What is miscoding, and how does it function?

Whenever a merchant applies for opening an account for processing of VISA/ MasterCard payments, it is assigned a Merchant Category Code by the account provider during the process of account set up. Once they receive the code, it’s hard to change it. However, there are exceptions in every area, and we will discuss the same in the case of merchant category code.

What is an MCC (Merchant Category Code)?

A Merchant category code is a four-digit code that explains the merchants about the category to which they belong. Banks can credit card networks assign this four-digit code to merchants based on their specific categories and type of business. Every business has an MCC code assigned by the payment network.

The MCC code can significantly impact your business, the first being the pricing charged for transactions and the risk profile of your account. The risk profile explains how likely the merchants in your category may get customers complaints, chargebacks and refunds.

  • In a nutshell, a merchant category code indicates the main category in which a merchant operates and may be used:
  • To determine the interchange fee to be paid by the business as high-risk businesses are charged high processing fees as compared to the low-risk merchant.
  • By the credit card providers to update the cashbacks and reward points for paying in specific merchant categories
  • By card networks for identifying rules and restrictions for credit card transactions.
  • For taxation purposes to decide whether a payment comes under “Services” and report the same to the Internal Revenue Service to determine tax or it comes under “Merchandise”, which does not need to be reported.

What is Miscoding of MCC?

Although the code has been established, merchants route transactions of various categories through the MID and operate legally. This activity of routing the transactions is known as miscoding. For example, merchants in the games industry direct their gaming traffic through the gaming MID.

VISA found that some merchants have been selling their products and services in countries where local laws prohibit such transactions or have strict licensing requirements from the relevant financial services authority.

Why is MCC Miscoding done?

The miscoding of merchant category code occurs when a bank assigns a different category code to a merchant in order to gain lower interchange rates or a higher approval ratio for that merchant. Miscoding is usually done at the time of setting up a merchant account with the acquiring bank and payment gateway. It is done in cases in which the merchant has very high transaction volumes or if it is willing to pay higher rates for miscoding.

Over time, risk systems built into card issuers’ systems and their processors began to use MCC as a trigger to flag and block transactions. For example, MCC 7995 identifies merchants who process card transactions related to online gambling and casino chips. Such transactions are often challenged retrospectively by cardholders based on the fraudulent activity.

Due to this, most of the issuing banks and their processors began to block all transactions on MCC 7995.

Some Examples of Miscoding

There have been reports of intentional coding errors by businesses, in which the restaurants that need to be coded with MCC-5812 and Bars with (MCC-5813) in order for a payment processor to offer a lower fee to restaurants as bars typically have lower interchange fees.

The single-digit number in an MCC that distinguishes a bar from a restaurant holds much significance. It may not sound like much, but it could mean great financial loss for the merchant.

Here is an example of MCC miscoding: A customer uses a Visa Rewards card in a restaurant. The applicable exchange rate is 1.95% (0.0195) + 10 ¢. Thanks to the miscoding done by the restaurant’s payment processor as a bar, the interchange fee is 1.65% (0.0165) + 10 ¢.

While the 0.003 point difference seems pretty irrelevant, a restaurant with higher tickets generating significant volume can cut the system short by $25 to $75 on monthly transactions with this type of Visa card.

Penalties for MCC Miscoding

If such a type of miscoding is discovered during an audit, penalties of between 1,000 and 10,000 US dollars per transaction could be imposed. While a payment processor is more likely to incur these penalties, it is also possible that restaurant operators using processors that miscode intentionally could be held liable.

So what the restaurant operators should do when they come to know that their transactions have been miscoded? If a restaurant or hotel believes their MCCs are miscoded, the restaurant should immediately contact their payment processor and request a written correction.

Liabilities of Being Miscoded

Although miscoding is rare, a merchant might get coded as a low-risk merchant even if it comes under a high-risk category. This miscoding is usually done by the acquiring bank by mistake. However, merchants should never attempt to deceive the banks to miscode them in order to achieve lower exchange rates.

If a merchant is considered as a low-risk merchant by the bank, it may be subject to be monitored less due to miscoding despite being involved in high-risk transactions. Such merchants are considered “transaction launderers”.

Therefore, if a bank deems a business as a low-risk merchant, both the bank and merchant are deemed responsible for MCC miscoding, even if they are ignorant of the transaction laundering.

How to fix MCC miscoding?

If you are a merchant being miscoded, and even if you are involved in transaction laundering unintentionally, it can put you and your business in serious trouble. The key to fix this is to contact your merchant account representative. 

Your merchant account representative can help you to fix the miscoding and assign you the correct merchant category code for your business. Moreover, you should tie-up with a reliable payment processor like Paypound that conducts all the required checks before signing a contract to avoid the problems like miscoding.

Summing Up

Having the right MCC code is essential for the hassle-free running of any business. Activities like MCC miscoding to gain lower interchange rates or higher approval ratio is illegal in most countries and can put your business in serious trouble. Therefore, if you are running a business in any country, you should avoid such activities and get the right MCC code to run your business as per the commercial regulations in your country.

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