Tipping and tax
For the owner of a hospitality business the question of tipping and when to tax, charge VAT and pay National Insurance contributions is a minefield. Making a mistake can be costly and ignorance is not an excuse when it comes to defending these mistakes.
The following guide should help establish some general points, but employers are strongly advised to seek professional advice especially with regard to PAYE and National Insurance Contributions. Both are complex in legal and tax terms and open to interpretation in some cases.
What is a tip?
A tip or gratuity is defined as a payment made as a voluntary addition to charges made by a hotel or restaurant. It can also be added to the charge account of a hotel bill and reflects a personal reward from the guest to the staff concerned.
There is no specific law governing the handling of tips and gratuities and the regulations affecting their treatment for taxation purposes depend on the way in which the tips or gratuities are collected or distributed.
Are there different ways in which tips are given?
There are three main types of tipping arrangements in the UK.
Cash tips are given to the worker directly, for example those left on the table.
A central "tronc" in which all employees pool the tips and then distribute them on an informal basis or via the troncmaster. This is normally a nominated staff representative.
Tips collected centrally by the employer, for example via a service charge and distributed to staff via the payroll.
How does the tronc system work?
The basic system is that employees pool their tips and distribute them among themselves. Inland Revenue guidance suggests that in order to count for tax and National Insurance purposes as a proper tronc then it must be run independently of the employer.
Some examples of conditions include not allowing the employer to dictate how the gratuities are shared out, and not allowing the employer to inform employees of how the tronc system works. The troncmaster should not be someone who also acts for the employer.
There are various references to troncs and their operation in the Employers Further Guide to PAYE and NIC and in the Income Tax (Employment) Regulations 1973.
Who is the troncmaster? The troncmaster is designated by the employees sharing the pooling arrangement for tips and for tax purposes becomes recognised as the secondary "employer" and is personally responsible to operate PAYE in respect of all amounts distributed. It could be a head waiter or waitress, for example.
What is a service charge? The standard definition of a service charge in a hotel or restaurant is "a compulsory addition to, or inclusion in, the price charged for accommodation, meals, drinks or other facilities." A service charge is almost always based on a percentage of the relevant price and in the UK it is usually between 10 and 15%.
There is often confusion over the distinction between service charges, tips and gratuities.
Tips and gratuities are always discretionary additions to charges made by the hotel or restaurant. Sometimes an establishment states that an added service charge is "discretionary" or "suggested". In these cases its acceptance by the client is considered to be voluntary, and its treatment will follow that of tips and gratuities.
There is a trend towards the quotation of prices on an "inclusive of service" basis, but this is not compulsory.
There are no legal requirements determining the handling of service charge income
by the establishment. Instead it is up to the employer and employee to determine whether the service charge income is distributed to the employees. If it is made via the payroll, both National Insurance and PAYE should be deducted.
Who is responsible for the income tax?
As a general rule, employees are liable for income tax on all earnings arising from, or as a result of, their employment. This applies to any additions they receive, be they from service charges, pooled tips, or direct from the guest.
However, the employer will pay the tax through the PAYE system if tips and gratutities or service charges are paid through the establishment's payroll.
If a tronc system is in place, the troncmaster is responsible for operating a PAYE system on the amounts paid.
If payments are received in any other manner, the employee is liable to declare the amounts received to the Inland Revenue himself.
Who is responsible for National Insurance? If the tip is paid directly to the employee or into a tronc system no National Insurance is paid.
If the employer is paid the tip (eg a "charged tip" that the customer voluntarily asks to be added to his bill), the position depends on who is responsible for deciding how tips are to be allocated.
If the employer decides this, Class 1 National Insurance contributions must be paid, even if the employer gets someone else (eg a tronc committee or a troncmaster) to pay the money to each employee.
If the troncmaster or someone else independent of the employer allocates the money then no National Insurance contributions are made. This is the case even if the employer makes the actual payments to employees.
Any amount that a customer is required by the management to pay for services is not a tip or gratuity for contribution purposes. It is a "service charge" and the proceeds of this charge are distributed to employees. Class 1 National Insurance contributions must be paid on them by employer and employee, irrespective of who allocates the proceeds.
This is a complex area with several technical details, such as whether the tip is paid into the employer's bank account, determining if National Insurance is due. Consult a professional advisor and for information consult the Guidance Book CWG2 (2001) - Employer's Further Guide to PAYE and NIC published by the Inland Revenue.
When do I as an employer need to pay VAT on tips or service charges?
In order to ensure the correct VAT treatment, it is important to see that there is a clear distinction between compulsory and voluntary additions to basic prices, whatever you may call them.
Any amount given voluntarily by the guest, ie as a tip or voluntary gratuity, will not be subject to VAT.
Any charge forming part of the price levied by the establishment, such as a service charge, will be subject to VAT.
If service is added to the basic price charged, value added tax applies to the resulting
total. If the price includes service, value added tax is applied to the inclusive price.
Where a price is quoted inclusive of value added tax, but exclusive of service, the service
charge added is deemed to be inclusive of value added tax.
The subject is referred to in Customs and Excise Notice No 709 (Catering, Hotels and Holiday Services).
Any other advice?
The Inland Revenue is currently reviewing industry practices. In hospitality there is a trend for the arrangements to be set out in the verbal or written contracts of new employees. In general terms the contract of employment specifies the weekly wages an individual receives and sometimes specifies a guaranteed tip. The Inland Revenue will seek PAYE and NIC on this tip on the basis that the payment is contractual.
by Sara Guild
Thanks to Howard Field and David Reilly, employer tax consultant at RSM Robson Rhodes, for their contributions to this article.
