Money Laundering Regulations - Relevance to payroll service providers

13 December 2007

On 15 December 2007, the Money Laundering Regulations 2007 come into effect. They revoke and replace the 2003 Regulations. The new Regulations

bring new businesses under the supervision of HMRC

introduce a new "fit and proper test" for people in positions of ownership or control in Money Service Businesses (MSBs) and Trust or Company Service Providers (TCSPs), and

require businesses to implement risk-based systems and controls to help prevent money laundering and criminal financing.

The new Regulations also affect High Value Dealers (HVDs) and Accountancy Service Providers (ASPs). HMRC already supervises MSBs and HVDs for compliance with the former 2003 Regulations. The new regulations extend this supervision to ASPs as well as TCSPs.

The four types of business that fall within the scope of the new Regulations are:

Money Service Businesses (MSBs), i.e. bureaux de change, money transmitters and third party cheque cashers

High Value Dealers (HVDs), i.e. businesses that deal in goods and accept (or are prepared to accept) a payment or payments in cash of at least 15,000 euros (approximately £9,000 or more) in total, whether the transactions are executed in a single operation or in several operations that appear to be linked.

Trust or Company Service Providers (TCSPs), i.e. persons whose business involves forming companies, partnerships or other legal persons, or acting as a director, secretary, partner or similar role for such businesses, unless they are supervised by a designated legal or accountancy professional body.

Accountancy Service Providers (ASPs), i.e. auditors, external accountants and tax advisers, unless they are supervised by the Financial Services Authority or a designated legal or accountancy professional body.

The issue under consideration in this article is whether or not payroll service providers (PSPs) fall within the scope of the new Regulations and, as a result, are required to register and fulfil other statutory obligations. The expression "payroll service providers" is used here to include all businesses that act as agents on behalf of employers in any or all aspects of payroll processing. So, it includes bookkeepers, accountancy practices and payroll bureaux. Payroll bureaux provide a wide range of services, from a basic pay calculation and payslip printing service to a fully managed service.

PSPs could fall into two of the four types of businesses listed above.

Firstly, a PSP would be a High Value Dealer if it were prepared to accept cash (at or above the specified level, in one or more payments) from a client

as payment for the payroll services provided,

to fund the payments sent to the employees, or

to fund the tax and NICs due to HMRC's Accounts Office.

It is the author's understanding that payroll bureaux do not, as a general rule, handle money belonging to their clients (cash or otherwise), for the purpose of paying employees or HMRC. Whether some accountancy practices do this is not known. The issue, however, is not that a PSP does not routinely accept cash from its clients, but whether it would be prepared to do so if a client suggested it. It would not be illegal to accept cash for any of these purposes, as long as the PSP is registered as an HVD and carries out due diligence on the client.

Secondly, a PSP is an Accountancy Service Provider if it provides "accountancy services". Professions that are always viewed as providing such services are auditors, external accountants and tax advisers. Unlike the HVD category discussed above, this is not an issue of whether ASPs handle their clients' money. Rather, it is the extent to which they are involved in keeping the financial records and transactions of their clients. If they are "recording, reviewing, analysing, calculating or reporting financial information", they are providing "accountancy services". They must register with HMRC as ASPs, unless their business is supervised by a relevant professional body. The Explanatory Memorandum on the Regulations estimates that there are around 65,000 external accountants in business, 40,000 of which do not belong to any supervisory body.

References to "payroll agents" in HMRC's various guidance notes make it clear that, in most situations, a PSP will be viewed as an Accountancy Service Provider because some of its key activities are "accountancy services". For example, HMRC's guidance notes on Registration, in Appendix 5, specifically refers to "bookkeepers, payroll agents, tax consultants" as "external accountants" and consequently covered by the Regulations. The same information is given in the basic guidance to help businesses decide whether the Regulations apply to them. The Registration form MLR100 also lists "payroll" as one of the services that an ASP may offer to customers.

Accountancy firms that process the payrolls of the clients for whom they keep the books certainly fall within the scope of the Regulations. It does not really matter whether the additional payroll services they provide fall within the definition of "accountancy services" - they must register because they are directly handling their clients' accounts. The same would be true of bookkeepers who process the payrolls of those clients for which they keep the books. But, what of payroll bureaux that do not provide traditional accounting services - only payroll services?

Because of the several references to "payroll" in the published guidance, we asked HMRC to comment on the situation of payroll bureaux. The response, reproduced below, is very clear. While initially stating that it "depends on the full extent of the service they provide", HMRC is of the view that, if a payroll bureau is "recording, reviewing, analysing, calculating or reporting financial information", it is an ASP. As an example of such activities, HMRC refers to "determining the amount of tax due to HMRC (income tax and NICs) - under PAYE" and states "We would see the calculation of pay or tax liability as accountancy services".

As ASPs, payroll bureaux would be obliged to carry out due diligence on their customers, i.e. the employers with which they are contracted to provide payroll services. They would not, however, be required to carry out due diligence on the employees being paid as they are not customers of the bureaux.

What does due diligence involve? It is one of the many measures that ASPs have to put in place to determine whether there are reasonable grounds for knowing or suspecting that money laundering or terrorist financing may be taking place. Other measures include obtaining additional information on customers, conducting ongoing monitoring of the transactions and activity of customers with whom there is a business relationship, and having systems to identify and scrutinise unusual transactions and activity.

Due diligence involves the verification of the identity of customers and, where relevant, the identity of the corporate owners of the customers. However, ASPs must take a risk-sensitive approach to due diligence and be able to demonstrate to HMRC that the due diligence measures that have been applied are appropriate in view of the risk of money laundering and terrorist financing faced by each business.

The inevitable question, therefore, that must be addressed by all PSPs - and by HMRC - is: What is the potential for money laundering in the context of payroll processing? If there is little or no risk of it ever happening, an ASP is likely to reason that only minimal due diligence measures need be put in place. More importantly, it raises the question of why HMRC should think that PSPs need to register as ASPs at all.

Would it be possible for an employer wishing to dispose of cash obtained illegally or wishing to transfer money to terrorist groups to do so through the payroll? The only method that is used at times to make fraudulent payments through the payroll is to create "ghosts", or "phantom" employees, with the objective of diverting the employer's money to the fraudster. The author has never heard of the use of payroll "ghosts" for any other purposes than personal fraud, but that does not mean that it could not be used to move money to terrorists. (HMRC's response suggests that all cases of fraud using ghost employees should be reported to the Serious Organised Crime Agency.) However, it is an almost impossible type of fraud to hide as rigorous PAYE compliance procedures tend to expose it quite quickly. It is also more likely to occur in an in-house payroll environment, where the payroll administrator works unchecked, than in the payroll team of a payroll bureaux, where strong checking disciplines are usually in place and there would have to be collusion with the customer.

Compliance by payroll service providers with the Money Laundering Regulations is likely to be a major issue over the coming months. Registration of those ASPs that are not supervised by a designated professional body is due to start in April 2008, with a deadline of 1 July 2008. Before then, HMRC must provide full guidance for PSPs, explaining exactly what will be reasonably expected of them. But it is of concern that HMRC should believe that PSPs need to be brought into the scope of the Regulations, suggesting thereby that its own stringent PAYE recording and reporting procedures are inadequate to prevent money laundering through the payroll.

HMRC's comments on the application of the Money Laundering Regulations to payroll service providers, dated 12 December 2007

Liability of Payroll Services under MLRs 2007.

1. Do payroll services firms fall within the MLR's?
Answer: The MLRs cover external accountants and tax advisors when they are acting in the course of business. We see payroll services as falling within the external accountant or/and tax adviser categories depending on the full extent of the services they provide.

2. How far does this extend to payroll bureaux which are not directly providing accountancy services?
Answer: It depends on what services they are providing.
What exactly are they doing? Are they recording, reviewing, analysing, calculating or reporting financial information? Are they providing tax advice, i.e. providing advice about the tax affairs of other persons? For example are they determining the amount of tax due to HMRC (income tax and NICs) - under PAYE?

3. If they are calculating pay and paying via BACs will they have to put in place MLRs?
Answer: We would see the calculation of pay or tax liability as accountancy services. The method of payment will not affect the liability of the payroll services.

4. Is it the responsibility of bureaux to vet employees?
Answer: Bureaux must carry out customer due diligence. The employees will not normally be the customers of bureaux and therefore there will be no requirement for payroll bureaux to carry out customer due diligence on their employees.

5. When they are working on behalf of employers should payroll bureaux vet the employers?
Answer: If their customer is the employer then they will have to carry out customer due diligence on the employer including obtaining and retaining evidence of ID.

6. What happens to situations where there are ghosts on the payroll? (people who don't exist, but their names are on the payroll and their money goes into another person's account).
Answer: Under Part 7 of the Proceeds of Crime Act and Part 3 of the Terrorism Act, businesses in the regulated sectors and their employees are required to disclose information to the Serious Organised Crime Agency (SOCA) in circumstances where they "know or suspect, or have reasonable grounds for knowing or suspecting that another person is engaged in money laundering or terrorist financing."

MLR 2007 regulation 20 requires that unusual transactions and any other activity that is regarded as particularly likely by its nature to be related to money laundering or terrorist funding must be identified and scrutinised.

The situation outlined above would appear to be a suspicious activity indicative of money laundering etc and should be reported to SOCA.

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