If you run a business where customers may leave tips or pay service charges, you should know that there are new regulations in place meant to foster greater transparency, clarity, and fairness in how tips are managed and distributed. For me, there is an additional issue here in that some businesses may be leaving themselves exposed by not fully complying with VAT and PAYE obligations. Read on to find out why.
Payment of Wages (Amendment) (Tips and Gratuities) Act
Regulations giving effect to the Payment of Wages (Amendment) (Tips and Gratuities) Act 2022 came into effect on 1st December 2022. This law affects a wide range of services where tipping employees may be part of a transaction, for example:
- tourism and hospitality services, including food delivery services
- hair, beauty, tattoo, and piercing salons and clinics
- transport services in certain public service vehicles, e.g. taxis
- licenced bookmaker services and gaming premises
I use the example of restaurants in this blog as we have lots of clients in the restaurant sector but also because I think that they could have significant exposure if they don’t take certain obligations into account. I spoke to Michael Ryan of Gara Ryan about this new regulation to get his perspective as an experienced tax advisor.
The definition and use of service charges
A big part of this new regulation is bringing greater transparency to the idea of a service charge, which many restaurants habitually add to bills. A mandatory service charge is a payment that a customer must pay for certain goods or services, in addition to the cost of the goods or services. Employers cannot now use the term ‘service charge’ (or a similar term) unless the payment goes directly to staff – whether this is received electronically or in cash.
If an employer performs the same work as its employees, to a substantial degree, it may keep a share of electronic tips, but only an amount that is fair and reasonable. Employers may only make deductions from tips where it is legally required or fair and reasonable (for example, a card transaction fee).
Service charges are not part of basic salary
The new regulation places service charges outside the scope of a person’s contractual wage. In other words, if a restaurant offered someone a job at a rate of €15/hour, it could not pay them less than that and make up the difference by distributing the service charge. The employee must make €15/hour basic salary, with any tips being in addition to that.
As the text of the Act states, “The employer shall treat all payments, whether made by an electronic mode of payment or any other means, received from customers pursuant to such a charge as if any such payment was a tip or gratuity received by an electronic mode of payment.”
Make sure you have a Tips and Gratuities Notice
From 1st December 2022, you must display a ‘Tips and Gratuities Notice’ to customers explaining what happens to mandatory service charges and tips/gratuities – i.e., whether and how they are distributed to employees. This should be on your website and/or at your premises as relevant.
Electronic tips must be distributed in a fair and transparent way, and compliance is ensured by the Workplace Relations Commission (WRC). Fines of up to €2,500 can be imposed by the WRC for noncompliance with the legislation.
Where relevant, an employer must provide a written statement to each employee within 10 days, breaking down the distribution of tips, the total amount retained, and the amount distributed to the employee for that period.
Tax obligations on tips or gratuities
I said in my introduction that I believe some businesses may be leaving themselves exposed by not considering the taxation implications of tips and gratuities. Indeed, Michael Ryan had a situation where a client had faced just that. Luckily, Revenue allowed this particular restaurant to make a voluntary declaration and pay the VAT and payroll taxes they had not reported on tips. So, what am I talking about exactly?
Firstly, it’s important to understand that tips are taxable income. While you may not use tips to make up an employee’s basic pay, that doesn’t mean that they are tax-free earnings. If a tip is collected by the restaurant – for example where the bill is paid by card and the service charge/tip part of the bill is passed to an employee, that amount should go through payroll.
Secondly, VAT is applicable on service charges. It is applicable at the standard rate – 23% – and not the reduced rate generally applied in hospitality.
In a scenario where a customer pays a bill of €100 and adds €10 as a tip, this means:
- The €100 bill is subject to VAT, either at 23% (drinks and alcohol) or the reduced rate of 9% (the current temporary rate, which will increase later in 2023).
- The €10 service charge is subject to 23% VAT. The net amount of €7.70 is subject to payroll taxes.
Unfortunately, I’m seeing some basic accounting issues arising from how a restaurant manages tips. For example, they ring up the bill of €100 on the till but on their point of sale system takes a card payment of €110. Then they take €10 cash out of the till to put in the tip jar to “balance” up. Unfortunately, they have in fact just made things very unbalanced, because they consistently have a credit card system showing more takings than the restaurant has had on paper. That’s not OK.
Michael agrees that this situation could cause a lot of issues in the event of a Revenue query. Revenue will start by reviewing your bank statements and the discrepancy with your sales receipts will become apparent instantly. This could lead to a full audit of the business, causing a lot of disruption and cost.
Bookkeeping and tax reporting
Because the new regulation requires a written statement breaking down tip apportioning to each employee, we think this is the ideal opportunity to put in place a more structured approach to managing tips more generally within the business, which includes deducting VAT and payroll taxes.
If you do get inspected in two or three years’ time, you’ll want to be sure you have been doing this properly. Becoming suddenly liable for many months of VAT, PAYE, and overdue interest could have a significant impact on your bottom line and cash flow.
We can’t be certain that restaurants will be targeted by Revenue in the future; on the one hand, the industry had a tough time during Covid-19, but, on the other, restaurants appear to have bounced back really well in the past year. Considering the new regulation, it’s not unreasonable to think Revenue might do a sweep of the sector in the future, and it would be wise to be ready to give a full account of how you have managed tips since this new regulation came in.
