The tipping point?

An exclusive poll conducted for Caterer by the London restaurant guide and website Square Meal this week revealed that most people believe the service charge added to their bill goes straight to the staff as a bonus - on top of their wages.

Of the 715 people who responded to the poll, 523 (73%) said they thought that the 12.5% charge ended up in the hands of staff. While that may well be the case in a large number of businesses up and down the country, possibly even in the majority, anyone who has worked in the industry knows that, all too often, it is not so.

If the tronc isn't actually openly being used to top up the £4.85 national minimum wage (NMW), most waiters will be able to recall infuriating situations when bosses have dipped into the money to cover anything from so-called "breakages" to the cost of booze for the staff party. At the very least, the tronc is often used to cover credit card charges and administrative costs incurred from running the tronc itself.

The truth is that it's a rare occasion when 100% of the service charge makes it into the pockets of the staff, especially when that charge isn't paid in cash.

Should that worry us? According to the Inland Revenue, it should not. Although the Revenue's remit is simply to collect taxes, not to pass moral judgement on employment law, the new guidelines have put into black and white the practice of using the tronc to top up the employers' NMW requirement. On page 7 of the Revenue's booklet E24, Tips, Gratuities, Service Charges and Troncs, an example is given of how Jill, an employer, may do this - as long as she pays all her taxes and national insurance contributions (NICs) on the part of the tronc she uses.

Although the original law surrounding the NMW also allowed for this, the Revenue's previous guidelines stipulated that NICs would then be liable on all monies in the tronc if the employer used any portion of it. They also allowed monies to be used to pay credit card charges, but again this would mean incurring NICs on the whole tronc.

The new guidelines allow the tronc to be broken up - some to be used as a wage (liable for NICs) and some to be left in the tronc (and remain, therefore, free from NIC liability).

According to David Peck, who runs an account outsourcing company and looks after the books for seven London restaurants, these crucial adjustments will make it a lot more attractive for restaurateurs to use part of the tronc. "NICs make up a big bill - 12% on top of all your wages is a lot of money. Without it, there is a lot of money to be saved," he says. "If they are allowing restaurateurs to deduct credit card charges, and if we can pay less than the minimum wage, then it is a massive plus."

However, according to Bob Cotton, chief executive of the British Hospitality Association (BHA), there is no danger of more restaurateurs taking from the tronc. "I have every confidence that more restaurants won't start dipping into the tronc to pay wages," he says. "The BHA's recommendation to its members has always been that house [basic] pay should be above the minimum wage."

Cotton concedes, however, that "we can't insist on that". The reason the BHA can't insist on it is because, quite simply, neither does the law.

In 2002 four London waiters took a complaint on this subject as far as the European Court of Human Rights. They claimed that the money given to them as tips should not be used to make up their minimum wage. But the case of Nerva et al vs United Kingdom was lost, with the courts ruling that money collected via cheques or credit cards remained the property of the restaurant.

Some people in the industry believe that money collected via the service charge rightfully belongs to the employer or owner. Richard Shepherd, owner of Langan's Brasserie, was quoted in this magazine (Caterer, 17 February, page 7) arguing that service charges were part of wages. "Without the business, you wouldn't get the service charge or tips," he said, "and it's the restaurateur's responsibility to control what goes through the restaurant."

The problem for the restaurateur is that the service charge represents a massive chunk of cash. Peck says: "In a big restaurant, there is so much coming in the employer thinks, ‘Hold on!' If you think there are some people paid £15,000 a year to be a waiter, I know of some places in London where people are earning as much as double, even triple, that. And suddenly the employer who is paying rents, wages and business rates thinks they need to get hold of some of that money."

But despite taxes being collected according to law, with the law ruling that the service charge can be used to pay the minimum wage, is the interpretation of the law correct? Rob Rockwell, a tax analyst with accountancy firm Ernst & Young, says: "The guidelines rely on the law. Whether it is the correct interpretation of the law is another matter."

He continues: "I'm not convinced by the idea that the NMW should take tips into account. I'm not convinced that this doesn't change the status of the tip into a statutory charge. You accept it as a gratuity at the point it is received, but then, at the time it's paid out, it has changed its nature."

At one leading central London restaurant, the assistant manager, who wished to remain anonymous, explained that he and the rest of the waiting staff now received their wage as a yearly salary, with all the service charge - labelled to the bill payer as "optional" - being collected by the restaurant. "We have a fixed salary that works out at about £7.20 per hour - the service charge is used to keep that level all year round," he says. "Employers are very clever. If they collect the 12.5% and the turnover is £10,000 on a busy day, that's someone's salary for a month. It is the customer that is then paying the employee."

As a result of the service charge being used this way, the assistant manager says customers no longer leave tips. "You don't get them any more," he says. "It's fair enough - why should the bill payer leave more?" He adds that, although the balance from the service charge is meant to be shared out at the end of the year, it never is. "It's not fair," he says. "We do a hard job and we work very long hours. It's a situation that needs to be cleared up in the eyes of everybody."

According to one well-known chef, it is commonplace for the employer to "rape the tronc" before the troncmaster shares the contributions among the staff. "I've seen people get around the troncmaster by giving him a regular backhander - that way if the employer goes down, the troncmaster goes down with him. It's easy for the employer to get hold of a couple of grand a month - that's their spending money."

Considering that 73% of those polled believe the service charge goes towards a bonus, this is potentially embarrassing for the restaurant industry, whose rapid growth over the past 10 years has involved overcoming - albeit not altogether convincingly - the public's suspicion that eating out is a rip-off. Mark-ups on water and wine have already created many a scandal story in the press, and the industry could do without service charges joining that list. Cases such as those described above make it look like restaurants are deceiving the very people who are their lifeline. If they are, then they are heading for a fall.

What's next?

According to Cotton, however, this is not the end of the story. The Government and the Inland Revenue are aware of the problem, and Cotton, who spent 18 months lobbying and discussing the issue with the Revenue, thinks there will be further tightening up of regulations.

"There are more than 100,000 restaurants, so you will never get unanimity," he says. "But you will get the Government or Revenue clearing up a few loose ends. One of the things they may look to tidy up is this issue of whether house pay is statutory pay. That is a legal point, but it could mean that house pay has to become the minimum wage."

That would certainly be a start, but would it solve the issue of the service charge and what happens to it? As revealed in the example above, many restaurateurs are using the service charge to pay basic wages, yet still call the charge "optional" or even "discretionary". The reason is because, as set out in the guidelines, there is an advantage to maintaining that the tip is "freely given", as it means the restaurateur is not liable for VAT payments.

But restaurateurs who are using the tronc to meet their minimum wage obligations should be wary of maintaining that the charge is optional. What happens to staff wages if, for instance, the service charge has been refused by an above-average number of customers? In another Square Meal survey, 68% of 440 diners polled said that they had refused to pay the service charge at least once. If that happened too often in an operation using the tronc to boost wages, it might then be unable to meet even the minimum wage. It would then be breaking the law.

In reality, by including the service charge in the total, most restaurateurs make sure that the 10%, 12.5% or even 15% charge is paid on top, even if it is advertised as being optional. But, judging by how often the issue is raised in the restaurant columns of the national press, it is rapidly becoming a major bone of contention for the restaurant-going public.

Peck says: "Personally, the service charge infuriates me - it is spoiling the industry. You are charged service charge, and then there is a gap left for the tip. When I was in Paris, the waitress said service charge was included but the tip was not! The same thing is starting to happen here - it just becomes part of the bill."

On this issue, there is another warning to businesses. Although the new guidelines say it is acceptable for restaurants to include a voluntary service charge on the invoice - ie, written into the bill (see page 4 of booklet E24) - the Revenue has said it will test those places that do so. From April, when the Revenue joins forces with Customs and Excise to form HMRevenue and Customs, restaurateurs can expect the combined manpower to lead to more rigorous inspections. Peter Davies, a tax consultant with Vantis Tax, says employers should make sure their staff understand each restaurant's stance: "Restaurants need to make sure their staff know it is a discretionary service charge if that is what they advertise it as," he says. "You never know who might be an inspector, and if a customer asks for the charge to be removed and there is any sign of a waiter browbeating that customer, it could lead to trouble."

Solving the problem

One solution, and perhaps the most obvious one, would be to get rid of the service charge completely. North-west-based Paul Heathcote is one restaurateur who has taken action.

"We used to have a service charge but we have removed it in the past 12 months," he says. "There was just too much ambiguity. Service charges can be seen to create a clear line for the customer, but the bad thing was that it was forced on them." Now, he says, the whole issue has become "very clear and very simple". A tronc scheme is run with the tips that are given, which is divided between front of house and kitchen staff.

"Employers are fooling themselves if they can't run their businesses the same way," he adds. And that is exactly how diners would like the system to be run, too: another Square Meal survey of just less than 1,000 people revealed that a massive 88% of diners believed the charge should be completely discretionary.

Michelin-starred restaurant Fischer's Baslow Hall, in Derbyshire, also runs without a service charge. Rupert Rowley, its head chef, who says that he has worked in several kitchens where he got 30% of his wage in cash from the tronc, explains: "We don't have a service charge - it is all up to the customers themselves. Any tip gets taxed and divided up between service staff and kitchen - anyone who works unsocial hours."

He continues: "You should just split up the 12.5% over the wine and the food. Then leave it to the customer's discretion. I like to think that most people leave a tip unless they have had a really bad time. But it should not be automatic."

Another advantage of this system, he adds, is that you give yourself an instant barometer of how well the restaurant is performing. "If you leave it up to the customer, you have an instant way of checking how satisfied customers are," he says. "You can ask yourself, ‘Are we too expensive?' You can judge the customer's experience."

Paying your staff a decent basic wage in the first place will also reap rewards. Generally, at the top end, a good wage is paid. If you want to attract the best staff, you make sure you reward them.

Some will argue that we have a free labour market: if you don't like the fact that your boss uses your tips to pay your wage, or doesn't give you any of the tips on top, well, you don't have to lump it. Certainly, this is valid if the industry wants to attract journeyman waiting staff with little or no commitment to individual businesses or dedication to improving their own professional skills. But if the customer and the staff know a decent wage is being paid, and that rewards can then be given for going the extra mile, the industry will have motivated staff and, more importantly, secure staff.

For new operators, or small businesses still building customer loyalty and not yet breaking even, there may simply not be enough money going through the tills not to use the tronc for wages. For them, factoring in an extra 12.5% to menu prices to cover wage bills could inflate the price of a meal to the point of being uncompetitive. But not to increase your prices could be a false economy, as Cotton explains. "Restaurants that are paying below the minimum wage are putting themselves at a disadvantage," he says. "If you want to recruit the best staff, you have to pay the market rate, and then put the tronc on top of that."

No one wants a situation where one restaurateur takes 20% of the tronc to pay for commissions and salaries, while next door another takes 40%. To the restaurant-going public, the variations will be veiled behind the service charge, and they'll continue to be left unsure when it comes to leaving a tip.

If the Inland Revenue does tie up the loose ends and interprets the law to mean that the basic wage has to meet the NMW without tips, then that will be a step in the right direction. If it then cracks down on those businesses that claim a service charge is optional when in reality it is always paid, then that will clear up confusion even more.

But, ultimately, the industry needs to adopt a common approach - preferably removing the service charge, allowing the customer to tip on an individual basis, and passing those tips on to staff. Then the dining experience for the customer, the most important person of all, will be made as enjoyable and as transparent as possible.

Unless the industry takes it on itself to follow that common policy, there will be an even greater gap between what people think they are paying for and the reality of where their money is going - and that is an unsavoury secret no one wants the industry to bear. n

(Quotations are from respondents to the Square Meal online survey)

Key points

• Income tax is due on all tips, no matter how they are received.
• If tips are given to staff in cash by the customer, it is for the employee to declare them for tax purposes.
• Tips and all service charges received from credit cards must have income tax deducted by the employer.
• Proprietors and company directors still may not act as troncmasters.
• If there is no formal tronc registered with the Inland Revenue, then the business must operate the deduction of tax, and if it wants to avoid paying national insurance contributions (NICs), then it must be able to demonstrate that it is not influencing the allocation of tips to staff. Make sure that there is a written record from staff listing how they have decided to divide the money.
• A business may choose what proportion of the service charge and tips to pass on to the troncmaster. If any of the amount retained is paid out to staff by the employer - as part of a bonus on top of their salary, or to meet the minimum wage - it must have NICs paid on it.
• The proportion passed to the troncmaster will be NIC-free, provided that the business has no influence over how it is distributed.
• n Credit card commissions and other expenses may be kept by the business from the tronc without incurring NICs on the whole amount.
• Non-discretionary service charges attract VAT in full, and NICs must be paid on any part distributed to staff.

To download the new guidelines, visit www.inlandrevenue.gov.uk/employers/tips-gratuities.htm.