ECSH82815 - Use of gross profit to calculate penalties under the penalty framework

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As part of the penalty framework, HMRC use a business鈥檚 gross profit as an element of calculating type 1 (scale charge) and type 2 (trading whilst unregistered) penalties. Doing so ensures that the starting penalty is not disproportionately high compared to the gross profit of the business. 鈥�听

In order to calculate the gross profit, for the purposes of the penalty calculation, the decision maker (DM) should use听the most recent annual accounts available at that time.听

Note:听The use of gross profit meets the requirement to consider the financial strength of the person being sanctioned (as per 听of The Money鈥疞aundering, Terrorist Financing and Transfer of Funds (Information on the Payer) Regulations 2017 (MLR 2017), and therefore the starting point of the penalty should be the gross profit of the business as a whole. If this results in a penalty that is disproportionate, for example, because the level and risk associated with supervised activity is:听

听 听 (a)听听 A very small portion of the overall business activity; or

听 听 (b)听听 So significant that a penalty based on the gross profit of the business would not be dissuasive, effective or proportionate听to听the scale of the breach,听

HMRC may adjust the penalty to reflect that 鈥� see ECSH85650 for more information on the appropriateness review.听听


Accounting standards do not define what gross profit is. However, company law and the Appendix to Section 5 of the鈥�听(FRS 102) include a profit and loss format that shows turnover, less cost of sales, equals gross profit. UK Generally Accepted Accounting Practice (GAAP) does not define cost of sales but defines turnover as 鈥�the amounts derived from the provision of goods and services鈥� [after discounts and taxes] (Appendix I Glossary FRS 105, FRS 102).鈥�听

For the purposes of calculating type 1 (scale charge) and type 2 (trading whilst unregistered) penalties for breaches of MLR 2017, HMRC鈥檚 policy is to exceptionally accept inclusion of certain elements as a cost of sales. We do this both to reduce the administrative burden of applying the framework, and to ensure that the penalty is proportionate.听

Exceptional basis听

Gross profit is normally calculated as set out above.听Exceptionally, for the purposes of calculating MLR penalties only, HMRC accepts that, as they are incurred by the business for running its day-to-day operations, the following may be deducted to determine the gross profit figure for the purposes of calculating penalties under the MLR 2017.鈥�The starting point for determining these expenses will usually be from the accounts provided or tax returns filed.鈥� However, see the section below, accuracy and compliance checks, if there is any doubt or concern over the figures.听

This is not a one size fits all list and the nature of the business activity needs to be considered especially where we describe something as 鈥榚ssential鈥�.听

  • Administration costs鈥� - for example: postage,听stationery鈥痑nd general overheads involved in running the day-to-day business activities.听

  • Advertising听- including anything designed to promote the business in print, broadcast media, online or by phone/text, with a view to increasing sales.听

  • 颁辞尘尘颈蝉蝉颈辞苍鈥�- including commission paid to staff, not otherwise included in salaries, and commission incurred by the business in carrying out its business activity.听

  • Licences, registrations,鈥�or subscriptions听- essential to carry out the business鈥檚 activity鈥痵uch as fees to trade associations,听professional bodies, or software licenses.听

  • Office/premises overheads -for example: water, rent (including renting temporary space), lease, rates, electricity, gas and telecoms/internet. 鈥�听

  • Professional fees听- for example: accountancy and legal fees incurred by the business,鈥痑s would normally be allowed for tax purposes - 蝉别别鈥�天美影院.听

  • Home office use -鈥�any additional costs incurred as a result of having to work at home. Costs cannot be claimed if you choose to work from home and includes where your employees of the business have a contract that lets them work from home some, orall of the time.鈥� Further information on the types of expenses that can be allowed can be found鈥�听

  • Salaries and related National Insurance and pensions costs听- including directors鈥� remuneration.听However, dividends paid to shareholders (whether directors or not) do not relate to the day-to-day operations of the business and are not considered to be a direct cost. Shareholders dividends must not be deducted.听

  • Travel, transport and subsistence听- as would normally be allowed for tax purposes paid to an employee, director or incurred by a sole trader鈥�see 天美影院.

(This content has been withheld because of exemptions in the Freedom of Information Act 2000)


听Accuracy and compliance interventions听

Businesses are not generally required to calculate gross profit for other purposes,听and so听are often not overly concerned with the classification of costs between cost of sales (in arriving at gross profit) and distribution or administration costs (recognised after gross profit) when calculating gross profit in the accounts submitted to HMRC.听

HMRC give fair warning听in the majority of cases by providing a pre-penalty notice, which听clearly sets out how we have arrived at the figure used for gross profit听when applying the penalty framework, to calculate the penalty. If the business considers our calculation is incorrect, it has the opportunity to restate its gross profit as part of this process.鈥� We must consider this before issuing the penalty notice.鈥�听

However, the DM should query the credibility where we have any听concerns with the expenses claimed in the accounts provided or tax return filed or, in any revised figures provided.听The DM will only look behind the calculation where they believe, on the basis of evidence, that there is a clear error in the figures or the DM has a genuine suspicion (which can be evidenced) that the figures are not being submitted in good faith.