A long-awaited rule change is now in force and protects the tips paid to hospitality. It will mean that employers cannot retain any proportion of those tips. The Employment (Allocation of Tips) Act came into force on July 1, 2024. Stephen Poleykett, partner at chartered accountants and business advisers MHA, assesses the implications.
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IT IS VITAL that employers are aware of the scope of the new rules, how they will apply to various ways of tipping and the tax implications. Businesses in the hospitality industry should therefore consult with staff about how tips will be allocated and ensure they have clear policies in place.
It is common in the UK hospitality industry for customers to reward good service by leaving money on the table for the staff member that served them, adding a voluntary gratuity to their credit card payment or paying a mandatory or suggested percentage as part of the bill.
These days, the majority of tips are paid on cards with the expectation that they will be given to the person who served the customer. It was previously common practice for employers to retain part of the tip to cover administration costs but this will now be unlawful.
A statutory Code of Practice on Fair and Transparent Distribution of Tips has been published that will, helpfully, be effective from October 1 this year. This Code of Practice applies to all workers, including agency worker and those on zero hours contracts and sets out the following principles:
- It applies irrespective of the method of paying the tip.
- It applies to all tips either received by the employer or over which the employer exercises control. Payments made directly to a worker by cash or via an app are outside the code’s scope.
- All tips and service charges must be passed on to the relevant worker(s). The employer cannot retain any part of them for administration.
- Where the tips are for a number of workers, the employer can use factors such as type of role, hours of work during the period in which the tip was paid, seniority, performance and the intention of the customer to determine how they are distributed. The employer should gain broad agreement from workers regarding their system of distributing tips.
- The Code states that the factors must not be discriminatory. However, length of service is included as a suggested factor and this clearly could be indirectly discriminatory on the grounds of age.
- The employer must have a written tipping policy in place that explains how tips are accepted and distributed. That policy must be accessible by workers but is not required to be displayed for customers.
- Tips must be distributed no later than the end of the month following that in which they were paid. Employers are permitted to use a “tronc” system either via a worker or a third party. If the latter is used, this must be within a clear framework and the employer must take action if it becomes aware of any unfair or improper action. Employers must keep records of all tips received and the amounts allocated to each worker for a period of three years. Workers can make a written request to see the report provided that they worked for the employer during the relevant three-year period.
Employers must have a process in place to resolve any issues arising from the allocation of tips and must treat queries or complaints from agency workers in the same way as those from directly engaged workers. Unresolved issues can be referred to the Employment Tribunal.
Businesses should consult with their workers regarding the allocation of tips and put a clear policy in place to ensure that all staff and management are aware of the ramifications of the new Code.
Employers cannot use tips, gratuities, service charges and cover charges to make their workers’ pay up to the National Living Wage / National Minimum Wage. All workers must receive at least these legal minimum hourly rates in their base pay and any tips they receive must be on top of this.
All tips received are still considered taxable income and therefore subject to income tax. Whether an employer is required to operate PAYE in respect of tips depends largely on the method by which they are distributed.
If a customer pays a tip to an employee directly or leaves it on the table and the employee collects it with no involvement of the employer, there will be no need to operate PAYE on the tip itself. It is, however, the employee’s responsibility to advise HM Revenue & Customs of the tips received each year and HMRC will adjust the employee’s tax code to collect the tax payable.
If tips are distributed by the employer, the employer will be responsible for the operation of PAYE on the value of the tips.
Tips are often pooled and distributed by a designated member of staff in a scheme known as a Tronc. The designated member of staff is known as a troncmaster, who has sole responsibility for the allocation of tips among the staff. The troncmaster is responsible for deducting tax – but not National Insurance Contributions – and for paying it to HMRC. Any reporting of National Insurance will be the responsibility of the employer.
Where a tronc is in place, the employer is responsible for advising HMRC of its existence. Failure to do so could result in the employer facing liability for any tax, NI, interest and penalties. Employers are also responsible for notifying the appointment or replacement of a troncmaster to HMRC.
Sometimes employees arrange the distribution of tips among themselves – for example, colleagues decide to pool tips to ensure kitchen staff receive a share. If there is no formal arrangement and no employer involvement in the distribution of the tips, there will be no need for the employer to operate PAYE. However, the employees concerned will be required to declare the receipt of such tips to HMRC, who will alter their tax codes to collect the tax that is payable.
National Insurance will only be payable in respect of tips where an employer is involved in their collection or distribution. In particular, no NI will be payable if tips are given directly to an employee or left on a table by the customer and are collected by the employee or if tips are distributed by a troncmaster with no involvement from the employer.
Where tips are handled by a troncmaster and the employer is involved in allocating the tips among staff, the troncmaster will be responsible for the tax that is due while the employer will be responsible for NI.
Tips are not subject to VAT nor are certain service charges. The position depends on whether the customer has a genuine option to pay the service charge. This applies even where the service charge appears on the bill. The important factor is the wording on the menu, which creates a contract between the customer and the restaurant. If it is clear that a service charge will be added, VAT is due.
However, where the service charge is described as discretionary or optional, no VAT is due as the customer has a genuine option to pay or not pay the service charge. This is the case even if it is added to the bill without asking the customer.
The distribution of service charges to staff has no effect on the VAT position. Where VAT is due, it should be deducted before payments are made to staff.
These rule changes represent a complicated and potentially high-risk challenge for employers in the hospitality industry. To find out more, contact a MHA tax specialist. mha.co.uk.
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