Tax Payable on Tips, Gratuities, Service Charges

07/05/2022 - 9 minutes read

Tax payable on tips is a frequently asked question by those responsible for arrangements to share tips, gratuities and service charges amongst employees in the catering and service industries.

Tax on Tips

A customer may make different types of payment on top of the basic charge, but usually, it will be one of the following:

  • – mandatory service charge
  • – discretionary service charge
  • – gratuity paid to the employer as part of a cheque, credit or debit card payment
  • – gratuity paid into a staff box or similar
  • – gratuity handed or paid directly to an employee

This guide explains the treatment for each of these types of payment.

What is a tip or gratuity?

A tip or gratuity is an uncalled for and spontaneous payment offered by a customer. This can be in cash, as part of cheque payment, as a specific gratuity on a credit or debit card payment or paid using a digital payment service or application.

What is a service charge?

A service charge is an amount added to the 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 there is no obligation to pay, the payment is a voluntary service charge. Where this is not the case, the payment is a mandatory service charge. If you impose a mandatory service charge and the money is paid out to your employees, National Insurance contributions are always due on the payments no matter what the arrangements are for sharing out the money.

HMRC will accept that a payment is a voluntary service charge if it is clearly presented to the customer as an entirely optional payment.

The literature seen by the customer should reflect this and be consistent with advice given to customers by employees. Any amount entered on an ‘open’ credit or debit card slip by a customer is likely to be a gratuity.

What is a tronc?

A tronc is a special pay arrangement used to distribute tips, gratuities and service charges.

What is a troncmaster?

A troncmaster is the person, other than the employer, responsible for arrangements to share tips among employees.

Tax payable on tips

Tax Payable on Tips, Gratuities, Service Charges

Tax payable on tips – VAT treatment

Tips are outside the scope of VAT when genuinely freely given. This is regardless of whether:

  • – the customer requires the amount to be included on the bill
  • – payment is made by cheque or credit or debit card
  • – the amount is passed to employees

Restaurant service charges are part of the consideration for the underlying supply of the meals if customers are required to pay them and are therefore standard rated.

If customers have a genuine option as to whether to pay the service charges, it is accepted that they are not a consideration (even if the amounts appear on the invoice) and therefore fall outside the scope of VAT.

More information is available from the Notice 700 VAT guide and Notice 709/1 Catering and takeaway food. Go to VAT notices or contact the HMRC VAT helpline.

Tax payable on tips – Income Tax treatment

If customers give or pay tips directly to employees or leave them on the table and individual employees keep them without any involvement from the employer, then PAYE does not apply. There will still be tax payable on tips but no National Insurance contributions will be due.

It is the responsibility of the individual employee to advise HMRC of the amounts received by either including how much they received in tips in their Self Assessment tax return or reporting the amount of the tips received to HMRC so HMRC can calculate the tax payable on tips.

The tax payable on tips will usually be recovered by an adjustment to the employee’s PAYE tax code.

If your employee does not fill out a tax return then they must report the number of tips they have received. They can do this either online using the personal tax account or by calling HMRC’s Income Tax enquiries helpline.

HMRC will give the employer an adjusted tax code so they can collect any additional tax payable on tips through PAYE. This is where tax is taken from the employee’s wages before they get them.

Employees can contact HMRC using their personal tax account or by calling HMRC’s Income Tax enquiries helpline if they think their tax code is wrong or to report the tax payable on tips they have received.

PAYE must be operated on all tips paid by an employer to an employee. Responsibility for operating PAYE rests with the employer even if the employer delegates the task to an employee if there is a tronc operating.

There may be arrangements where:

  • – someone other than the employer decides how tips are shared amongst employees but does not handle the tips or have control of them
  • – the employer makes the payment

If arrangements like this are in place, the employer is responsible for operating PAYE on the tips.

Tax payable on tips – National Insurance contributions

The legislation provides that any amount paid to an employee which is a payment ‘of a gratuity’ or is ‘in respect of a gratuity’, is exempt from National Insurance contributions if it meets either of the following 2 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
  • – it is not allocated, directly or indirectly, to the employee by the employer

By ‘allocated’ we mean deciding who should receive what amount by way of tips. Whether either of the conditions applies will depend on the facts.

In most cases where you pass tips to an employee, you are liable for both employer and employee National Insurance contributions because neither of the 2 conditions is satisfied.

Tax payable on tips paid electronically

Customers can also pay tips in an electronic format, such as through a digital application designed for the purpose, rather than making a payment direct to either an employer or an employee by card or in cash. This does not change any of the basic principles that apply as set out in this guide for calculating the tax payable on tips or deciding how tax is to be accounted for on those tips and whether a National Insurance liability arises.

How can MCL Accountants help?

Contact MCL Accountants on 01702 593 029 if you have any queries on Tax payable on tips or if you need any assistance with the preparation and submission of your business accounts or self-assessment tax returns to HMRC.