Question.

I pay my staff their wages under the normal PAYE system.  My accountant looks after this for me by calculating and deducting income tax and national insurance from their earnings before processing their wages.  In our line of business many of the employees regularly receive tips and gratuities from the customers and this can often supplement their earnings significantly.  Should I be operating PAYE on these tips?

Answer.

This is an area of tax which is frequently checked by HMRC, especially during a PAYE audit or enquiry.  If the taxation of tips received by employees is not operated and disclosed correctly, it can result in onerous penalties and interest charges for the employer.  All tips are taxable.  The way a tip is given by a customer and the person responsible for paying it to the employee, determines its tax treatment. 

If the customer gives a tip directly to the employee then this payment is categorised as employment income but it is not subject to Pay as You Earn (PAYE).  In this circumstance the employee is obliged to inform HMRC of the amounts received and the tax is generally collected by an adjustment to the employees PAYE code.  The employee also has the option of disclosing tips on their annual self assessment return.  If the employee receives the tip directly from the customer you, as an employer, have no tax obligations at all in respect of this employment income paid to your employee.

If however you operate a scheme under which you collect and distribute out the employee tips (which includes gratuities and service charges) you must include these as part of the employee’s remuneration and operate PAYE and National Insurance Contributions, in the same way you would when paying the weekly or monthly salaries.

In some industries such as the catering industry it is very common for tips to be collected and dealt with under a tronc scheme.  This situation arises when an employee is responsible for collecting and distributing the gratuitous tips given by customers.  The employee who takes on this responsibility is known as the tronc master.  As long as the tronc master operates independently of the employer when distributing the tips to the employees, there is no National Insurance liability, but the tronc master must operate his own PAYE scheme to deduct the appropriate income tax from the payments.  This is an onerous and difficult task for most employees and therefore very few employees are willing to take on this role.  There is often a level of uncertainty in respect of the tax rates which apply to tronc income and specific guidance from your accountant on this matter is recommended.