HM Revenue and Customs change their minds about the exact details of the way tips should be taxed with depressing regularity, so it is worth saying that this article is based on their guidance published in the leaflet E24(2009) – and even this may be out of date, as we shall see.
Types of Tip
The way a tip is given by the customer, and what happens to it subsequently on its way to the employee, determines its tax treatment. At one end of the scale is a cash tip given directly to the waiter by the customer, which the waiter keeps for himself. At the other is the “service charge” added to the bill by the restaurant.
All Tips are Taxable
The cash tip given directly by the customer to the member of staff, who keeps it for himself, is the simplest for tax purposes. The restaurant has no tax obligations in such a case, and the staff member is required to declare his tips for the tax year as income on his self assessment return – it would be an interesting exercise to make a freedom of information request to HMRC asking how many such returns are filed each year!
The treatment of service charges depends on whether they are “voluntary” or not. If the charge is simply included in the bill, then it is part of the restaurant’s turnover (for VAT as well as income tax or corporation tax), and any payments to employees go through the payroll in the same way as their wages.
If the service charge is genuinely voluntary, and it is made clear to the customer that he does not have to pay it unless he wishes to do so, then from the restaurant’s point of view this is outside the scope of VAT. What happens when the tips or service charges are distributed to employees depends on how this is done.
Distributed by Employer
If the employer distributes the tips to the employees, then PAYE (including National Insurance Contributions) must be deducted in the same way as for wages.
This applies even if the employer distributes the tips “indirectly” – for example by having a set of rules such as a points system which determines how the tips are divided up.
Distributed by Employee (Tronc)
If an employee is responsible for distributing the tips, he is called a “Troncmaster”. Provided that he acts independently of the employer when sharing the tips out, there is no NIC liability, but the Troncmaster must operate his own PAYE scheme to deduct income tax from the tips.
Being a Troncmaster is a risky business, as the Troncmaster is personally liable for any PAYE errors he makes.
National Minimum Wage
A recent case (involving the famous Annabel’s) has made it clear that tips do not count towards the National Minimum Wage in the case of tips retained by staff, or where a Tronc system operates, but the judgement in the Court of Appeal also included the unwelcome news that a Tronc is a form of “discretionary trust”. Unless something is done to overturn this, it means that the whole Tronc system has been taxed incorrectly for years, because the trustees of a discretionary trust are required to account for tax at the “rate applicable to trusts” which is currently 40% and due to increase to 50% in April 2010.
So far, there has been a deafening silence from HMRC on this aspect. I am very glad I am not a Troncmaster, and I pity those who are, given the current uncertainty as to their tax obligations!