Lee Sharpe looks at the new Tipping Act and the tax implications for employees and employers.
The new Tipping Act (The Employment (Allocation of Tips) Act 2023) received Royal Assent in 2023, but is being enforced from 1 October 2024. This article considers how the new regime will affect employees and employers, focusing on the tax aspects.
Background
Tips are commonplace in hospitality, be it cash left on a restaurant table or added to a payment for a round of drinks, but also in traditionally cash-centric businesses, such as hairdressing and taxi driving.
As tippers, we tend to think of a tip or gratuity as a reward for good service. But we also see restaurants add (say) a 10% service charge – effectively a presumption by the business that customers will want to tip for good service; sometimes these service charges are optional – a ‘suggestion’, so still gratuitous – but in some cases they are not, so they are not really ‘tips’.
The new law responds to significant and sustained public concern over some of the more draconian rules enforced by employers who manage tips for their staff, going back more than a decade. Some of the more extreme examples highlighted by the press and ultimately debated in parliament include:
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setting off the costs of any tables that ‘dine and dash’ – customers make off without paying – against employee tips (apparently a common practice for petrol station forecourt staff as well);
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where the employer charges an ‘administration fee’ – as high as 16% – for managing staff tips;
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employers charging their serving staff a percentage fee on all table orders, irrespective of tips received (apparently, some unlucky employees have ended up having to pay money from their own funds at the end of a shift because that fee exceeded the tips they ‘earned’); and
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using tips to boost basic salaries, to bring the employee’s wages up to the national minimum wage (NMW) – so the generous patron is effectively subsidising only the employer rather than the employee. Nor are these always trifling amounts; in one case, a chef’s salary advertised at £28,000 per annum turned out to be a basic salary of £16,000, plus a ‘guaranteed share’ of front-of-house tips of £12,000 per annum.
The last of these will have been of particular interest to HMRC, given that it is responsible for policing the NMW.
The dubious honour of the tronc-master
In the world of tips and gratuities, the ‘tronc’ is the common pot into which tips are deposited and managed on a collective basis. In theory, a tip given to a specific employee belongs only to them, but many employers encourage (or insist on) a collective pooling of tips into the tronc. So, you may sometimes see several tips glasses behind a bar, one for each server, or you may see one large tips jar meant for all staff combined – the tronc.
In restaurants, most tips or gratuities will come through the service charge, so it is received first by the business as part of the bill, usually then to be pooled and passed over to the collective tronc. It is then administered to be divvied out amongst the employees, by the ‘tronc-master’. Traditionally, the tronc-master is one of the oldest or longest-serving waiting staff, such as the ‘maître d'’, but the potential complexity of running a tronc has meant that a more senior employee – or even the employer – may have to take on the role.
Here, we might see, from the employer’s perspective, why an administrative charge might have been justified – where it is taking up a lot of their time to look after a scheme that is not really anything to do with them. Running a tronc can be a serious undertaking. But how we then get to a charge of as much as 16%, or some employees having to pay for the privilege of working tables, is less clear. The pandemic has pushed many hospitality businesses to the brink or even beyond, but many of these reported issues surfaced long before the pandemic.
What has changed?
The Tipping Act has introduced a mandatory statutory code of practice; together, these require that:
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all qualifying tips must be paid on to workers (broadly, permanent employees and agency workers);
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no deductions are allowed from tips – except mandatory adjustments like income tax (see below);
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tips must be distributed to staff no later than the end of the month following the month in which the customer paid the tip (e.g., a tip paid on 25 October must be paid on to staff by 30 November);
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where the employer sets out the rules for distributing tips (or exerts significant influence over those rules), those rules must be fair and transparent;
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a written policy be maintained on how tips are dealt with that is accessible to all workers; and
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a record be kept of tips received and how they were allocated amongst workers.
These rules apply to any tips either paid first to the employer (such as a service charge paid as part of the bill for the meal) or that the employer handles, manages, or otherwise has a meaningful say in their allocation, etc.
Special tax treatments of tips and troncs
Tips are always subject to income tax (thanks to ITEPA 2003, s 62(2)(b)). However, they become the employer’s responsibility and subject to PAYE only if the employer actually receives the money in the first place, or sets out (or influences) the rules governing the allocation of the tip.
Example 1: Tip paid directly to waitress
A customer pays a £10 tip directly to their waitress. The employer has no rules governing how such direct tips should be dealt with, so all the tip is an income receipt of that waitress, and PAYE is not applicable.
The waitress must account for tax on those earnings directly to HMRC (perhaps through self-assessment, or otherwise by reporting her tax year total tip income to HMRC).
Example 2: Tip paid by credit card
A customer settles her table’s lunch bill and includes £25 as a discretionary service charge. This is taken by the employer business initially as a credit card receipt but is then passed over in full to the tronc-master, as the employer is not involved in setting up or managing employee tips.
PAYE should be applied to the tronc, which may have its own PAYE scheme, or as an addendum to the employer’s PAYE scheme (where the employer’s scheme is then acting as payroll agent to the tronc-master).
Special NICs treatment of tips and troncs
Tips are not always treated as earnings which are subject to National Insurance contributions (NICs). Simply, NICs are due only if the employer undertakes to pay certain amounts to an employee, so they will be exempt if either:
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the tips never go through the employer; or
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the employer is not involved in determining the amount of tips then to be allocated to employees, usually because the tronc is run independently by the employees.
So, even where most tips are paid as part of the bill by card, etc., NICs will still not be due so long as the employer is distanced from deciding how tips should be split amongst the workers; likewise, student loan deductions, or mandatory pension contributions. In theory, this should incentivise employers to allow the tronc to run independently, so limiting secondary employer NICs – although an employer’s potential exposure here likely depends on whether they pay a lot of staff relatively little, or a lot to relatively few staff. But the employer may feel obliged to get involved if they feel that the tronc is not being applied fairly (e.g., if kitchen staff are being excluded, despite having contributed to the diners’ experience).
What are the implications?
Firstly, employees will get more (all) of their tips. Employers will get no part of them anymore.
The tax and NICs rules are not directly affected by the new regime, but it would be sensible to review the PAYE implications, etc., as policies and systems are overhauled following the introduction of the new tipping rules.
In theory, the new rules are demanding of employers only when they are involved in the tronc process or allocation system. So, a more ‘hands-off’ approach will mean less obligation under the new regime, happily aligning with lower payroll imposition – NICs, student loans, etc. – as above. So far, so good.
But it is not difficult to see that employers may ultimately feel obliged to step in, such as if a tronc is being poorly run or if the employer operates nationally and does not want the risk of different tronc rules in each site. The new rules are well-intended but the potential NICs savings, etc., rely on the independent tronc’s being consistently run fairly and well.
