The problem
The Inland Revenue has always found it tricky to trace and collect tax and national insurance contributions (NICs) due on tips. However, it is becoming increasingly hawkish, and some employers have been stung by massive NIC bills following impromptu inspections.
The Law- Tips are always liable for income tax; however, the way in which employees receive the tips will determine how this is collected.
- Tips or contractual payments passed from an employer to an employee are liable for both employee's (current rate, 11%) and employer's (current rate, 12.8%) NICs.
- Payments made by a troncmaster to an individual are not liable for NICs.
- A tronc must operate completely independently of the employer.
- Compulsory service charges added to a customer's bill will always be liable for NICs and should not be passed on to the tronc.
Expert AdviceThe fundamental problem for the Revenue is that it is reliant on individuals making truthful declarations about the amount they earn in tips. It therefore conducts regular "swoops" to clamp down on any dishonesty.
A tronc is an arrangement for pooling tips, which are then shared between its members. If properly established and managed, a tronc ensures that its members are not liable for payment of NICs on tips. For the Revenue to regard a tronc as "operational", the rules relating to it must be determined by the employees and it must be managed by a troncmaster, independently of the employer.
Since 5 April 2004 an employer must notify the Inland Revenue when a new troncmaster is appointed, although he should play no part in the appointment of the troncmaster. The Revenue will then set up a PAYE scheme for the tronc in the troncmaster's name.
The key to securing relief from NICs on tips lies in the tronc's independence. Any evidence of an employer being involved in, or exerting any influence over, the distribution of tips, or on the membership or rules of the tronc, will result in the employer being responsible for operating PAYE, and NICs will be payable on the tips.
As an example, Amy runs a restaurant. She does not impose compulsory service charges, and tips paid by cash, cheque, debit and credit card are all passed to Paul, the troncmaster, who has been elected by the other staff. Paul operates PAYE on the tips he distributes, and an independent staff committee determines the allocation of tips.
As Amy has not influenced, directly or indirectly, the distribution of tips, no NICs will be due on the tips received by the tronc members.
When Paul decides to leave the restaurant, staff appoint Shayne as the replacement troncmaster. Amy must notify the Revenue of the change so that they can set up a PAYE scheme for the tronc in Shayne's name.
In theory, both employers and employees should benefit from the existence of troncs, because neither will have to pay NICs on tips. In addition, membership of a tronc transfers the legal responsibility for recording and reporting PAYE from the individual to the troncmaster.
In an industry characterised by seasonal workers and a high turnover of staff it can be difficult for the Revenue to keep track of earnings, especially tips. However, neither employers nor staff should think that they can always escape the taxman. Where there's a will, there's a way; and since cash doesn't leave an audit trail, the Revenue looks for discrepancies in returns, either for an individual or between staff at similar restaurants, hotels, etc.
Detailed records are the only way to dispute the Revenue's estimates of earnings and avoid a hefty tax bill, which can be either for a particular year or backdated over up to six years.
Beware!The total exposure to NICs can be nearly a quarter of all tips distributed to staff. Therefore it is vital to have procedures in place which will withstand the Revenue's scrutiny.
ContactsAndrew Burnham, MacIntyre Hudson
020 7583 7575
andrew.burnham@macintyrehudson.co.ukThe Inland Revenue guidance booklet E24, Tips, Gratuities, Service Charges and Troncs, is available at
www.inlandrevenue.gov.uk/helpsheets/e24.pdf