The question of whether tips and gratuities are taxable and subject to National Insurance Contributions (NICs) often results in a lively debate. Broadly, their treatment will depend on how they are paid to the recipient.
Cash tips handed to an employee, or say, left on the table at a restaurant and retained by the employee, are not subject to tax and NICs under PAYE, but the employee is obliged to declare the income to HMRC.
Where HMRC believe that employees in particular employment are likely to have received tips which have not been declared, they will generally make an estimate of the tips earned on the basis of facts available to them. HMRC often make an adjustment to an employee’s PAYE tax code number to reflect the amount likely to be received during a tax year and the tax and Class 1 NICs due will be collected via the payroll.
By contrast, if an employer passes tips to employees that are either handed to them (or the employees) or left in a common box/plate by customers, the employer must operate PAYE on all payments made. Tips will also be subject to PAYE if they are included in cheque and debit/credit card payments to the employer, or if they pass service charges to employees.
The obligation to operate PAYE remains with the employer where the employer:
Delegates the task of passing the tips or service charges between employees, for example to a head waiter in a restaurant; or
Passes tips/service charges to a tronc (see below) but the tronc is not a tronc for PAYE purposes.
Marcia, a restaurant owner, passes on all tips paid by credit/debit card to her employees. She has made a payment to her staff and must operate PAYE on these payments as part of the normal payroll.
Franco, also a restaurant owner, allows all cash tips left on tables to be retained in full by his staff. However, to ensure the kitchen staff receives a share, he collects all the cash tips and shares them out to the staff at the end of each day. Franco is involved in the sharing out of the tips and he must, therefore, include the amounts received as part of the payroll and operate PAYE on them.
Where tipping is a usual feature of a business, there is often an organized arrangement for sharing tips amongst employees by a person who is not the employer. Such an arrangement is commonly referred to as a ‘tronc’. The person who distributes money from a tronc is known as a ‘troncmaster’. Where a person accepts and understands the role of troncmaster, he or she may have to operate PAYE on payments made. Broadly, under such arrangements, the employer must notify HMRC of the existence of a tronc created and provide HMRC with the troncmaster’s name.
There are no hard and fast rules regarding how a tronc should operate and HMRC will apply the PAYE and NIC rules to the particular circumstances of each tronc. Where payments made from a tronc attract NICs liability, responsibility for calculating the NICs due and making payment to HMRC rests with the employer. If a troncmaster is responsible for operating PAYE on monies passed to the tronc by the employer and has failed to fulfil his or her PAYE obligations, HMRC can direct the employer to operate PAYE on monies passed to the tronc from a specified date.
The legislation provides that any amount paid to an employee which is a payment ‘of a gratuity’ or is ‘in respect of a gratuity’ will be exempt from NICs if it meets either of the following two conditions:
It is not paid, directly or indirectly, to the employee by the employer and does not comprise or represent monies previously paid to the employer, for example by customers; or
It is not allocated, directly or indirectly, to the employee by the employer.
Review business records
It is worthwhile checking that businesses treat tips and gratuities correctly. From time to time HMRC carry out reviews of employers’ records to make sure things are in order for PAYE, NICs and separately for the National Minimum Wage (NMW). Any errors in tax and NICs treatment could prove costly.