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When and How Tips are Taxed

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When and How Tips are Taxed

In this post we examine the rather interesting question of ‘when are tips taxable?’ Believe it or not, there is legislation expressly governing how tips are to be taxed. The relevant legislation is The Income Tax (Pay As You Earn) Regulations 2003. Click here to see for yourself.

Why write a post on the taxation of tips?

Tips have been in the headlines recently with revelations that large-chain restaurants such as Bella Italia, Pizza Express and Café Rouge deduct an ‘admin’ charge from their employees’ tip earnings. Many people paying tips have long suspected these goings-on and these headlines seem to confirm those suspicions. This ‘snouts in troughs’ practice understandably angers diners who believed they were paying the waiting on staff for good service and not the company that runs the restaurant.

What are tips?

Tips are classed as gratuitous payments for service and therefore tips cannot be a compulsory charge. Tips can be paid in cash directly to the staff who have been providing the service in cash but also as an additional specific amount on a card payment. Some employers collect these earnings and then re-distribute them between all employees.

Tips should not be confused with service charges, which are added to a bill before it is presented to the customer. If it is a voluntary charge and there is no obligation to pay and this is made clear to the customer then it is effectively treated in the same way as a tip. However if it is a mandatory charge and the employee receives any of it in his or her wages the employer must deduct PAYE and National Insurance (NI). Mandatory service charges also attract VAT, whereas tips and voluntary service charges don’t.

Many businesses new to the service-sector assume tips are not taxable. However this assumption could be costly. Tips almost always attract PAYE tax and in many cases attract National Insurance contributions (NIC) too so by assuming they don’t employers could face claims for underpayment from HM Revenue & Customs.

Below we look at the various ways that tips are commonly paid to staff in the service-sector and the taxation implications for each of them.

When customers pay tips directly to staff

When tips are paid directly to the staff or ‘left on the table’ they themselves are responsible for declaring these earnings to HMRC. Provided there is no involvement from the employer, the employer doesn’t have to do anything as PAYE doesn’t apply. HRMC will make an adjustment to the employees’ tax code in order to recover income tax

Tips paid directly from the customer to employees do not attract National Insurance contributions (NICs)

When tips are collected by the employer

These days many customers prefer to make payments by debit or credit card and restaurants allow them to add a tip, which the restaurant will then distribute to their employees. When the employer administers the payment of tips they are subject to PAYE and NI.

The payment of tips via a tronc

‘Tronc’ is the French word for a collection box and the tronc system is used when staff agree to put all of their tips into a pot. At some point the tips in the pot are distributed to staff using an agreed and pre-determined ratio.

The person in charge of the tronc is known as the ‘troncmaster’ HMRC has officially defined a troncmaster as a person ‘other than the employer, and responsible for arrangements to share tips amongst employees.’ The troncmaster is responsible for operating a PAYE scheme and may be held responsible for not deducting tax from tronc payments.

Tronc payments do not attract NICs if the troncmaster is allocating money, which was paid direct to employees and the employer does not pay the money to the employees or determine how it is allocated. If the above does not apply then the payments attract NI however it is the responsibility of the employer to calculate how much is due and pay it to HMRC

If you require further advice on how tips are taxed be sure to contact your local The Financial Management Centre office. Click here.

Or click here for more information and examples from HMRC