What are the tax rules for restaurant tips?

Paying dinner
By Susan Cattell, Head of Taxation (England and Wales)

4 September 2015

Susan Cattell reminds members of the tax rules for tips and service charges in the hospitality sector, following a government call for evidence into how these payments are handled by employers.

Restaurant service charges have been in the news recently with some high profile chains receiving publicity for not passing on service charges to staff or for deducting large administration fees.

The Department for Business Innovation and Skills (BIS) has launched a call for evidence to find out what is happening in the hospitality sector but also in other sectors where tips are common.

Call for evidence

BIS wants to gather information on how tips and service charges are collected and how much employers deduct when passing these on to employees. It also seeks views on whether the Government should take action to ensure greater transparency.

The Government has also said it will consider possible action to prevent employers withholding from tips anything other than the cost of administering credit card and payroll transactions. The call is specifically aimed at employers and employees in the hospitality sector but the Government is keen to hear from other sectors too.

Voluntary code of practice

A voluntary Code of Best Practice on Service Charges, Tips, Gratuities and Cover Charges already exists. It was issued in 2009 and aims to provide businesses with practical guidance on operating in a fair and transparent way and ensuring that customers have sufficient information before they leave a tip or pay a voluntary service charge. Part of the call for evidence asks about awareness of the code and whether businesses have signed up to it.

National Minimum Wage

This is not the first time tips and service charges have hit the news. In 2009 publicity about the treatment of tips in some nightclubs and restaurants led to changes to the National Minimum Wage (NMW) rules to prevent employers using tips and service charges to make up NMW pay. Workers must be paid at least the NMW for every hour worked before tips, gratuities, cover and service charges. HMRC, which enforces the NMW, has apparently found limited evidence that NMW rules are being broken both from complaints it receives and from investigations it carries out in the hospitality sector.

Tax

Businesses in the catering and service industries where tips are common also need to be aware of the tax rules relating to tips and service charges. The rules are complex and HMRC provides detailed guidance but here is an outline of some key areas which need to be considered.

Income tax

If cash tips are given directly to staff or left on tables and are kept by individual staff members it is up to the individuals to tell HMRC what they have received. However any tips paid by the employer to employees have to be dealt with under PAYE. Sometimes a troncmaster will control tips and distribute them to employees; PAYE will still need to be operated but depending on the identity of the troncmaster this might be through the employer's scheme or through a separate PAYE scheme.

National Insurance contributions

In most cases where an employer passes on tips to employees both employer and employee National Insurance contributions (NICs) will be due. However, there are limited circumstances where tips may be exempt from NICs if they meet one of two conditions:

  1. Tips are not paid, directly or indirectly, to the employee by the employer and do not comprise or represent amounts previously paid to the employer (for example by customers).
  2. Tips are not allocated, directly or indirectly, to the employee by the employer.

HMRC's guidance gives numerous examples to illustrate how these conditions work in practice.

VAT

If tips are given freely they will be outside the scope of VAT. This will be the case whether or not they are passed on to staff. However if a restaurant service charge must be paid by customers (ie it is not voluntary) then it will be part of the consideration for the meal and will be standard rated. HMRC accepts that if customers have a genuine choice as to whether to pay a service charge it will not be consideration.

Topics

  • Tax

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