Tips - Avoid the pitfalls

A tip for a tip

If you operate within the hospitality or service sectors then tips and service charges are commonplace.  When HMRC open up enquiries, within these sectors, they find many rich pickings as businesses can easily trip themselves up as they try to deal with the tax, national insurance (NI) and VAT complexities surrounding this subject.

A tip is an uncalled for, spontaneous payment by a customer.

A service charge is an amount added to the customer’s bill before it is presented to them. It could be either discretionary or mandatory. A purely discretionary one is where the customer is not obliged to have to pay it. It should be clear to the customer that is the case.

It is important to differentiate the two because, if mandatory, it will attract VAT at 20%, whilst discretionary will not.

Any mandatory service charge, which is then subsequently paid out to employees, will always incur a national insurance liability irrespective of what arrangements the employer might put in place to make that payment.

A national insurance liability on a pay out to an employee of a tip or a discretionary service charge can be avoided if one of the following two conditions are met:

1. a) The tip is not paid, directly or indirectly, to the staff member by the employer and does not represent monies previously paid to the employer, for example, by the customers.
2. b) The employer does not control, directly or indirectly, who receives the tip and the amounts involved.

A clear and obvious scenario would be where the customer pays the staff member direct, or leaves the tip on the table and the employee picks it up and keeps the monies for themselves. This will be taxable on them, but no national insurance will be due. The responsibility to notify HMRC of this taxable income would rest solely on the employee and not the employer.

https://www.gov.uk/government/publications/e24-tips-gratuities-service-charges-and-troncs/guidance-on-tips-gratuities-service-charges-and-troncs#:~:text=It%20is%20the%20responsibility%20of,the%20employee's%20PAYE%20tax%20code.

Another way to potentially ensure that no national insurance arises is if a tronc scheme is set up correctly. 

A tronc is a special arrangement used to distribute tips.  A person or third party, other than the employer, agrees to be the troncmaster, who then becomes responsible for sharing out the tips to the employees. The troncmaster could be a member of staff within the business establishment itself or a Third-party organisation.

The employer would need to notify HMRC that a tronc had been created and who the troncmaster was.  HMRC would then set up a Tronc PAYE scheme and the troncmaster would then be responsible for deducting the tax from the tips and paying it over to the Inland Revenue. As long as the employer, or somebody connected to them, was not the troncmaster, nor did they dictate how the tips were allocated out, then no national insurance liability would arise on the payments made. If the employer fails to adhere to those conditions national insurance would be due.

Example

• Lewis is the owner of a restaurant.
• All tips cash, credit or debit card received by Lewis are paid across to Christine who is the troncmaster.
• Lewis has devised a points system, based upon length of service and seniority, which Christine needs to follow when distributing the tips.
• All these tips paid out by the tronc will be liable to national insurance. Why? Because Lewis, is indirectly allocating the tips through Christine as a result of the points system he has devised.
• It is important to note here, that on the national insurance front, it is the owner’s responsibility to account for the national insurance and not the troncmaster. Lewis should put the national insurance through the business payroll.
• If, however, the points system had been independently worked out and agreed by say a staff committee, then national insurance would not be applicable.

It is also important to note that tips do not count towards complying with the national minimum wage criteria.

Tip

For any business, where tips and/or service charges are involved, it is wise to ensure that there is a clear policy as to how it all operates and that processes are correctly followed so that tax and NI issues do not come to bite the business on the posterior later.  Please do not hesitate to contact us if you require any help on this matter.