benefits + (£7,500 – 25%), plus £2,000 sanction administration charge.
  • £5,000 + £5,625, plus £2,000 sanction administration charge.

Payment within the 30 days does not affect any right to request a review or make an appeal.

Examples

Example 1

Money transmitting MSB has failed to undertake PEP checks upon their entire network of businesses. Two years prior, the business was warned about this concern, but no further sanctions were issued because there were no PEP transactions at this point. During the inspection, HMRC identified numerous PEPs within the customer list. Upon inspection, it was established that PEP transactions totalled £600,000.

Component A

The business charges 1% commission rate for transactions therefore the business, through remittance fees, has received £6,000 income.

As well as this, where the business has not undertaken PEP checks upon all of their customers via the customer due diligence service they use, the business has potentially saved £2,000 (the cost for enabling the PEP check service)

Combining the profits made from contraventions, as well as losses/costs avoided, the value at Component A is £8,000.

Stage One

The contraventions are categorised as warranting a Higher Penalty. This is because of the high level of risk associated with PEPs which has not been mitigated and the previous warning issued for this exact same failure. Whilst the contraventions are only associated with PEP checks, it has resulted in a systemic failure across the business (relating to PEPs) and the business has previously been warned of this. As the penalty is categorised as Higher, the Stage 1 penalty is the value established at Component A, multiplied by 2.

£8,000 x 2 = £16,000

Stage Two

The next step is to consider the behavioural reduction (only for the Stage 1 value (£16,000)).

The contraventions are identified as part of a compliance inspection; therefore, the disclosure is prompted: no reduction.

The business was previously warned of this; therefore, the contraventions are to be categorised as knowingly: no reduction.

The business has been proactively cooperative throughout the entirety of the intervention, sharing relevant information without being asked for it: 25% reduction.

£16,000 - 25% = £12,000

The income generated and losses avoided, established in Component A, are now added to the penalty (including relevant reductions) to determine the amount to be paid (plus the admin charge).

£8,000 (Component A) + £12,000 (Stage 2 after reductions) = total amount payable of £20,000

Stage Three

The business most recent gross profit equates to £50,000.

The disgorgement of benefits (£8,000) plus the penalty calculated thus far (£12,000) is below the business’ gross profit (£50,000). The contraventions only impacted a small percentage of the business’ throughput (2% in total), but the business had previously been warned about this failing and had not acted on these. Looking at the entirety of the facts in this case, the penalty calculated up to Stage 2 is considered appropriate.

No further profits made, or losses avoided are identified. The total sanction (and therefore the total amount publishable) is £20,000 (consisting of the disgorgement of benefits and the penalty). The payment due will be the £20,000 plus the sanctions administration charge.

If the business pays within 30 days of the Penalty Notice being issued, they will only be liable to pay

  • £8,000 Disgorgement of benefits + (£12,000 Penalty – 25%) + sanctions administration charge
  • £8,000 + £9,000 + sanctions administration charge = £17,000 + sanctions administration charge

Example 2

An MSB does not have an appropriate risk assessment, therefore, does not have an appropriate policies, controls and procedures in place to manage money laundering, terrorist- and proliferation-financing risks.

The entire throughput of the business is therefore at risk.

The business has been registered for two years and their throughput has been £10 million in that time.

Component A

The business exchanges are made up of 70% Euros, 20% US Dollar, 5% Canadian Dollar, 5% Australian Dollar.

As it will prove to be too difficult to calculate all of the exchange rates over two years, the business’ income for the past two years is noted. There is no other business activity, therefore all of the income can be accounted for by the currency exchange.

For the two years of relevant activity, the business averaged mark-up of the following

  • Euros 1.5%
  • US Dollar 3%
  • Canadian Dollar 4%
  • Australian Dollar 5%

Euros

70% Euros = £7 million

£7 million with 1.5% mark-up = £7 million / 1.015 = £6,896,552

£7 million - £6,896,552 = £103,448

Profits from Euros exchanges = £103,448

US Dollar

20% US Dollar = £2 million

£2 million with 3% mark-up = £2 million / 1.03 = £1,941,748

£2 million - £1,941,748 = £58,252

Profits from US Dollar exchanges = £58,252

Canadian Dollar

5% Canadian Dollar = £500,000

£500,000 with 4% mark-up = £500,000 / 1.04 = £480,769

£500,000 - £480,769 = £19,231

Profits from Canadian Dollar exchanges = £19,231

Australian Dollar

5% Australian Dollar = £500,000

£500,000 with 5% mark-up = £500,000 / 1.05 = £476,190

£500,000 - £476,190 = £23,810

Profits from Australian Dollar exchanges = £23,810

The income combined is therefore £103,448 (Euros) + £58,252 (US Dollar) + £19,231 (Canadian Dollar) + £23,810 (Australian Dollar) = £204,741

Stage One

The contraventions are categorised as warranting a Higher Penalty. This is due to the fact the contraventions are widespread across the business and the fact that the contraventions have been occurring for two years (the entire time the business has been undertaking relevant activity).

£204,741 x 2 = £409,482

Stage Two

The next step is to consider the behavioural reduction (only for the Stage 1 value (£409,482)).

The contraventions are identified as part of a compliance inspection; therefore, the disclosure is prompted: no reduction.

The business is aware of their requirements to undertake a business risk assessment but has made a poor attempt, knowingly neglecting, key aspects and resulting in inappropriate risk assessment and policies, controls and procedures. Therefore, no reduction is appropriate.

The business has been passively cooperating throughout the entirety of the intervention, providing only what information we have expressly asked for. Upon further investigation, the compliance officer found that the business held additional pertinent information regarding its non-compliance, that we had not requested specifically. Whilst we cannot evidence that the business tried to hide this information from us, it had not proactively disclosed. Whilst the business has not been obstructive, and we have not had to use information-gathering powers, its behaviour does not warrant a 25% reduction.

The income received and losses avoided, established in Component A, are now added to the penalty (including relevant reductions) to determine the amount to be paid (plus the admin charge).

£204,741 (Component A) + £409,482 (Stage 2, no reductions) = £614,223 (plus admin charge)

Stage Three

The business’ most recent gross profit is £120,000. As well as this, the business has net assets totalling £15,000.

Due to the concerns relating to the business’ risk assessment and policies, controls and procedures, combined with the relevant money laundering and terrorist financing risk within the sector, the business’s registration is to be suspended for 6 months. During this time the business will need to satisfy HMRC that the reason(s) for the suspension no longer exist. If it does this before the suspension ends, it will be lifted at that time, and it can resume trading. If it fails to do this, a further suspension, or other sanctions, should be imposed.

The penalty calculated is in excess of three times the amount of the most recent gross profit.

As well as this, the business, which derives all its income from supervised activity, is set to have no income from MLR activities for the next six months due to the suspension (unless the issues are rectified, and the suspension lifted sooner).

No other profits gained, or losses avoided were identified.

The Stage 3 considerations suggest that the penalty amount derived at Stage 2 is inappropriate, primarily due to the business’ financial strength.

Normally, if the penalties calculated at Stage 2 exceed three times the most recent gross profit, the business is likely to struggle to pay and the penalty may not be appropriate. In this scenario, 3 year’s profit would equate to £360,000.

As well as this, the business will not generate any income for the next 6 months (unless the suspension is lifted sooner). Thus, there is a strong case for reducing the penalty from the £614k identified in Stage 2.

The penalty amount calculated at Stages 1 and 2 only (not Component A) should be re-examined and reduced as appropriate.

In this scenario, combining the disgorgement of benefits at Component A with a smaller deterrence penalty than that calculated in Stage 2, as well as the suspension of registration, is considered an appropriate sanctions package for the business.

The suspension places a significant sanction on the business and will act as a risk-prevention measure and deterrence against future non-compliance. Considering this, as well as the financial situation of the business, reducing the Stage 1/2 penalty component would be in order. Applying a 75% reduction to the Stage 1/4 component produces a deterrence penalty of 50% of the disgorgement of benefits figure calculated at Stage 1.

50% of £204,741 = £102,370

Final payment due = £204,741 disgorgement of benefits, plus £102,370 penalty, plus sanctions administration charge of £2,000. Total amount = £308,841

Alternatively, the case officer might impose a penalty equal to 3 year’s gross profit less the six months of the suspension (£360k - £60k = £300k).

Using the £308k penalty, if the business pays within 30 days of the Penalty Notice being issued, it will only be liable to pay

  • £204,741 Disgorgement of benefits + (£102,370 Penalty – 25%) + £2,000 sanctions administration charge
  • £204,741 + £76,777 + £2,000 = £283,518

Example 3

A HVD has recently expanded and recruited an additional employee to assist with sales. The employee has been in role for 6 months when the HMRC intervention takes place. During the intervention, it is noted the new employee has not had any appropriate training in anti-money laundering, counter terrorist financing or counter proliferation financing, therefore cannot accurately identify risks if they occur. Additionally, that employee has processed a small number of HVPs without conducting appropriate risk assessments and due diligence. Equivalent members of staff have undertaken the training which cost £1,200 per person.

Component A

The employee has completed 4 relevant transactions in that time, equating to £52,000, on which the HVD received an income of £4,500. The business has also saved £1,200 in training.

£4,500 + £1,200 = £5,700

Stage One

The contraventions are categorised as warranting a Lower Penalty. This is because the business had adequate risk assessments and policies, controls and procedures in place, but failed to train their new member of staff who didn’t follow these. Thus, contraventions are focussed only on a small fraction of the business, undertaken by one individual, over a short period of time.

£5,700 x 1 = £5,700

Stage Two

The next step is to consider the behavioural reduction (only for the Stage 1 value (£5,700)).

The contraventions are identified as part of a compliance inspection; therefore, the disclosure is prompted, so no reduction.

The business was aware of the requirements to train relevant employees in anti-money laundering and counter-terrorist financing topics but failed to train a relevant employee. The awareness is shown by the fact that other employees of the business are all appropriately trained. Considering the above, with the period of time (6 months) the employee in question has been in the role without any relevant training, it is reasonable to conclude the business was aware the employee should already be trained, therefore no reduction is appropriate.

The business has been cooperative throughout the entirety of the intervention: 25% reduction.

£5,700 - 25% = £4,275

The benefits made and losses avoided, established in Component A, are now added to the penalty (including relevant reductions) to determine the amount to be paid (plus the admin charge).

£5,700 (Component A) + £4,275 (penalty, plus reductions) = £9,975

Stage Three

The business most recent gross profit equates to £68,000.

The penalty calculated thus far (£9,975) is below the business gross profit (£68,000). Considering the contraventions only impacted a small percentage of the business throughput as well as the penalty being categorised as ‘Lower’, plus the behaviours of the business, the penalty calculated up to Stage 2 is considered appropriate.

No further profits made, or losses avoided are identified.

Final payment due = £9,975 plus sanctions  administration charge of £2,000.

If the business pays within 30 days of the Penalty Notice being issued, they will only be liable to pay