Tax Factor
07 May 2010
A Brief Tax Guide to Tips & Troncs
HMRC have successfully contended in the Court of Appeal that tips paid employees through a ‘tronc' scheme do not count towards the National Minimum Wage.
Do you know what a ‘tronc' is? And do you know the correct tax treatment for tips, gratuities and service charges?
In this article we look at the way in which tax and National Insurance Contributions should be accounted for on these and whether this is the responsibility of the employer or the employee.
Customers in restaurants, hairdressing salons, nail bars and the like often make an additional payment on top of the basic charge but before we look at the tax treatment of these payments we need to define exactly what they represent:
Tip/Gratuity
An uncalled for and spontaneous payment made either in cash, or as part of a cheque or credit/debit card payment.
Voluntary Service Charge
An amount added to a customer's bill that is purely discretionary with no obligation for payment.
Mandatory Service Charge
An amount added to a customer's bill that carries an obligation for payment to be made.
Tax Treatment
If customers give a cash tip/gratuity directly to employees or simply leave the money on the table as they leave, PAYE does not need to be applied, providing the arrangement is that employees keep the tips without any involvement from the employer. It is then the responsibility of each individual employee to advise HMRC of the amounts received and tax is usually recovered by means of an adjustment to the PAYE coding.
Service charges differ from tips/gratuities in that these are amounts added to a customer's bill before presentation. Where it is made clear to the customer that the charge is purely discretionary and there is no obligation to pay, the payment is a voluntary service charge. Where this is not the case, the amount is a mandatory service charge, and will always be liable to National Insurance Contributions when the money is paid out to employees. A payment will only be recognised as a voluntary service charge if it is clearly presented to the customer as an entirely optional payment.
In situations where tips/gratuities are paid to an employee by the employer, PAYE must be operated. This is straightforward enough where the employer handles the distribution of tips to employees, but where there is a tronc in place the treatment changes. A tronc is a special pay arrangement, used to distribute tips, gratuities and service charges, and is controlled by an individual usually referred to as a troncmaster. The troncmaster is a person, other than the employer, responsible for sharing tips amongst the employees.
A PAYE scheme will usually be set up in the troncmaster's name and he/she will then be responsible for all aspects of operating the scheme. The tronc PAYE scheme must be independent of that of the employer and records must be kept separately. The troncmaster may be held responsible for any failure to deduct tax from payments from the tronc.
It is important to note that if the employer, business partner or an official of the company performs the troncmaster role, then tips paid to employees in relation to the tronc should be paid through the employer's normal payroll.
National Insurance Contributions (NICs)
Gratuities paid to an employee will be exempt from NICs where either of the following conditions are met:
- The payment is not made directly or indirectly by the employer, and does not include monies previously paid to the employer.
- The employer has not decided who should receive what by way of tips.
Payments made from a tronc can also attract a liability to NICs; however the troncmaster is not required to pay NICs on those payments. Responsibility for the calculation and payment of NICs remains with the employer.
Payment of tips from the tronc will not attract NICs where:
- The troncmaster is allocating money that was not originally paid to the employer.
- The employer has not decided, directly or indirectly, who should receive what by way of tips.
National Minimum Wage
For pay periods starting on or after 1 October 2009, amounts paid by the employer to the employee which represent tips, gratuities or service charges do not count towards the national minimum wage.
VAT
Tips are outside the scope of VAT when genuinely freely given. Restaurant service charges are however part of the consideration for the underlying supply of the meal if customers are required to pay them, and are therefore standard rated.
If tips, gratuities or service charges feature in your business then you should make sure that the correct arrangements are in place, seeking specialist advice if you are in any doubt as to your responsibilities regarding tax and NICs.
