A long-awaited rule change that came into force early this month protects the tips paid to hospitality workers and will mean that employers cannot retain any proportion of those tips. The Employment (Allocation of Tips) Act came into force on July 1, 2024.
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.
Tipping, in various forms, is commonplace in the hospitality industry in the United Kingdom. It is common 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. But while it was previously common practice for employers to retain part of the tip to cover administration costs, this will now be unlawful.
A Code of Practice
A statutory Code of Practice on Fair and Transparent Distribution of Tips has been published that will, helpfully, be effective from October 1, 2024. This Code of Practice sets out the following principles:
- The Code is applicable to all workers, including agency workers and those on Zero Hours Contracts.
- It applies irrespective of the method of paying the tip.
- It applies to all tips that are either received by the employer or over which the employer exercises control. Payments made directly to an individual worker by cash or via an app are outside the scope of the Code.
- 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 to determine how they are distributed e.g. type of role, hours of work during the period in which the tip was paid, seniority, performance, and the intention of the customer. The employer should gain broad agreement from workers regarding their system of distributing tips.
- The Code states that the factors must not be discriminatory. Interestingly, however, length of service is included as a suggested factor - this clearly could be indirectly discriminatory on the grounds of age.
- The employer must have a written tipping policy in place which 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. Where a third party is used, this must be within a clear framework and the employer is obliged to take action if it becomes aware of any unfair or improper action.
- Employers are obliged to 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.
Employers should also remember that tips, gratuities, service charges and cover charges cannot be used 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.
Tax implications
The new act does not change the way in which tips are treated for tax purposes. All tips received - in whatever form - are considered taxable income and, therefore, subject to income tax. Whether or not an employer is required to operate PAYE in respect of tips depends largely on the method by which they are distributed.
Direct payment to employee
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 HMRC of the tips received each year and HMRC will adjust the employee’s tax code to collect the tax that is payable.
Tips distributed by employer
If tips are distributed by the employer, the employer will be responsible for the operation of PAYE on the value of the tips.
Troncs
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. Where a Tronc is in place, the troncmaster is responsible for deducting tax - but not National Insurance Contributions - and for paying it to HMRC. Any reporting of National Insurance (NI) will be the responsibility of the employer (see below).
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 that may be due.
Informal arrangements
Sometimes employees arrange the distribution of tips among themselves. For example, sometimes employees decide to pool tips to ensure kitchen staff receive a share. If there is no formal arrangement and there is 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.
Tax
Read more about TaxRead moreEmployers are also responsible for notifying the appointment or replacement of a troncmaster to HMRC.
National Insurance
National Insurance (NI) 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.
VAT on tips and service charges
Tips are not subject to VAT. Certain service charges are also outside the scope of VAT. The position depends on whether the customer has a genuine option about whether 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 the 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.
What you need to do
These rule changes represent a complicated - and potentially high-risk challenge for employers in the hospitality industry. If you have any concerns about this topic please consult one of our tax experts.
