Tips, Service Charges, Troncs and Government consultations – An accountancy view

It is a peculiarity that has been remarked upon previously that there are some service sectors where people expect to pay a tip and others where they don’t. Thus you will typically give a tip to a taxi or even a coach driver – but never to a train driver. In a hotel you might tip the bellboy for carrying your luggage – but you would never think to tip the shop assistant who sold you that luggage. In the hospitality sector, where tipping is the norm, many businesses rely on the goodwill of consumers in the form of service charges and tips as a key motivator for their staff to provide great customer service.

From an accountancy viewpoint, one question that we are regularly asked by our clients is “Why should I – or my staff – be taxed on tips? Surely it is a gift from the customer?” The answer comes in part from the legislation – and in part from a Tax Case involving a taxi driver. The legislation regarding the taxation of employment income defines earnings as including salaries and wages but also any gratuity or “other profit or incidental benefit of the employment”. In 1947 (before the legislation contained a reference to gratuities) a taxi driver by the name of Wainwright, who was employed by a taxi firm, appealed against a tax assessment which charged tax on his tips. In the High Court[1], the judges held that his tips were not a ‘personal gift’ but were instead a reward from the customer for the services that had been provided by Mr Wainwright in the course of the employment – and as such, they were other profits of his employment and taxable as earnings.

Having decided that tips are taxable, the tax authority then has the task of taxing them. For taxi drivers, HMRC will typically operate on a rule of thumb and expect the taxi driver to receive tips of something in the region of 10% to 15% of the fares. For the hospitality sector, because of the variation in tipping levels, the numbers and mobility of the workforce, it can be a far more difficult area and this is where Troncs come in use, not only to the employer and the employee but also to the taxing authorities.

Troncs are an effective way of rewarding and incentivising employers and workers by offering significant savings to both parties on National Insurance Contributions (NIC), as well as increasing the workers take-home pay. Unfortunately, there has been considerable media coverage recently which suggests that there has been malpractice by some well-known businesses in their retention of a sizable proportion of the discretionary payments received by them.

Sadly it is a feature common to all forms of media that bad behaviour makes good news so that what might amount to malpractice by a small minority of employers seems to have merited a disproportionate number of news column inches. These in turn have prompted a Government Consultation with implications of some kind of legislative ‘solution’ to the issue.

In the Consultation the Government highlighted three key policy objectives:

  1. For consumers to be aware that all payments for service are discretionary;
  2. For these discretionary payments to be actually received by the workers; and
  3. For employers to be clear and transparent, both to consumers and workers, about how these payments are treated.

It is clear from the consultation that the Government believe these policy objectives are not being met, and that action needs to be taken to ensure that both workers and consumers are protected. However, one point to note is that the Consultation refers to a figure of some 150,000 businesses operating in the sector, whereas the media has only reported on a handful of businesses who have misused the Tronc schemes. This does lead one to question how widely spread this perceived malpractice actually is, and whether Government action is necessary.

The Consultation has suggested several potential remedies to achieve the above policy objectives, one of which is to restrict or prevent the employer from making deductions from the discretionary payments. In practice, the administration of a Tronc does involve an employer in some costs and it only makes commercial sense for the employer to be able to cover those costs in some way.  In our experience, very few employers take a disproportionate proportion of the service charge to cover administration expenses so we do not see this as representing quite as big a problem as the media coverage might present.  

The Consultation also proposed either an update to the current voluntary “Code of Best Practice on Service Charges” or statutory enforcement of the Code. We have engaged with many employers and found that not only were they all aware of the Code of Best Practice, but most of them actively follow the Code. Whatever the outcome, generally, we believe that employers like all taxpayers are more inclined to respond positively to the hypothetical carrot than the stick. 

The very fact that that there has been a Consultation suggests that change is on the horizon for employers in the hospitality sector. Whether change is in fact necessary is arguable, but we believe that as tips and discretionary service charges provide such a key motivator for staff in this sector, and as Troncs remain the most effective process for handling both the taxation and the distribution of them, it would be wise for the Government to provide detailed consideration of the impact both on employers and the motivation of their employees before implementing any substantial changes.

[1] In the Tax Case of Calvert (HM Inspector of Taxes) v Wainwright 27 TC 475

Anonymous
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  • Is it not a confusion of an already complex subject to treat a voluntary payment of an amount determined by the customer and paid directly to a member of staff as the same as a service charge levied by business but the payment of which is discretionary?  A hospitality business is free to determine whether and at what level to apply a service charge - and best practice should mean that what it is for and how it is used is made clear to all.  Providing minimum wage legislation has been followed any further distribution by means of bonuses or pay supplements should be between the employer and employee.