The recent announcement banning the use of tips to top up the minimum wage, combined with the public's ongoing concerns over how service charge is used, means many customers are now reverting to cash tipping. Tax expert Peter Davies explains how employees and employers can stay on the right side of the law.
Over the past two decades, we have seen a number of changes to customers' tipping habits, with less and less being paid by cash. First, there was the increased use of credit cards and then came the advent of the service charge. Collecting piles of coins and notes from tables and sharing them out at the end of the night became a minor aspect of the tips system for many restaurants.
There are, however, signs that this may be changing. Recent media interest in the whole issue of tipping, the naming and shaming of some well-known restaurants/chefs over their tipping policies and the Government's announcement this month of new rules to stop payments of tips from counting towards the national minimum wage have all heightened customer awareness about what happens to their tips.
In an effort to ensure that all tips are retained by the waiting staff rather than absorbed into a larger pool (which may or may not be partly kept by the owners of the business and used to help pay wages), many customers are now choosing not to tip by card or pay a service charge.
First, what do we mean by cash tips? This includes any change or other cash left on the table by a customer for a member of staff to pick up, any excess cash handed to a member of staff and any money left in a tip box or dish by the till.
However, it doesn't include any discretionary service charges paid in cash or any tips paid by credit card, but then taken out of the till in cash.
Unlike discretionary service charges and credit card tips, cash tips do not belong to the business or the owner of the restaurant. They belong to the member of staff to whom they have been given. If a box or a dish is used, then they belong to employees as a group, but again not to the business or owner.
Many employees will often agree to pool or share their cash tips, but an employer cannot force a member of staff to do this. A business that disciplined or even dismissed an employee who refused to share their cash tips would probably find itself before an employment tribunal.
IS THERE A TRONC?
In law, a tronc is defined as an organised arrangement for tips to be shared among employees by a person who is not the principal employer - ie, the owner of the business.
A system does not have to be called a tronc, as long as it has these features. So, any system of pooling and sharing that has rules, a method of division and a person responsible for calculating and dividing the pool is a tronc. However, if staff keep their own cash tips it is not.
It is also important to bear in mind that employees do occasionally agree informally between themselves to share tips or give a proportion to kitchen and other staff. These types of arrangements are not usually organised and, as such, may not count as a tronc.
If an arrangement is a tronc then a business is obliged to disclose it to HM Revenue & Customs (HMRC). If it doesn't, then the business will be held responsible by HMRC for the tax on those tips plus interest and penalties.
All tips received, in whatever form, are taxable income and subject to income tax. Cash tips are only tax-free if no one tells HMRC about them, which is tax evasion - a very serious offence.
Discretionary service charges and credit card tips must always be taxed, at source, under PAYE. However, the treatment of cash tips depends on what actually happens. If a tronc exists, then tax at source must be deducted by either the employer or the troncmaster.
Where no tronc exists, the responsibility for tax falls on the employees themselves. Staff receiving cash tips that have not been taxed at source are required to keep a record of monies received and declare these to HMRC after the end of the relevant tax year (5 April). HMRC doesn't require an employee to complete an entire self assessment tax return just to declare cash tips - a letter to the tax office, providing details of the total annual cash tips received, is all that is needed.
WHAT IS HMRC GOING TO DO?
Collecting tax on cash tips is difficult for HMRC but it is aware that only a tiny proportion of the amount actually due is ever paid.
Where a business has operated a discretionary service charge (which most customers have paid), HMRC has generally taken the view that provided these amounts are taxed properly then it is getting most of the tax due. Consequently, trying to collect any further tax that might be due on the small amount of cash tips isn't worth the effort.
But, this will surely change if businesses abandon their service charge (as some have already done) or if an increasing number of customers refuse to pay it - HMRC will not be content to see a taxed source of income replaced by an untaxed one.
If an employee working front of house in a restaurant does not make any declaration of cash tips, or makes an implausibly low declaration, then HMRC will consider a number of options.
These include estimating the likely amount of cash tips received based on the turnover of the restaurant and the number of front-of-house staff (all information that it holds). In simple terms, this could be: ‘This restaurant had sales of £1m last year; the tipping rate is approximately 10%, which means £100,000 of tips shared across the 20 waiters, and so each waiter got £5,000'.
Once HMRC has issued an estimate then the onus is on the waiter to prove it is wrong. If he or she has not been keeping a contemporaneous record of what they have received, then this will be impossible. The estimate will then stand, and, like most estimates, it will probably be on the high side. In addition, it is also now an offence not to tell HMRC if an estimate it has used is too low.
It is also extremely important to remember that once HMRC discovers that an employee has failed to declare cash tips, it can estimate not only the last tax year, but up to four previous years as well. This could very quickly become a large sum of money. Anyone in this situation needs specialist professional help.
Generally, cash tips will be free of both employees' and employers' National Insurance. The only exception will be when the employees agree to pool their tips and that pool is controlled and divided up by the owners of the business.
NATIONAL MINIMUM WAGE
Cash tips have never counted towards the national minimum wage. This is unchanged by the Government's recent announcement, which concerns only discretionary service charges and credit card tips.
- You cannot force employees to pool or share cash tips.
- If staff operate a pooling system you must tell HMRC about it.
- If you control the pooling system, national insurance will be due. If you fail to pay it, you will be held responsible by HMRC.
- If you receive your cash tips without deduction of tax, it is your responsibility to keep an accurate record and declare these annually to HMRC. If you don't, you will be held responsible for the tax plus interest and penalties.
- HMRC can assess up to four years back.
- The onus is on you to disprove any HMRC estimates.
Peter Davies, senior manager, Tax Disputes & Litigation, Vantis
020 7417 firstname.lastname@example.org
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