There is a lot of noise at the moment about how to distribute tips to employees following the Allocation of Tips Legislation that came into effect in October 2024. But another aspect of tips that also causes great confusion and isn’t discussed is how you handle VAT on tips.
So in this blog, we are shedding light on this aspect of tips management.
Defining tips
Sounds like a simple thing, but this is where the first level of complexity comes in.
When we talk about tips, we’re really talking about two different things. First, there are the traditional tips that customers choose to give, like leaving a few extra pounds after a meal or adding a tip when paying by card. These are entirely voluntary, and customers can give as much or as little as they want. Increasingly, operators are adding ‘service charges’ to the bill, but as long as it is optional and the customer can choose to pay it, it still comes under the label of discretionary tips.
Then there are the mandatory service charges, which may have different names. It doesn’t matter what they are called; if they are a fixed charge added to the bill automatically, this puts them in a different category of tip. They are non-discretionary.
Understanding this difference is essential when looking at how VAT works with tips.
Tips and VAT
Here’s where it gets interesting, and why you need to be able to define and separate the two different types of tips.
When a customer leaves a voluntary tip, you don’t need to charge VAT on it.
This applies whether they hand cash directly to your staff or add it to their card payment. The key thing is that it must be truly voluntary, the customer needs to decide for themselves whether to leave anything and how much.
Mandatory service charges work differently. Because they’re a mandatory part of the bill, you need to charge VAT on them, just like you do with food and drinks. This is true even if you later share that money with your staff.
Common mistakes to avoid
Many businesses get confused about what needs VAT and what doesn’t. The simple rule is: if it’s a voluntary tip, there’s no VAT. If it’s a mandatory service charge that appears automatically on the bill, you need to charge VAT.
Another common issue is mixing up tips and mandatory service charges in your accounts. Keep them separate from the start – it’ll save you a lot of headaches later.
The way people pay is changing all the time. More customers are using contactless payments and digital wallets, and some are even tipping through apps. Keep an eye on these changes and make sure your systems can handle them.
Managing tips in your business
The subject of handling tips within your business is much wider than just the VAT aspect, and there are some best practice tips that will help you not only comply with legislation but also be fair to your employees, customers, and your bottom line.
Keep good records – know how much money comes in through the various types of tips and how you share it out amongst your staff
Make sure your till payment system is set up to show discretionary tips separately from mandatory ones.
Ensure that you are compliant with the Employment (Allocation of Tips) Act 2023, which states that employers must pass on to employees 100% of all tips received.
These days, more and more people pay by card or phone rather than cash. This means you need a clear system for handling card tips. When a customer adds a tip to their card payment, make sure your system records this separately from the main bill. This helps both with VAT and with making sure the right amount goes to your staff.
Keeping your staff happy
It’s important to be open with your staff about how tips work. They should know exactly how tips are shared, whether they come from cash, cards, or service charges. This helps avoid any misunderstandings and keeps everyone happy.
Remember that tips are extra. You can’t use them to make up your staff’s basic pay. They need to earn at least the National Minimum Wage before any tips are counted.
Consider using a tronc scheme to process your tips. This ensures that both the employees and the employer do not pay National Insurance Contributions on the tip amounts. See our blog ‘Why your hospitality business should use a tronc scheme’ for more information on this.
Key takeaways
Managing tips and VAT doesn’t have to be a headache. The key things to remember are:
- Keep voluntary tips separate from mandatory service charges
- Charge VAT on mandatory service charges but not on voluntary tips
- Keep clear records of everything
- Be open with your staff about how tips are handled
This blog gives you the basics, but every business is different. If you have specific questions about your situation, it’s always best to check with a professional who knows the details of your business, or you can get in touch with our team here at Tips and Troncs.