How to deal with employee tips

The NMW is administered by the Inland Revenue and they have be quick to pick up this practice. Furthermore there has been a recent European Court of Justice ruling on the treatment of tips received on credit card and cheque payments. The ruling deems the tips to be payments to the employer, and therefore the onward payment to the employees is regarded as being administered by the employer.

The clamp down by the Revenue will effect businesses which control how tips are collected and given to staff as well as formal tronc arrangements. If either system has not been operated correctly, the Revenue are assessing employers for PAYE and/or National Insurance Contributions. Even where a tronc system has been administered correctly, the Revenue are still obtaining national minimum wage awards for employees, so the employees benefit from the tips plus an additional payment from the employer. As the Revenue are empowered to go back for 6 years and this can produce a very large unexpected tax bill in an already tight market.

What types of payment are at risk?

All tips, gratuities and service charges are taxable. The arrangements by which they are paid determine who is responsible for accounting for the tax.

What is a tip or service charge?

A tip or gratuity is a spontaneous and uncalled for payment offered by a customer either in cash, in part of a cheque payment, or as a specific gratuity on a credit/debit card slip. A service charge is an amount added to a customer's bill before it is presented to the customer. If it is made clear to the customer that the charge is a purely discretionary amount and that there is no obligation to pay, then the payment is a voluntary service charge. Where that is not the case, the payment is a mandatory service charge. The tax and National Insurance treatment of such payments is determined by the nature of the payment and the arrangements under which it is paid.

Employees liability

The only arrangement where the responsibility for payment of the tax due on tips etc lies with the employees is where they receive cash tips directly from the customers and the monies never pass through the employers hands. It is up to each individual employee to declare cash tips received by them on their tax return.

Employers liability

Where the tips etc are distributed by the employer then the amount paid to each employee must be included in their gross pay, with PAYE deducted accordingly. National Insurance contributions are due only in the case of mandatory service charges or where the employer has any control over the distribution of the payments. The flowchart in the enclosed attachment shows the National Insurance treatment for tips, gratuities and voluntary service charges. As long as the employer plays no part in deciding how the tips should be shared among the employees, and there are no mandatory service charges, then no National Insurance contributions should be due.

Tronc systems

An alternative arrangement is to operate a tronc system. This is, in effect, a separate payroll operated for tips, etc. The tronc must not be operated by the employer or company director and should be operated by an ordinary employee, often the Head Waiter/Waitress. The troncmaster must register as an employer with the Inland Revenue and becomes responsible for the deduction of PAYE (not NIC) from the payments distributed to staff. It will also be necessary to inform your local tax office of any new tronc system coming into operation.

Further information and guidance

If you believe that your business could be vulnerable to an attack by the Inland Revenue, you must contact a qualified accountant or taxation practitioner immediately. They will be able to advise on any risk to your business as a result of a Revenue Inspection and will be able to advise on how any irregularities should be disclosed.

A full document with gratuity flowchart is available for download from the Industry Info section.