Tipping and Tax

23 March 2006
Tipping and Tax

Any hospitality business owner will know that the area of tips and tax, National Insurance Contributions (NICs) and National Minimum Wage (NMW) is a minefield.

HM Revenue & Customs' (HMRC) view of when NICs are due changed in 2006 with the result that a potentially major burden for employers is avoided.

HMRC now states that when tronc monies are used to bring pay up to the level of an employee's Minimum Wage entitlement, NICs will no longer be due provided that the employer has not directly or indirectly allocated the tronc money.

So long as a business has not allocated specific amounts to specific employees for this purpose, NICs will not be payable on the tronc by either the business or the employee. This change enables a potential combined saving of almost 25% in NICs related to this element of pay.

HMRC has also conceded that mentioning a tronc in an employee's contract of employment will not give rise to NIC liability unless a specific amount has been promised.

The connection between NMW and NICs will have been one where businesses may not have recognised their liabilities, and major claims involving interest and penalties may have been made by and settled with HMRC. The announced change in treatment will enable businesses to claim for refunds of any such amounts settled plus interest.

HMRC's guide which covers this subject is now being reviewed, and the previous version has been withdrawn.

What's a tip? According to HMRC a tip or gratuity is a "spontaneous payment offered by a customer either in cash, as part of a cheque or as a specific gratuity payment on a credit/debit card payment."

The key here is that it is voluntarily given and not expected. And, importantly, income tax is due on all tips no matter how they are received.

What's a service charge? A service charge is a charge added to the customer's bill before it is presented to the customer. If it is made clear that the payment is voluntary and there is no obligation to pay, then it is regarded as a voluntary service charge. In this case it is treated as a tip.

Are there different ways in which tips are given? There are three arrangements in the UK and each has different implications for who is responsible for the tax and NIC payments.

1. Cash tips are given to the worker directly - eg if left on the table.

2. A central pool of tips, known as a tronc, in which all employees pool the tips and then distribute them on an informal basis or via an employee appointed the troncmaster. The employer may also pay tips left on credit/debit cards or on cheques directly to the troncmaster.

3. Tips are collected centrally by the employer, eg via a service charge, and distributed to staff via a payroll.

How does the tronc work? This is a way of pooling the tips and service charges and distributing them among employees. No NIC contribution is due if certain conditions are met. The employer must play no part in the tronc and must have no say in how the tips are distributed.

The employer should inform HMRC of the existence of a tronc and of the identity of the troncmaster.

The troncmaster or, by prior agreement with HMRC, the employer should administer a PAYE scheme to ensure the income tax is paid on all payments made to staff by the tronc.

Who is the troncmaster?
Ideally, the troncmaster should be appointed by a committee of existing staff who decide who would be the most suitable person to take on the role. However, in small family run businesses, it may be possible to agree with HMRC that the employer appoints the troncmaster, so long as the individual does not have any influence in how the business is run e.g. a director of a company.

Who must pay the income tax?
1. Cash tips
If retained by an individual employee he or she must declare the tips for income tax purposes.

2. Tronc
The troncmaster or the employer should operate PAYE on the amounts paid out.

When is NIC due?
National Insurance Contribution by employer and employee is due unless one of two conditions are met.

1. The money is not paid, directly or indirectly, to the employee by the employer and does not comprise or represent monies previously paid to the employer by a customer

2. It is not allocated, directly or indirectly, to the employee by the employer

So if the employer influences in any way how gratuities will be distributed regardless of the system set up to distribute them, NIC is due.

In addition if there is a contractual promise of how much employees will receive in tips (not solely a reference to participate in a tronc) then the employer will have to pay NIC through their payroll system.

However, HMRC has ruled "the employer will not be considered to be allocating the payments where he simply makes deductions from tips received (such as credit card charges or for breakages) before passing the money to the tronc for the troncmaster to allocate".

This clarification now allows a business to split a tronc up, holding back some of the monies paid to the tronc and then allowing the tronc master to freely administer the remaining funds.

If the business has a mandatory service charge in place and pays the monies to the staff, NIC is also due, regardless of the system set up to distribute them.

Service charges and VAT
Any tip freely given by the customer does not attract VAT. But any charge levied by the establishment, such as a compulsory service charge, will attract VAT.

If a business shows an optional' service charge on its bill, it must be genuinely voluntary for the customer to qualify for a VAT exemption. If it is a non-discretionary service charge, it attracts VAT in full. .

HMRC inspects restaurants imposing service charges, to ensure they are genuinely voluntary. Employers should ensure that employees are fully aware of the service charge policy of the business.

Further clarifications?
These notes have been prepared on the basis of current understanding of the relevant regulations. As has been mentioned, HMRC has withdrawn and is reviewing the official guide.

It is advisable to consult professional tax expert with regard to these matters. This advice should also cover how the business accounts for these transactions in its management and financial accounts, to ensure there is no conflict with compliance with the payroll tax, VAT and NIC treatments.

Further information and general guidance on this subject is available through the British Hospitality Association and the British Association of Hospitality Accountants.
Thanks to Howard Field FHCIMA FBHA, and to Doug Sinclair of KPMG for their assistance with compiling these notes.

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