Jennifer Adams considers whether the Employment (Allocation of Tips) Act 2023 will have any tax consequences.
On 1 October 2024, the Employment (Allocation of Tips) Act 2023 came into force, aiming to ensure a fairer distribution of the payments customers leave as gratuities to staff. The tax treatment of tips and service charges depends on how staff are paid – does the new legislation change the tax position?
PAYE for income tax purposes includes wages, salaries, commissions, bonuses and certain benefits-in-kind. It also covers gratuities, service charges and troncs rewarded to staff for services rendered.
Methods of payment
There are three main methods by which gratuities, etc., are distributed:
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Payments added to the bill are paid directly to the employer and therefore become the legal property of that employer. The employer can decide what to do with these payments, e.g., distribute across the workforce or even withhold them from staff, unless they are subject to a tronc arrangement.
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Cash tips paid directly to a worker generally become the legal property of that worker. The employee keeps the payment with no involvement from the employer, although employers can dictate the redistribution via their employment terms and conditions.
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Cash tips paid into a ‘tip pot’ (or similar) become the legal property of the employer and can be distributed as the employer wishes, unless the tips are subject to a tronc or other form of distribution agreement.
Under method 1, the employer is obliged to deduct PAYE and National Insurance contributions (NICs) from any payment distributed. Under method 2, PAYE and NICs do not apply as the employer will not be involved; the worker keeps the tip, and no PAYE is charged. However, the employee is supposed to notify HMRC of the payment received for services rendered. If notified, tax will be deducted by any adjustment to the employee's tax code. Under method 3, as with method 1, the monies become the property of the employer and, as such, are subject to PAYE and NICs (unless a tronc arrangement applies).
Troncs
When the distribution of tips is managed by a troncmaster, a different system comes into play. A tronc is a special pay arrangement used to distribute tips in a NICs-efficient way.
A tronc must be controlled and managed by an independent person (the troncmaster) who is responsible for distributing the payments according to agreed terms, and will operate a computerised payroll. When a tronc commences, the troncmaster notifies HMRC, and PAYE tax is charged only; no NICs are payable. The employer has no control over the payments (hence no NICs charged), although they can operate PAYE as the troncmaster's agent, provided the troncmaster keeps separate records.
Impact of the Act
The Act will have an impact by making it law that employers who retain tips under method 1 must distribute 100% of the tips and service charges paid by customers to staff (including any agency workers) fairly and transparently.
With the increasing use of the 'cashless' society, some employers were retaining tips in full or requiring workers to pay a percentage out of their tips accumulated during a shift or charging workers an administration fee for handling tips.
Practical tip
In 2022, HMRC issued guidance on electronic tipping, which confirmed that if the employer receives tips paid electronically and passes them to its employees, it must apply PAYE tax and NICs to the payments.
Under the Act, employers must pay qualifying tips to workers within one month of the end of the month in which they were received. If tips are not paid on time or are unfairly allocated, a staff member can raise a tribunal with compensation of up to £5,000.
The methods and tax liabilities of tips distribution remain the same under the Act and may increase the amount given to employees. Employees are generally required to report all tips as part of their taxable income. If the Act leads to changes in how tips are shared or reported, employees should ensure they comply with these rules, to avoid potential penalties.
