The Conservative party have announced that they will be reviewing the taxation of tips and service charges, but in the absence of any new legislation it is worth refreshing ourselves with the current regulations.
It may come as a surprise to some, but tips are always taxable. Often overlooked by many businesses in the hospitality sector, if ignored this will be an easy target for H M Revenue & Customs who could charge penalties in addition to any unpaid tax and interest.
Tips come in many forms, from cash given directly by a customer, to a mandatory or discretionary addition to the bill in the form of a service charge. The way in which tips are taxed will depend upon who the payment is made to.
An uncalled for and spontaneous payment of cash by a customer is a tip. This will be subject to tax, whether it is retained by the employee or pooled for distribution. However, if a customer adds a “gratuity” to their debit or credit card payment, they are making a payment to the business and not to the member of staff.
What the business chooses to do with this payment is up to them. However, a payment made to staff at the discretion of management, may not only be subject to tax through the PAYE scheme, but also national insurance at 12%. In addition, the business will be subject to the employer’s national insurance contributions at 13.8%.
In order to avoid the payment of national insurance on the distribution of tips and discretionary service charges this should be administered separately in a way that is outside the control of the business and its management. This is done through a special pay arrangement often called a tronc. A tronc master is appointed to administer and control the pay arrangement and is accountable to staff. The tronc master must not be involved in senior management of the business.
Payments to staff can be made separately in which case the tronc master will have to operate a separate PAYE scheme. However, in many cases this will be run through the business’s payroll, although in order to ensure the correct treatment they have to separately identify the payment of tips.
Whether or not a business decides to pass on tips and service charges, staff should take some consolation in the fact that from October 2009 tips cannot be taken into consideration for National Minimum Wage, or even National Living Wage purposes.
Like all areas of tax, mistakes can be costly so it is important to get it right.
By Partner, Sean Smith
Further guidance is available from The Hospitality Professionals Association (HOSPA). If you have any doubts or require further advice please contact me, or a member of your local Thomas Westcott team.