Tips are payments that you can get in addition to your normal wages. Tips are usually paid by a customer or a client. Tips are subject to tax under section 62 Income Tax (Earnings and Pensions) Act 2003 (ITEPA 2003).
Wages are the number of hours worked multiplied by the hourly rate of pay. Your wages include commission, bonuses, holiday pay or other payments connected with your job. Your wages do not include tips and other gratuities. You are protected against your employer making deductions from your pay or wages. If your employer makes a deduction from something that does not count as your pay or wage you are not protected. You should be able to make a claim for breach of contract if you are entitled to the payment under your employment contract.
The way that income tax and national insurance contributions are deducted depends on the way your tips are paid to you. HMRC has a great publication called Tips, Gratuities, Service Charges and Troncs for those responsible for arrangements to share tips, gratuities and service charges amongst employees in the catering and service industries. It covers the treatment of tips, gratuities and service charges for Income Tax, National Insurance contributions (NICs), national minimum wage (NMW) and VAT purposes, including the treatment where a tronc exists. Page 29 of HMRC’s Employer Further Guide to HMRC and NICs CWG2 further explains the tax treatment of tips and gratuities.
Under Schedule 3, Part X and paragraph 5 of the Social Security (Contributions) Regulations 2001, if you are tipped directly by a client or customer, your employer is not involved and it is up to you to let HMRC know. Your employer should inform you that tips that are paid directly to you are outside of PAYE and it is up to you to get in touch with HMRC.
If tips in your workplace are pooled and shared between you and your colleagues who are on duty for that shift, each of you is responsible for notifying HMRC and paying tax on your share of the tips.
Here you are not required to pay national insurance contributions. This is because the tips were not paid by your employer or paid to your employer. Under paragraph 5, Part 10, Schedule 3 of the Social Security (Contributions) Regulations 2001 this allows the tips to be ignored for national insurance contribution purposes.
According to section 5 of Tips, Gratuities, Service Charges and Troncs (HMRC), tips given to an employer for onward distribution to staff can happen in one of two ways.
Here, the tips form part of your earnings and your employer is responsible for PAYE on the total amount of tips. Class 1 National Insurance Contributions will be deducted under section 6 Social Security Contributions and Benefits Act 1992.
Tips are sometimes paid through a tronc system. A tronc is a special pay arrangement used to distribute tips, gratuities and service charges. Commonly a tronc is a central pool of funds in which some or all of the tips and service charges paid by customers are distributed to employees. How such arrangements work is entirely a matter for the business. How amounts paid from the tronc are distributed is a matter for the troncmaster, tronc committee (if one exists) and/or tronc members. In a tronc system, HMRC treats the tips distributed by the troncmaster as earnings and the troncmaster operates a PAYE scheme for those tips which is independent of your employer’s PAYE system – section 6 of Tips, Gratuities, Service Charges and Troncs.
Under Schedule 3, Part X and paragraph 5 Social Security (Contributions) Regulations 2001, national insurance contributions are deducted based on two criteria;
If the tronc has its own rules, then there is no national insurance contribution payable because even though the money was given to the employer, the employer did not distribute it to workers.
If the tronc shares pooled tips according to the employers rules then Class 1 national insurance contributions must be paid – See section 8 of Tips, Gratuities, Service Charges and Troncs (HMRC) and section 6 Social Security Contributions and Benefits Act 1992.
All employees have the right to a minimum level of pay under the National Minimum Wage Act 1998. Tips are not included in your wages whether they are paid through your employer or through a tronc system. This is because the National Minimum Wage Regulations 2015 specifically excludes any ‘service charge, tip, gratuity or cover charge’.
Service charges are most common in bars and restaurants. It is added on the bill, and can be between 10-15% of the total bill. If the menu and the bill say that the service charge is optional, then the service charge is treated as a voluntary gratuity. Tax and national insurance contributions would then be the same as for tips. If the service charge is compulsory then it is treated as part of the takings of the bar or restaurant. When an employer passes on the service charge to workers, it is treated as a normal payment of earnings and is taxed, with national insurance contributions deducted accordingly, even if it is paid through a tronc system – see section 3 Tips, Gratuities, Service Charges and Troncs (HMRC).
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