As coronavirus restrictions are lifting, businesses have begun to welcome back customers to restaurants, bars, beauty salons, hairdressers and other venues. In these industries, it is customary for tips to be given for the service provided but, with this, comes complicated rules for the deductions of tax and national insurance such as who needs to operate and when.
We therefore thought it was quite timely to give an overview of the rules and the traps to watch out for in any industry where tips are paid by customers.
Tips, gratuities and service charges
For the purposes of this article, when referring to ‘tips’, we are looking at any voluntary payments made by a customer for example a tip, gratuity or voluntary service charge.
Where there is a mandatory service charge (i.e. not at the customers discretion), PAYE and NIC will be due on any amounts passed on to employees, regardless of the circumstances or arrangements in place.
The income tax treatment of tips will depend on how it is received by the employee:
- If a cash tip is left on the table which the individual employee is entitled to keep, PAYE does not need to be operated by the employer providing there is no involvement from the employer. Instead, the employee will be personally responsible for reporting the income to HMRC. This is normally dealt with via an adjustment to the employee’s PAYE tax code, rather than requiring a self-assessment tax return.
- Any tip paid by an employer to an employee – in all other cases, other than the above, PAYE must be operated on any tips paid to an employee. This includes where a cash tips are collected in and then redistributed to employees.
In some cases, an arrangement known as a ‘tronc’ may be used to distribute tips. The tronc is run by an individual known as the ‘troncmaster’ who is responsible for sharing the tips amongst employees.
Where the troncmaster is not the employer or a director of the company, the tronc scheme should be registered with HMRC and the troncmaster will be responsible for operating PAYE on any tips, albeit can use the employer’s PAYE scheme to report the tax. Separate records must be kept, and it must be independent to the employer’s scheme. The advantage of such an arrangement is that the tip may be exempt from national insurance (see below).
National insurance contributions (NIC)
A tip passed onto an employee will be exempt from NIC if it meets either of the following two conditions:
- The tip is not paid (directly or indirectly) to the employee by the employer and does not comprise monies previously paid to the employer (e.g. by customers); or
- The payment is not allocated, directly or indirectly, by the employer to the employee.
In the majority of cases, where the employer passes tips on to an employee, they will be liable for both employer’s and employee’s NIC as they will not be able to satisfy either of the above conditions.
For example, if the employer received tips paid by credit card and decides to pass these on to the employee who served that customer, neither condition will be satisfied and NIC will be payable. Similarly, if all tips are collected in and the employer decides to split them amongst all staff (for example, to include kitchen staff), then again, neither condition for the exemption will be met.
Where there is a tronc in place, however, NIC will not be payable on tips where the troncmaster is not the employer and they (or a group of employees) decide how the tips should be allocated, without any involvement from the employer.
Where tips are voluntary, they will be outside of the scope of VAT. Where, however, the service charge is mandatory, the service charge will be subject to VAT at the standard rate.
Although the standard rate of VAT is 20%, there has been a temporary reduction for the hospitality sector with a reduced rate of 5% until 30 September 2021 and 12.5% from 1 October 2021 to 31 March 2022.