New legislation introduced this year makes it illegal for employers to withhold tips from their staff, overhauling gratuity practices to ensure that from 1st October 2024 workers can keep 100% of the money they have earned in the form of tips and service charges.
Primarily applying to businesses in the hospitality sector, the government expects this change to boost wages by giving around £200 million back to workers each year.
Paying tips is likely to cost both employers and employees through increased National Insurance Contributions (NICs), but employers can circumvent this by using a tronc arrangement.
Read on to learn more about the new tipping laws, troncs, and what your business can do to distribute tips fairly and stay on the right side of HMRC.
The Employment (Allocation of Tips) Act 2023
Following a consultation several years ago, which looked into the unfair distribution of tips due to employer malpractice that was highlighted by the media in 2016, the Employment (Allocation of Tips) Act 2023 was given Royal Assent in May 2023.
This amends the Employment Rights Act 1996 with the introduction of Part 2B, which applies in England, Wales, and Scotland.
While the legislation, often referred to as the Tipping Act, was due to take effect in July 2024, delays caused by the general election meant the Act only came into force on 1st October 2024.
Employers must now pass all tips, service charges, and gratuities on to employees without deductions – for example, retaining a portion as an ‘administration fee’ is no longer allowed.
Cash tips given directly to a worker without involving the employer were already legally protected, but the new law covers cashless tips via card payment, too.
Employer obligations for distributing tips
Under this legislation and the Code of Practice on Fair and Transparent Distribution of Tips, which came into effect at the same time, employers must:
- Pass on tips to workers in full with no deductions (other than tax or NICs)
- Have a written tipping policy and keep a record of how tips were managed
- Provide information about their tipping record if a worker requests it
- Pay tips to workers within 1 calendar month of the customer paying the tip
- Not alter an employee’s hourly wage (tips don’t count towards minimum wage)
- Consider different roles, performance levels, seniority, and customer intention
This applies to hospitality businesses like cafés, restaurants, and bars, but also any business that accepts tips, such as hairdressers. The legislation covers all employed workers, including agency workers and those on zero-hour contracts.
The Act regulates the fair and transparent allocation of tips to staff, so if their employer retains their tips, workers can submit an employment tribunal claim against them. Employers found to have acted illegally could have to pay fines or compensation to workers.
Tips, Income Tax, and NICs
Tips are subject to Income Tax and employee NICs, typically through the PAYE system.
Customers giving cash tips directly to individual employees or leaving them on the table are subject to Income Tax, but not National Insurance, as PAYE doesn’t apply. In these cases, it’s the worker’s responsibility to report income from tips to HMRC via Self-Assessment.
In all cases of an employer forwarding tips to an employee, they must operate via PAYE, whether the employer makes the payment or delegates this task to an employee.
When it comes to NICs, gratuity payments paid to employees are exempt if:
- It isn’t allocated by the employer to the employee, whether directly or indirectly
- It isn’t directly or indirectly paid to the employee by the employer and doesn’t comprise of monies paid to the employer previously by customers
On most occasions, an employer passing tips on to an employee will be responsible for both employer and employee NICs, because neither condition is satisfied.
An 8% NIC rate applies when tips (added to normal earnings) reach between £1,048–£4,189 a month. When a threshold of £758 a month is reached, employers must pay NICs, but their liability is usually reduced by the £5,000 annual employment allowance.
As an example, if a restaurant pays £25,000 in tips, the employer could face nearly £3,500 in additional NIC costs, while the extra cost may be up to £2,000 for staff.
In situations like these, tronc arrangements can come into play to help reduce costs.
Troncs and troncmasters
A tronc is an arrangement or system used to divide tips, service charges, and gratuities to pay employees their share. A troncmaster is responsible for managing this.
If a troncmaster decides on tip distribution and not the employer, there are no employee or employer NICs due, but it’s still possible to include the tips on the employer’s payroll.
An employer can appoint the troncmaster, whether it’s a member of staff or a specialist provider, but they must play no part in the actual allocation of tips.
Tips will still be subject to Income Tax, but it will be the troncmaster’s responsibility to set up and run a separate PAYE scheme for this, which can be within the employer’s payroll but must be independent of the employer’s PAYE scheme.
The troncmaster must operate the scheme for tips, report the income to HMRC, and deduct tax accordingly, otherwise they will be held accountable for tax errors by HMRC.
If troncmasters need help with setting up or running a tronc and complying with PAYE requirements, they can consult the government guidance or contact financial advisers like the team at gbac.
What does this mean for your business?
Under the Employment (Allocation of Tips) Act 2023, if an employer breaks the rules, they could be taken to an employment tribunal and made to pay fines and compensation – so it’s essential for employers to stay on top of the changes introduced by this legislation.
Businesses that receive tips, service charges, and gratuities must review their tipping policies, allocation management, and record-keeping practices to ensure they are 100% compliant.
Changing these practices may have an impact on cash flow, but it should also contribute to higher rates of employee satisfaction and retention, saving on recruitment costs while also building trust between businesses and customers who want to tip employees.
It’s important to make sure all employees are on the right tax code, so any Income Tax or NICs due can be taken through PAYE. Using a tronc PAYE scheme can help with this.
If you have any concerns about adjusting your payroll services and keeping everything in order for HMRC to review, why not speak to our accountants in Barnsley?
At gbac, we offer a wide range of financial services, so if your business needs help managing tax liabilities on tips, then call us on 01226 298 298 or email info@gbac.co.uk.