The new Tips Act – what does this mean for your business?

What types of payments are affected?

A tip or gratuity is an “uncalled for and spontaneous” payment voluntarily made by a customer, usually in recognition of good service. The payment can be made either directly to a worker (usually in cash) or added to a bill (commonly paid via cash, credit or debit card or via a digital payments service).

By contrast, although in practice the two concepts are often confused, a service charge is an amount which is added to a customer’s bill by default and before it is presented to the customer. The service charge may be voluntary (or discretionary), or it may be mandatory – this should be made clear to customers.For ease of reference, tips, gratuities and voluntary service charge payments to workers are referred to as “tips” and mandatory service charges payments will be referred to as “service charges” in this article.

How does it work currently?

The current legal regime applies different treatment to tips and service charges.

• Cash tips which are paid directly to a worker generally become the legal property of that worker (although employers can dictate or influence the redistribution of cash tips via employment terms and conditions).
• Cash tips which are paid into a staff box or similar generally 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 formal distribution agreement.
• Tips paid by card are paid directly to the employer and become the legal property of the employer; the employer can therefore, legally, do what it likes with these tips, including distributing them across the workforce or withholding them from staff, subject to any applicable tronc.

A tronc is a separate pay arrangement used to distribute tips. There are several advantages to implementing a tronc, which is a commonly used tool in the hospitality sector. Troncs often allow the allocation of tips in a National Insurance-efficient way. Troncs are also seen as a transparent way of dealing with the distribution of tips on a fair basis, whilst taking into account the views of eligible workers.

The tronc must be controlled and managed by an independent person, known as a troncmaster. The troncmaster should ideally be viewed as independent from the employer (for that reason, it is common for a general, local or site manager to be appointed). The troncmaster is responsible for determining how tips should be allocated, for ensuring tips are shared according to the agreed arrangements and for ensuring the correct reports are made to HM Revenue & Customs (“HMRC”).

As a general rule, the tax implications for tips are dictated by the recipient of the payment and whether the payment is voluntary or mandatory, rather than the form in which the tip is paid. As a quick overview:

• VAT is not payable on any tips which are genuinely freely given (this includes genuinely voluntary service charges) but will apply to mandatory service charges.
• Tips paid directly to employees (and which employees keep without any involvement of the employer) won’t be subject to PAYE – tax will be due, but no National Insurance contributions (“NICs”) will be due, and the employee will be responsible for paying any taxes due and for any reporting of this income to HMRC.
• Tips that are paid by an employer to an employee will be subject to PAYE and the employer will be responsible for withholding income tax and NICs due at source and for reporting to HMRC (noting that the responsibility for distribution and reporting will fall to the troncmaster under a tronc).
• In most cases, the employer will be liable for both employer and employee National Insurance contributions where it passes tips to an employee (this includes the redistribution of cash tips left on tables or put into a communal staff box or tips jar). Note that NIC treatment differs for payments made under a tronc.Generally speaking, the tax treatment of tips paid via a tronc is more complex as it is in part determined by how the division of monies is decided.

Whilst tips cannot be used to make up any National Minimum Wage payments, workers within the hospitality sector often rely on tips to top up their wages. Such payments are particularly important to workers post-pandemic and in light of the current cost of living crisis, and are therefore a potentially useful recruitment and retention tool for employers.

Why are the proposed changes being made?

Employers (and workers) within the sector will be aware of the controversy around withholding of tips, which were the subject of significant media attention prior to the pandemic. Media attention was particularly directed at the following employer practices:

• retaining the service charge in full;
• charging workers an admin fee (usually between 5 -15% of the tip) for handling the tip; and
• requiring workers to pay back a percentage of their table sales during a shift, taken out of the tips generated from the shift and any subsequent tips payments.

The UK government issued a Call for Evidence in September 2015, which revealed that a large proportion of employers in the hospitality sector were either making deductions from staff tips or retaining the whole service charge payment. The government consulted on proposals to legislate in 2016, but no further steps or firm commitments were taken at the time beyond a general commitment to take steps at some point in the future.

A large number of employers altered their tips practices as a result of the media fallout and government statements, but many have not eliminated deductions entirely. Recent government analysis indicates that deductions of between 3 and 5% from tips are still common within the hospitality sector.

The pressure on the government to take action has increased, particularly as a result of the pandemic and the cost of living crisis. The hospitality sector suffered badly during the pandemic and has faced significant trials in its aftermath, including challenges with recruiting and retaining staff. The events of recent years have influenced consumer behaviour and contributed to the development of a cashless society, which has implications for workers in the sector. Government research carried out in 2021 indicated that 80% of all UK tipping now happens by card, and that proportion is likely to be higher now. In essence, this means that most tips go to the employer (subject to their discretion on distribution, and making it easier for them to retain some or all of the tips) rather than directly to their employees.

What is changing?

The Act amends the Employment Rights Act 1996 by inserting various new sections addressing the distribution and payment of tips, gratuities and service charges. The key provisions include the following:

• The new legislation applies to “qualifying tips, gratuities and service charges” (“qualifying tips”) which includes tips, gratuities and service charges received by employers and by workers. The Act doesn’t define a tip, a gratuity or a service charge.
• Broadly, employers are required to pass on all qualifying tips to eligible workers without deductions, other than withholdings for tax purposes and any other deductions required or authorised by statute. Employers are required to allocate all qualifying tips “fairly” between workers, although the legislation is silent as to what fair allocation would look like in practice, instead deferring that to the Code of Practice (see below). There is also a time limit - payment must be made to eligible workers “no later than the end of the month following the month in which the tip, gratuity or service charge was paid by the customer”.
• Employers are required to have a written policy governing the treatment and allocation of qualifying tips, which must be made available to affected staff. The policy must include provisions for the distribution of qualifying tips in a fair, transparent and consistent manner.
• Employers must keep a record of the allocation and distribution of tips for a period of three years from the date received. Workers can now request a copy of certain records, and the employer must comply with the request within four weeks of the date of the request. There is no set format for responding, but any disclosure must be in line with the UK GDPR.
• The Act seeks to avoid creating a loophole for agency workers, given their prevalence in this sector, by including a right for agency workers to benefit from the Act in the same way as directly engaged workers. Employers must distribute tips either to the agency worker directly or (as is more likely) to the agent. In keeping with the overarching principle of the Act, neither the agent nor the employer are permitted to make deductions from these payments other than those required or authorised by statute.
• Both workers and agency workers have the right to bring a claim in the Employment Tribunal in relation the distribution of qualifying tips and timings of payments. The Tribunal may:
  • make a declaration that the employer has failed to comply with the relevant requirements;
  • order the employer to comply with the requirements, revise the allocation to the worker and/or make a payment to one or more workers (including those who aren’t the complainant); and/or
  • make an order for payment to the complainant of up to £5,000 to compensate them for any financial loss they have sustained because of the non-compliance.

If the amount paid as part of the revised allocation is less than the original allocation, employers are specifically prohibited from seeking restitution of the difference between the two amounts. Note that that claims relating to the allocation of tips can be brought up to 12 months after the alleged failure to comply took place. The reason for such an extension to the normal three-month time limit for statutory employment claims is unclear.

• There is a separate right to bring a claim in relation to non-compliance with the provision of information, whereby the Employment Tribunal may order the employer to pay to the worker a sum of up to £5,000 to compensate them for any related financial loss they have sustained.
• The Act provides for the Secretary of State to issue a formal Code of Practice on tipping, which would set out the principles of fairness and transparency employers must take into account. Tribunals will be able to take into account failure to adhere to the Code of Practice when determining a claim but a failure to comply isn’t grounds for a claim in and of itself.
• The Act prohibits reimbursement provisions, defined as provisions that require a worker to make a payment to the employer or permits the employer to deduct or reduce their wages, where the payment, deduction or amount is related to the worker being allocated or receiving tips (whether qualifying, or worker-received but not qualifying).
• The allocation and payment of qualifying tips via a tronc will count towards the overall allocation and payment of qualifying tips where (i) the troncmaster meets the definition of an “independent troncmaster” under the Act, (ii) the tips, gratuities and service charges distributed via the tronc meet the definition of “qualifying”, and (iii) it is fair for the employer to make arrangements to distribute such payments under the tronc.

Commentary: What does this mean for employers in this sector?

The new legislation is clearly an attempt to ensure that more of the amounts paid which are intended by customers to be a recognition of service are subsequently passed on to workers rather than being retained by the employer. That said, the Act creates some tricky considerations for employers and leaves certain questions unanswered.

Whilst we don’t yet have a commencement date, the timing of the Act is likely to be unpopular with employers in the sector who are already dealing with the challenges of the current economic climate. Employers will need to manage the expectations of employees, and potentially renewed interest from customers as to how they treat service charges, tips and gratuities.

The obligations under the Act apply to the total amount paid by customers, which includes any amount which is subsequently deducted from that total such as any bank, payroll or admin charges. In practice, this means that employers who currently apply a portion of a service charge, gratuity or tip to meet these charges will need to change their approach and may need to pass on such charges to their customers more directly. Given the pressures on the sector in the current economic climate, some businesses may struggle to meet these charges without damaging their relationship with customers. Employers will need to look at the most efficient way to collect and distribute any tips whilst limiting the impact for their business and bottom lines.

The Act doesn’t necessarily prevent an employer applying a separate voluntary admin charge to the bill (albeit labelling it as a ‘service charge’) and retaining the money received to meet any such charges, provided the customer is informed of the purpose of the payment (making clear that the charge is not intended to be a tip, gratuity or other payment in respect of service and is not intended to be passed on to staff). Customers may be less willing to pay a charge that is clearly identified as an admin fee, particularly in the current economic climate.

The legislation does not allow for a transition period, so employers will need to make any required changes to their business operations in advance of the Act taking effect or risk the consequences of non-compliance. For employers who are currently using deductions or retaining service charges to boost their revenues and manage their cash flows, serious commercial consideration will be required. For those who are looking to comply and who anticipate significant time will be required to re-align their business model, preparations are likely to be complicated by the fact that a draft Code of Practice has not yet been published and the effective date of the Act is not yet confirmed. Employers will need to stay alert for developments in this area and put in place measures to allow for a relatively quick decision and implementation process for any changes.

As a final comment, the Act doesn’t address some of the more practical issues raised by sector leaders such as the question of allowing tips to be deemed as workers’ income or to otherwise ‘count’ for mortgage purposes. Whilst this might not be the right place for such steps, the UK government will arguably remain under pressure to do more to support the sector going forward, so watch this space.