Over the last year HMRC has set up a taskforce to tackle tax evasion by restaurants, fast food outlets and other businesses which often handle large amounts of cash, and has already successfully recovered millions of pounds in unpaid tax. The taskforce started work in London, moved to Scotland and the North West and was recently extended to the Midlands and South West.
Those who abide by the law have nothing to fear; HMRC aim to find those who evade tax. One of the taxes which HMRC will focus on is employee tax and whether all of your staff are properly paid through a PAYE Scheme. Taxation of tips and service charges is complex and you should ensure your business is complying with the tax requirements in preparation for a potential visit from the taskforce.
How tips and service charges are taxed will depend on whether they are compulsory or not, and whether they are given directly to staff by customers or distributed by you as employer or through a Tronc system.
In brief, taxation of tips is as follows:
Compulsory service charge
If you impose a compulsory service charge then you must deduct PAYE and Class 1 NICs even if this money is then distributed through a Tronc (see below).
Tips given direct to staff
If one of your waitresses or barmen is given a tip directly by a customer and they are allowed to keep this then you do not need to make any deductions from this money. There is no NIC payable and it is the employee’s responsibility to declare income received in this way to HMRC and to pay the tax due.
Tips distributed by you
If you share out tips collected by staff or tips given to you voluntarily by customers either in cash or added to a credit card payment then you, as employer, are required to deduct PAYE and NICs before you distribute money to staff.
Tips distributed via a Tronc system
A Tronc is an arrangement used to pool and distribute tips, run independently of the employer by a Troncmaster and the system is used extensively throughout the catering industry. PAYE is due on any gratuities distributed and the Troncmaster is responsible for calculating and deducting this. However, NICs are only due on payments from the Tronc if the employer directly or indirectly allocates the payments.
HMRC Guidance E24 covers “Tips, Gratuities, Service Charges and Troncs”. It sets out clear principles and rules for operating a Tronc account and includes many helpful examples and flowcharts.
You should check that your Tronc is operated in accordance with this guidance. You should also check that your employment contracts are properly drafted to ensure that the NIC exemption will apply i.e. there must be no contractual entitlement to tips or a minimum level of tips.
The Department for Business and Skills has produced a useful guide for the industry which aims to help ensure that tip and gratuity systems are fair and transparent. The aim is that customers understand where their money is going and can decide whether they want to leave a tip or not and staff should also understand the breakdown and distribution of tips.
The content of this page is a summary of the law in force at the present time and is not exhaustive, nor does it contain definitive advice. Specialist legal advice should be sought in relation to any queries that may arise.