Gratuities, Tips and Service Charge: Is VAT, Tax and NIC Payable?

The custom of tipping is so established in the hospitality sector that tips now contribute significantly to an employee’s income. However, despite the long standing tradition of tipping, many businesses are still unaware of the tax treatment applied to different types of gratuities and tips. With more businesses now being faced with penalties for failing to comply, it is important you know what tips are considered taxable and subject to National Insurance Contributions (NICs).

The way tips are accounted for depends on how they are received and who they are given to. The most common forms of tips are:

• Service Charge – This is either mandatory or discretionary and is applied to the final bill or included as part of the menu. It is based on a percentage of the bill and is paid directly to the employer. The employer then distributes the charge to their employees as a not-tip wage, although some employers may keep a portion of the service charge
• Voluntary tips and gratuities – Perhaps the most popular type of tip. This is where a direct cash payment is made to an employee. This can either be given directly to an employee or paid into a collection that is then shared between all employees
• Cover charge - It is becoming more popular for some restaurants to charge a fixed fee per customer, which is usually mandatory. This payment is often paid to the company at time of booking or as part of the final bill

The majority of businesses in the hospitality sector benefit from at least one of the above. Therefore, it is important to recognise that VAT, tax and sometimes NIC may be applicable on the gratuity you receive.

VAT

You must pay VAT on tips you receive if payment is not freely given. Therefore, service and cover charges should have VAT applied. Exceptions of where VAT is not applicable include:

• Bill Receipt: In the case that an individual freely pays more than what has been stated on the bill, VAT is not applicable
• Discretionary Service Charge: As the service charge is not mandatory and was freely given, VAT is not chargeable
• Payment made by Debit, Credit and Cheque: payments made via credit or cheque should always be at the consumer’s discretion

Income Tax

Tax is often payable on most forms of income, including tips. However, there are exemptions - where the individual receives payment directly from a customer and there is no employer involvement, then income tax is not applicable. However, the employee should declare the tips they receive on their self-assessment tax return.

Income tax is only payable where an employer has involvement in the distribution of the gratuity. In this instance, all tips are treated in the same way as wages and are subject to PAYE. (There are exemptions for this, which are addressed further on).

National Insurance Contribution

Although National Insurance Contributions (NICs) are uncommon on tips, there are cases where it is applicable. For a tip to be exempt from NIC:

• a genuine intent of gratitude must be made
• the employer must not have paid the tip (directly or indirectly) to its employees
• The employer must not have been involved in deciding the amount of the tip or in the distribution or allocation

If all of the above criteria are not met then NIC must be paid on the tip or gratuity.

Tronc and Troncmaster

Troncs are an effective way of distributing tips in the hospitality sector. However, it is important to understand that using a tronc or having a troncmaster means different rules are applied to the tip given. A tronc allows for the distribution of tips amongst all members of staff. The individual who looks after this is known as a troncmaster. HMRC must be alerted as to who the troncmaster is so that they can set up a PAYE scheme for the tronc.  In the case where there is a tronc master, they are held directly responsible and accountable for paying the correct amount of NIC and Income Tax.  In these circumstances the following rules apply:

How money is divided	What to pay
The employer decides how the tronc money is divided	The employer pays PAYE tax and NICs
The troncmaster decides how the money is divided	Troncmaster pays PAYE tax - no NICs are due
Someone else, who is not acting for the employer, decides how the payments are distributed	Troncmaster pays PAYE tax - no NICs are due

If you would like further information or require advice on your PAYE system and the treatment of tips, please feel free to contact Adam Moody at adam@raffingers.co.uk

 

Sources

https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/430329/E24_2015_v1_0.pdf

https://www.gov.uk/tips-at-work/tips-and-tax

http://www.hmrc.gov.uk/manuals/vatscmanual/VATSC56400.htm

https://www.gov.uk/guidance/employee-gets-tips-gratuities-or-service-charges-through-a-tronc