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Tips, gratuities, service charges and troncs
The Tax Bulletin issued in June 2005 provided guidance for employers regarding tips, gratuities and service charges. It included guidance on the National Insurance treatment of tips, gratuities and service charges.
Booklet E24 'Tips, gratuities, service charges and troncs: A guide to income tax, National Insurance contributions, national minimum wages issues and VAT' has been included on the HMRC website since February 2005. See also 'PAYE: NIC and Tips' by Elizabeth MacKeown and Robert Brockwell, Taxation, 3 March 2005, page 536. Following further legal advice, the booklet has been amended to exclude guidance about NI.
If tips paid by customers are paid to employees through an independently-run tronc, they are not liable for Class 1 National Insurance even where they go to meet a contractual obligation, or legal requirement such as the national minimum wage. For a payment to be disregarded from earnings under para 5 of Part 10 to Sch 3 of the Social Security (Contributions) Regulations 2001 (SI 2001 No 1004), the conditions are that a payment is:
- not paid, directly or indirectly, to the employee by the employer and does not comprise or represent monies previously paid to the employer; or
- not allocated, directly or indirectly, to the employee by the employer.
With regard to the national minimum wage, the June 2005 edition of the bulletin said that HMRC did not consider that payments that count for this purpose could be disregarded from earnings under the tips disregard. Following further legal advice, HMRC have changed their view. Where employees receive payments which are tips or payments in respect of tips and they are not:
- paid directly or indirectly to employees from sums previously paid to the employer; or
- allocated, directly or indirectly to employees, by the employer;
the payments are not liable for Class 1 National Insurance.
The fact that payments are taken into account for national minimum wage purposes does not determine whether the payments can be disregarded from earnings under the tips disregard for Class 1 NI. Amounts paid by a customer as service charges, tips, gratuities and cover charges count towards NMW pay if they are paid by the employer to the employee via the employer's payroll and the amounts are shown on the payslips issued by the employer.
Tips and gratuities given directly to the worker by a customer and tronc money paid directly from the tronc to an employee do not count towards NMW pay. However, if the tronc money is passed to the employer, and is both paid to the employee via the employer's payroll and reflected on payslips issued by the employer, then it will count. It will also count where the troncmaster operates PAYE on tronc distributions and uses the employer to pass the net payments to each employee, provided that the amounts are paid to the employee via the employer's payroll and are reflected on their payslips.
HMRC's guidance currently advises that if an employee's contract of employment indicates that he can participate in a tronc, any payments made by a tronc are liable for Class 1 NI because they are contractual payments and therefore not gratuitous.
Contractual terms may vary, but HMRC now accepts that where:
- the terms of a contract do not entitle an employee to receive a specific amount from a tronc; and
- the employee is receiving payments from an independently-run tronc funded from tips paid by customers; and
- the employer is not allocating tips to the employee either directly or indirectly,
the tips disregard applies so no Class 1 NI is due on payments from the tronc. Payments do not cease to be tips because an employee has a right to participate in a tronc.
In the event that an employer pays amounts to a tronc which exceed the total value of the tips paid by customers, the excess is not a payment of or in respect of a tip, so Class 1 NI is due on the excess.
The tips disregard may also apply even where an earner's contract of service, whether written, verbal or implied, entitles him to a specific amount that originates from tips and the employer is obliged to pay the specified amount. In such cases, Class 1 NI will only be due where:
- the payments are in respect of tips and the employer does not satisfy either of the conditions in the tips disregard; or
- the employer makes payments sourced from his own funds and not payments in respect of tips.
One of the conditions is that the employer must not allocate payments directly or indirectly to the earner. HMRC consider that where the employer promises or guarantees a certain amount from the tronc, that may indicate that the employer has sufficient control over the operation of the tronc to constitute an indirect allocation by the employer. Further investigation may be required to establish the true nature of the arrangements.
With regard to allocation of payments, liability for Class 1 NI will depend on the specific arrangements regarding the distribution of the tips operated by individual employers. 'Allocate' connotes deciding:
- who is to be the recipient of the payment; and
- how much the recipient is to get.
'Indirect allocation' refers to cases where the employer does not allocate payments in person or through an agent, which HMRC regard as 'direct allocation'. Rather, the employer establishes and controls a system that performs the allocation in such a way that the allocation can reasonably be said to reflect and give effect to the employer's wishes.
If Class 1 NI has been paid in error and included in a contract settlement, the employer can expect the tax office that dealt with the settlement to write to the employer no later than 31 May 2006. The employer will be given the opportunity to apply for a refund.
With regard to Class 1 NI paid in error in the current tax year not included in a contract settlement, the employer should take action as set out in paragraph 10 on page 17 of booklet CWG2(2006) Employer's Further Guide to PAYE and NICs to correct his records and refund overpaid employee's NICs to employees.
If all Class 1 NI paid in error were not included in a contract settlement, the person requesting the refund should write direct to HMRC, National Insurance Contributions Office, Refunds Group, Employers Team, Room BP1001, Benton Park View, Newcastle upon Tyne NE98 1ZZ.
Another article on the tax and National Insurance treatment of tips and troncs will appear in a future edition of Taxation.
PAYE online
Employers who had fewer than 50 employees when HMRC wrote to them in November 2004 will get a tax-free payment of £250 if their 2005-06 return is sent online. They will get that even if an agent files online for them.
If the return passes HMRC's quality checks, an online letter will be sent stating that £250 has been credited to the employer's PAYE payment record. Letters are likely to be sent out from June. If the employer has given HMRC authority to send information to an agent online, the letter will go to the agent. Otherwise it will go to the employer. A paper letter will be sent only if the employer:
- has not registered for PAYE Online for Employers — Internet, or
- has de-activated PAYE Online for Employers - Internet, or
- has not authorised the agent to get information on his behalf.
The quickest and easiest way that most employers can get the tax-free payment is to self-serve by deducting £250 from their next PAYE payment(s) for 2006-07. They must wait for the online letter before doing so. The letter will explain how to get a cheque payment from the accounts office if the employer cannot self-serve the tax-free payment.
Deficiency relief, ITTOIA 2005, s 539
With regard to deficiency relief, HMRC now accept that the most tax effective approach is to allocate the relief against dividends or other savings income in priority to non-savings sources of income, for example employment income. The additional tax saving can be up to 4.5% of the relief claimed. In practice this saving is likely to be much smaller. Deficiency relief, if given first against dividends, reduces the effective rate of tax from the dividend upper rate of 32.5% to the dividend ordinary rate of 10%. The tax saving is thus 22.5% of the income. HMRC's tax calculation currently allocates deficiency relief against non-savings income first reducing the tax rate from 40% to 22% giving a tax saving of 18% of the income; hence the 4.5% (22.5% minus 18%) difference.
The foregoing are extracts from longer articles in Tax Bulletin 82 to which reference should be made for details of the full text. Tax Bulletin is covered by Crown copyright and is available on the Internet at www.hmrc.gov.uk/bulletins/index.htm. For subscription details, contact Jayne Harler, tel: 020 7147 2317.
