Tips and troncs

A client runs a restaurant as a sole trader and intends to add voluntary service charges to each bill raised to customers. It would be clearly stated on each bill that the customer has a choice of whether to pay the service charge or not.

The owner of the business then wishes to pass all the service charges to waiters and the split among the waiters would be decided by the waiters themselves, according to their own formula.

The owner of the business would neither directly nor indirectly interfere in the way the service charges are split and distributed among the staff and there is no contractual right as to a precise amount of money that each employee would receive.

The owner would then process the payment of the service charges to employees through his business payroll and show it on the face of the payslips separately from the weekly wages.

Am I right to think that such an arrangement would mean that the service charges distributed to employees and included on the payslips would count towards the national minimum wage (NMW) and would be exempt from National Insurance contributions?

It is worth noting that the client does not wish to use a troncmaster, which would create an additional compliance burden and would not have counted towards the NMW. Also, would the service charge accounted for in such arrangement be subject to VAT?

Taxation readers’ views would be very much appreciated.

Query 17,487 – Vashka.

Reply from Nina

Vashka’s query hits on exactly the reason why HMRC’s leaflet E24, Tips, gratuities, service charges and troncs, has just been updated. The change was necessitated by the decision of the Court of Appeal in the case against CRC v Annabel's (Berkeley Square) Ltd and others [2009] WLR (D) 149.

A tip is a spontaneous payment offered by a customer and a service charge is accepted by HMRC as purely voluntary in circumstances where it is made clear to the customer that the charge is not obligatory.

The position is different where service charges are mandatory. If money collected in this way is paid out to employees, National Insurance contributions are always due on the payments, regardless of the arrangements for sharing out the money.

The same distinction is made for VAT purposes. Where a service charge is genuinely voluntary then it will not form part of the ‘consideration’ for the meal and will therefore be outside the scope of VAT.

However, mandatory service charges must, by definition, be paid. Therefore they are part of the consideration and as such will be standard rated. There is more information on this in The VAT guide issued by HMRC and also in their Notice 709/1: Catering and takeaway food.

So what is the position of voluntary service charges and the national minimum wage? In the Annabel’s case, it was found that employers must pay their staff members at least the national minimum wage, regardless of any tips, gratuities, service charges or cover charges.

Tips are exempt from National Insurance provided they are neither paid to, nor allocated by, the employer to the employee. Otherwise, both primary and secondary contributions become due. HMRC’s guidance in leaflet E24 explains that a troncmaster must have a separate PAYE scheme which must be run entirely independently of the employer’s scheme.

HMRC accept that a troncmaster may have insufficient knowledge of PAYE compliance matters to be able to perform the necessary calculations. Therefore, the employer will often stand in the position of a payroll agent and make the calculations for the troncmaster. But nonetheless, the PAYE records of the tronc must be maintained separately from those of the employer.

In Vashka’s case, there is to be no formalised tronc arrangement, albeit the waiters will determine the split of the service charge amongst themselves.

They also intend to ‘piggy back’ on the employer’s PAYE scheme. In this situation, those that are deciding the division of the service charge neither handle the tips nor have control of them and payment is ultimately made by the employer. For this reason, both PAYE and Class 1 National Insurance contributions must be paid in full.

But a payment will be ‘in respect of a tip’ if it is the tip from the customer that gave rise to the payment to the staff member. This will be true even where a subsequent payment from the employer to the employee is a contractual payment.

For pay reference periods commencing 1 October 2009, amounts paid by employers which represent tips do not count towards national minimum wage pay.

So it seems that Vashka has arrived at a result which is the worst of all outcomes. National Insurance will be payable, but the payments will not count for national minimum wage purposes.

Vashka will be wise to review the extensive press coverage of the topic of service charges that coincided with the launch of the new rules. Like a number of top London restaurants, his client may wish to reconsider the introduction of any kind of service charge.

With the suggestion that service might actually improve as a result, the restaurant customers might also be grateful!

Reply from Magnus

Vashka is recommended to read the HMRC leaflet E24(2009), Tips, Gratuities, Service Charges and Troncs, which gives a comprehensive explanation of the HMRC view of tips and troncs.

It is clear that service charges are subject to income tax under ITEPA 2003, s 62, whether dealt with in the business payroll or by a troncmaster. There is no argument about this.

The fact that the business owner intends to deal with the service charges through the business payroll is fatal to the saving of National Insurance contributions. Had a valid scheme involving at troncmaster been contemplated, then National Insurance costs could have been saved.

However, as it is intended that the amounts due to each employee will be shown on the business payroll and identified on the payslips given to each employee, then the share of the gratuities will count towards the national minimum wage. This applies to pay periods before 1 October 2009. However, revisions to the leaflet E24(2009) provide that for pay periods commencing on or after 1 October 2009 no gratuities count towards the national minimum wage.

As regards VAT, the customer has the option of whether or not to pay the service charge. This means that that part of the restaurant bill is not VATable. Had the service charge been, in effect, compulsory and shown on the restaurant bill, it would have been subject to VAT at the standard rate.

Reply from The VAT Consultancy

The main question posed by Vashka concerning the minimum wage addition has, we believe, been addressed following the recent government announcement that tips cannot be used to supplement to the minimum wage payment by the employer.

As regards to the VAT liability of services charges, we at the VAT Consultancy consider that the restaurant contract between it and its customer is the menu not the bill.

There appears to be only two cases before the VAT tribunal. First, in Potters Lodge Restaurant Ltd (905) the case the menu and bills rendered stated ‘10% service is added to all bills’ and was stated to be tax inclusive.

The business did not account for VAT on the service charge element and the Revenue issued an assessment. Needless to say this appellant lost their case. If the service charge is not declared on the menu, Vashka’s client must rely on the second tribunal decision in NDP Co Ltd (2653).

But even in this case, the tribunal noted that the description on the bill had been amended to show ‘suggested gratuity’. Clearly, any addition of a service charge or suggested gratuity charge must be seen as optional and voluntary and the customer is fully aware of this at the time of ordering their choice from the menu.

Reply from N.K.

It appears, from reading the various commentaries on the subject under scrutiny, that the question of who deals with the course of the monies involved is crucial in determining the tax and National Insurance outcome.

A summary of the way the service charge is to be dealt with in this query is that it starts with a notice to customers that it is voluntary. The monies collected by the business owner are passed directly to the waiters in general, who then decide as to the final destinations. It is noted that the use of a troncmaster is not wanted.

Generally there are three methods of collecting and distributing voluntary service charges to employees as follows.

1. The employees receive the tips directly from customers and are allowed to keep them. Here, no National Insurance contributions are due, but the employees will need to declare the total received to HMRC for income tax purposes.
    
2. The employer collects and distributes service charges to employees. In this case, both tax and National Insurance contributions are due.
    
3. Service charges are pooled and their distribution is decided by a single person (the troncmaster) other than the employer. In this case, PAYE tax is due, but National Insurance contributions are not, because the employer will not have any influence as to how the monies are distributed.

Under the National Minimum Wage Regulations 1999 (Amendment) Regulations SI 2009 No 1902, as from 1 October 2009 employers will no longer be able to use tips or service charges to make up a minimum salary, regardless of how these monies are received by the workers.

This has been done by deleting the ‘that is not paid through the payroll’ get out clause from the original regulation The National Minimum Wage Regulations 1999 SI1999 No 584, Reg 31(1)(e).

As far as National Insurance contributions go, as long as the employer does not have any connection as to which employee gets what in terms of tips these sums will not be liable to National Insurance in the hands of the waiters, even though they are received via the payroll.

The voluntary service charges are a ‘bonus’ given by the customer in addition to the standard charge for meals, and so, if freely given, they are outside the scope of VAT as they are not part of the consideration for the supply. HMRC’s VAT Guidance Manual at V1-3.10.6.1 gives a commentary on this subject, and also refers to three important tribunal cases.

• Potters Lodge Restaurant Limited (905).
   
• NDP Co Limited (2653).
   
• James Dominic Joyce (14573).

If the service charges were compulsory then they would indeed become standard rated and subject to VAT.

Reply from The Jazzman

The timing of Vashka’s query in Taxation, 24 September 2009 is interesting.

Prior to 1 October 2009 it was possible to include service charges paid to a worker when calculating the worker’s wage for national minimum wage purposes if the service charges were paid to the worker through the employer’s payroll and recorded on the payslip issued to the worker by the employer.

However, from 1 October 2009 service charges no longer count towards the national minimum wage; see the National Minimum Wage Regulations 1999 (Amendment) Regulations SI 2009 No 1902.

From a VAT perspective, I note that Vashka’s client intends to add a voluntary service charge to each bill, with each bill clearly stating that the customer has a choice of whether to pay the service charge or not.

As the customers have a genuine option as to whether to pay the service charges or not the service charges are outside of the scope of VAT. If the customers did not have a genuine option as to whether to pay the service charges these would be part of the consideration for the supply of meals and would therefore be standard rated.

According to the Social Security (Contributions) Regulations SI 2001 No 2004, Sch 3 Part X para 5, for service charges to be exempt from National Insurance they must satisfy either of the following conditions.

The first condition is that the payment:

a) is not made, directly or indirectly, by the secondary contributor; and

b) does not comprise or represent sums previously paid to the secondary contributor.

The alternative condition is that the secondary contributor does not allocate the payment, directly or indirectly, to the earner.

As the service charges have initially been paid to Vashka’s client, the secondary contributor, the first condition is not met. However, if Vashka’s client does not allocate the service charges, directly or indirectly, to the restaurant employees the alternative condition will be met and National Insurance will not be due.

As there is no contractual right as to a precise amount of money that each employee would receive and the owner of the business would neither directly nor indirectly interfere in the way the service charges are allocated between the waiters it may be hoped that HMRC would accept that the alternative condition is met.

However, the decision by the owner of the business not to use a troncmaster and to pass all the service charges to one group of employees, the waiters, could make it difficult to demonstrate to HMRC that the service charges are not being allocated, directly or indirectly, by the owner.

I would therefore suggest that either:

a) National Insurance is operated on the service charges; or

b) written agreement is obtained from HMRC that no National Insurance is due.

In my experience, HMRC will provide a written response if the payroll is run for one pay period and they are provided with full details of the arrangement.
 

A closer look at troncs and troncmasters

The above replies suggest that the use of a tronc, administered by a troncmaster, would be beneficial in such a situation.

HMRC’s leaflet E24 – Tips, Gratuities, Service Charges and Troncs – has been recently updated and explains HMRC’s views of the rules relating to troncs, together with a useful flowchart and many examples. Section 6, ‘Income tax and troncs’ explains the position as follows.

‘A tronc is run by an individual usually known as a troncmaster. Where the troncmaster is in control of the tips and responsible for sharing them amongst employees, the employer must tell HMRC unless the arrangement came into existence before 6 April 2004. This is so HMRC can identify the person responsible for PAYE in each period.

‘HMRC may check an arrangement exists to share tips amongst employees and that the troncmaster accepts that role. A PAYE scheme will be set up for the tips in the troncmaster’s name unless different PAYE arrangements need to be made.

‘The troncmaster is personally responsible for all aspects of operating a PAYE scheme. He or she may be held responsible for any failure to deduct tax from payments from the tronc. Troncmasters who need help in understanding their PAYE responsibilities should contact HMRC for advice.

‘A troncmaster with a PAYE scheme may use the employer’s payroll to operate PAYE on his or her behalf (the employer effectively acting as a payroll agent), but the troncmaster’s PAYE records must be kept separate from the employer’s. The tronc PAYE scheme must be entirely independent of the employer’s scheme and must be run as such.’

Perhaps the most important aspect of this is that the role of troncmaster is one that should not be undertaken lightly. The employer can perform the role of the troncmaster, but in such a case payments must be made via the employer’s payroll.

Issue: 4227 / Categories: Forum & Feedback