In much of the hospitality sector, it is common for workers to receive money in the form of tips and service charges from customers. Where this occurs, the employer should be aware of the rules surrounding deductions for PAYE (Pay As You Earn) tax and National Insurance contributions (NICs).
The application of income tax and national insurance differs depending on the following factors:
- whether the money is paid voluntarily by customers OR in the form of a compulsory service charge
- whether your employees receive the money direct from customers or whether it is distributed to them, either by you or through a central pool (known as a tronc)
Tips received directly and kept by employees
Where employees receive and retains the tips, directly from a customer then there are no NICs due on the tips and the tax due is the responsibility of the employee.
Compulsory service charges
If an employee receives money from compulsory service charges added to the customers’ bills, then the employer is responsible for calculating and deducting BOTH the PAYE (income tax) and Class 1 National Insurance Contributions elements.
This applies even when it is distributed through a tronc. Interestingly, the The person in charge of the tronc is known as the “troncmaster.”
Tips and voluntary service charges you distribute to employees
The rule of thumb is that if an employer distributes any money from tips or service charges to their employees then the employer must calculate and deduct both PAYE tax and NICs. This applies to a voluntary gratuity added to a credit card payment as well as to tips that are received directly by your employees but then given to the employer/manager to distribute.
There is an exception for situations in which someone else, such as a troncmaster, decides independently of you how much money from tips and service charges an employee should receive and then asks you to pay the amount to the employee. In this instance, you must calculate and deduct PAYE tax but no NICs are due.
If you pass tips and voluntary service charges to a tronc rather than distributing it yourself, or you don’t decide what amounts should be paid to which employees, then the rules outlined in the next section apply instead.
Tips and voluntary service charges distributed by a tronc
A tronc is an arrangement for pooling and distributing tips and service charges, and the person who operates the tronc is known as a troncmaster.
Even where tips are distributed through a tronc, employers are responsible for deducting both PAYE tax and NICs on all money that is distributed from compulsory service charges to your employees.
If employers use a tronc, you must tell us who the troncmaster is so that we can set up a PAYE scheme for the tronc.
For tips and voluntary service charges distributed by a tronc, PAYE tax is always due and it is the troncmaster’s responsibility to calculate and deduct it.
NICs are only due on tronc payment if the employer has a role in deciding which of your employees gets money from the tronc and how much each employee should get. Where NICs are due on a tronc payment they are the employers responsibility, not the troncmaster’s and you should discuss with the troncmaster and take the following actions:
- find out the amount being paid and the date of payment
- include the payment in the employee’s gross pay when calculating NICs and show the gross pay on the employee’s form P11
National Minimum Wage and tips
An Employment Appeal Tribunal has ruled in HMRC’s favour in the case of Annabel’s Restaurant and Nightclub. The case concerned the payment of tips through a ‘tronc.’ The ‘tronc’ was used by some restaurants as a means of distributing tips or service charges paid by customers. HMRC argued successfully that where the tips are paid in this way they do not count towards national minimum wage (NMW) entitlement.
However, it should be noted that where tips are paid along with wages through the main employer payroll then the tips and service charges distributed do count towards the NMW.