Taxation of Tips and Gratuities | HMRC Guidance
In previous article on the ‘Allocation of Tips’ we commented that:
‘The Employment (Allocation of Tips) Act 2023 does not change how these payments should be assessed for tax and National Insurance Contributions and they must all be accounted for to HMRC by either the employer or the employee in a manner depending on the nature of their receipt’.
On 8 April 2025, HMRC published updated Guidance clarifying the allocation of tips, gratuities and service charges payable to employees in the catering and service industries in respect of:
- VAT
- Income Tax,
- National Insurance Contributions,
- Tronc arrangements.
- National Minimum wage
The updated guidance applies to businesses or individuals responsible for collecting and distributing tips or service charges. It explains how various payment types are managed based on who receives them, the collection method, and whether the employer exercises control over distribution and taxation of tips.
Nazaqat Maqsoom of KANGS outlines the general position.
The Nature of Tips, Gratuities & Service Charges
In addition to the basic charge which a customer expects to pay from the outset, any further payment made which is intended to benefit the staff of the employer may take one of the following forms:
- mandatory - the customer is given no opportunity to refuse making payment,
- discretionary - the customer has the entitlement to choose whether or not to pay,
- gratuity paid to the employer,
- gratuity paid into a communal staff box or pool,
- gratuity paid directly to the employee.
Tip / Gratuity
Such payments made voluntarily and spontaneously by a customer over and above the payment due for the services received may be made:
- in cash,
- as part of a cheque payment,
- by way of credit or debit card,
- by way of a digital payment.
Service Charge
A service charge is a sum added to a customer’s bill and may be:
- voluntary - where the customer is made aware that payment is entirely optional,
- mandatory - the customer is obliged to pay.
It is essential for employers to fully understand these differentials in which payments may be received as HMRC specifically defines how each category is to be treated for tax purposes.
Taxation of Tips, Gratuities & Service Charges
VAT | Tips/Gratuities
When given freely, these do not attract VAT irrespective of whether:
- the amount is included on the bill at the customer’s request,
- payment is made by cheque, credit or debit card,
- the amount is passed to employees.
Service Charges
Mandatory
If a restaurant adds a service charge that is mandatory to customers, it is treated as part of the price of the meal and is subject to VAT at the standard rate.
Voluntary
Where the customer can genuinely choose whether or not to pay a service charge, and such option can be proven, it falls outside the scope of VAT and is not chargeable.
Businesses need to be cautious. If a service charge is automatically added to the bill without an explicit statement that it is optional, or if customers feel pressured to pay it, HMRC may still consider it mandatory, and therefore taxable.
Income Tax
Where an employee receives a tip directly from a customer, whether handed directly or left at the table, it becomes personal income which the employee must declare to HMRC.
PAYE does not apply and no National Insurance contributions will be due.
Where the employer is involved in collecting or distributing the tips, PAYE must be operated by the employer.
National Insurance Contributions
Any gratuity paid to an employee is exempt from NIC provided it is not:
- paid, directly or indirectly, by the employer and does not represent monies previously paid to the employer by customers,
- allocated, directly or indirectly, to the employee by the employer who calculates the apportionment to be paid.
Accordingly, most tips paid by an employer to an employee attract both income tax and NIC as neither of these two conditions will be satisfied. This situation is mitigated by the operation of a Tronc Scheme as explained below.
Tronc Arrangements
A properly formed arrangement of this nature removes liability for NIC deductions against tips and gratuities.
Under a tronc arrangement, a troncmaster, someone other than the employer, is appointed to control the tips and is responsible for sharing them amongst the employees.
Payments made through a tronc are subject to PAYE but not NIC. A PAYE scheme must be set up and the troncmaster, who has to accept the role, is personally responsible for all aspects of operating a scheme and may be held personally responsible for any failure to deduct tax from payments from the tronc.
The employer must advise HMRC of the arrangement to ensure that it is aware of the person responsible for payment of PAYE and must also ensure that appropriate records are kept. For a tronc to be valid and accepted by HMRC, the employer must not take any part in the operation of the tronc otherwise the exemption from NIC does not apply.
A troncmaster may use the employer’s software in order to operate the separate PAYE scheme but all records must be kept separately from those of the employer.
National Minimum Wage
Since October 2009, payments by the employer to the worker by way of tips, gratuities, service charges or cover charges paid by customers do not count towards the National Minimum Wage.
The employee retains the right to receive the full amount of the National Minimum Wage from the employer.
Payments made through a tronc do not count towards minimum wage entitlements.
How Can We Assist?
Whilst we have outlined in this article the general guidelines for the taxation of tips and gratuities, inevitably, there exists an array of accompanying rules and regulations requiring consideration.
The team at KANGS, on a daily basis, assists and guides clients involved in disputes with HMRC of every conceivable nature including advising clients challenging VAT Assessments, income tax and NIC Assessments and engaged in Tax Tribunal appeals of every nature.
KANGS is highly regarded for its expertise in defending clients against HMRC prosecutions related to alleged VAT offences and has been involved in many significant MTIC prosecutions.
If we can be of assistance, please do not hesitate to contact us using the details below:
Tel: 0333 370 4333
Email: info@kangssolicitors.co.uk
We provide initial no obligation discussion at our three offices in London, Birmingham, and Manchester. Alternatively, discussions can be held through video conferencing or telephone.
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