Tax on tips and gratuities is changing

Changes to tips, gratuities and discretionary service charges

Following consultation, the government has announced that an Employment Bill will include reforms to the way in which tips can be managed by establishments, to ensure that employees receive the full tip. The changes are expected to apply from April 2023 and will make it illegal for employers to withhold amounts from tips, whether these are received through a cash or card tip/gratuity or a discretionary service charge.

The legislation will also require employers to comply with a Statutory Code of Practice that will outline how tips should be distributed to employees to ensure fairness and transparency.  This will mean that the employer must put in place a formal tip policy, and ensure that it is followed in practice.

Employees will also gain the right to request information relating to an employer’s records on tipping, in order to assist with bringing a claim against an employer where rules have been broken. Any credible claims brought by an employee will go to an employment tribunal. This may result in the employee being compensated for any failures to operate the legislation properly, and the employer may incur fines. 

How should tipping arrangements work now?

At the current time, employers may apply a discretionary service charge to bills. Legally, the service charge belongs to the employer until it is transferred to an employee in full or with a deduction made by the employer. The service charge can be transferred to the employee by the employer directly or by a Troncmaster where a tronc scheme is in place. Typically, deductions are made from the service charge to cover certain costs such as credit card charges or the cost of administering and paying the service charge to employees.

The change in legislation is expected to prevent deductions such as these from the tips received by employees.  Therefore, where an employer makes deductions from tips for items other than tax/NIC (where applicable), these will need to stop. This will of course have a cost impact to the employer and, depending on the level of deductions, this may be significant. 

Where a tronc scheme is in place, it is anticipated that the implementation of these rules will still allow the use of a tronc to manage and allocate the tips independently of the employer.

What should employers do to prepare?

All employers whose staff receive tips will need to follow the legislation and will, therefore, be required to put in place a tip policy, or review and adapt their existing policy. Although the policy should be in line with the Statutory Code of Practice, details of this have not yet been released.

Other issues companies will need to consider in advance of the proposed implementation in April 2023 include:

• How will the loss of deducted amounts from tips or a discretionary service charge impact the business? 
• Should we change or even remove the service charge altogether? 
• What other financial adjustments will we need to make to compensate for potential loss of income?
• Will our current tronc system be compliant with the new legislation?

It will also be important for employers to make sure that they fully comply with the current rules on tips. Whenever there are major changes to a specific tax area, HMRC usually takes the opportunity to have a final look at tax compliance under the current rules. We would expect to see more investigations on this area in the coming months.