It is common practice for employees working in the hospitality sector to receive tips, gratuities or service charges from customers in addition to their basic pay. A "tronc" was originally a wooden box used in French restaurants to collect the cash tips. Her Majesty's Revenue & Customs (HMRC) now defines a tronc as a `'special pay arrangement used to distribute tips, gratuities and service charges''. The deduction of income tax and national insurance contributions (NICs) in relation to such payments depends on the arrangements that exist between the employer , "troncmaster" (typically a head waiter), customer and the employees. In the recent case of Commissioners for HMRC v Annabels (Berkeley Square) Ltd & ors, the EAT had to decide if tips paid by customers via a credit card or cheque and then transferred to the troncmaster's dedicated bank account for distribution could be taken into account for the purposes of the National Minimum Wage Regulations 1999 (SI 1999/584) (NMWR). Julian Yew considers the implications of the decision for employers in the restaurants, bars and hotels industry

Revised guidance from HMRC in 2006 (E24/2008) has simplified what is otherwise a complicated position. "Gratuities" are subject to class 1 NICs if they are directly or indirectly made by the employer from sums previously paid to it by customers, or where such sums are directly or indirectly allocated by the employer to the employees.

To minimise exposure to national insurance liability, tips are therefore normally administered and independently controlled by "troncmasters". Although tips may be exempt from NICs in some limited circumstances and would result in cost savings for businesses, employers must still ensure that any basic salary that is paid to their workers satisfies the national minimum wage (NMW), which is currently £5.52 per hour for adults.

The facts

Annabels, George and Harry's Bar are private members' clubs and restaurants. Each employer added a 15 per cent voluntary service charge to their bills to customers and operated two separate troncs for the distribution of tips to their waiters and bar staff. All voluntary service charges and cash tips were collected by the employer and handed to the relevant troncmaster weekly. Tips paid by credit cards were paid into the respective troncmaster's dedicated bank account for distribution to tronc members.

Each employer and their respective troncmasters operated their own payroll for the payment of basic wages and tronc monies respectively. Each worker also received a pay slip in respect of the basic wage separate to that issued by the troncmaster.

In March 2006, HMRC served enforcement notices on each of the employers requiring them to pay specified sums as the basic wage paid by the employers to their workers did not exceed the NMW. The tribunal had to consider:

  • regulation 30 of the NMWR, which provides for "all money payments made by the employer to the worker" to be taken into account when assessing if the NMW is satisfied
  • regulation 31(1) (e), which excludes "any money payment made by the employer to the worker representing sums paid by customers by way of a service charge, tip, gratuity or cover charge that is not paid through the payroll" from being taken into account.

The tribunal considered Wrottesley v Regent Street Florida Restaurant and Nerva v RL & G Ltd, which turned on the meaning of "paid by the employer" under the Catering Wages Act 1943 and Wages Act 1986. In each of those cases, it was held that tips given by customers to staff and kept in a box did not belong to the employer and, as such, it was not for the employer to distribute. However, in Nerva the Court of Appeal held that tips and services charges paid through credit cards or cheque were the employer's money and that such sums paid to the employees at the end of each week would be made "by the employer".

In Annabels, the tribunal was satisfied that the money in issue never became the troncmaster's money and that he only held it on trust for the employees for purposes of distribution. Thus, the sums distributed to the workers by the troncmaster constituted money payments "paid by the employer" for the purposes of the NMWR. HMRC appealed on the basis that the payments were paid by the troncmaster and the tribunal was wrong in fact and law to conclude the contrary.

The EAT disagrees with the tribunal

The EAT drew a distinction between cash tips and gratuities paid by a customer and kept in a box for distribution and a payment of a service charge by cheque or credit card by the customer to the employer. Looking at the tronc arrangements of the three employers, it held that the tribunal was wrong in law to conclude that money paid into the tronc fund by the employer never became the troncmaster's money. The EAT held that the troncmaster was far more than a "conduit". In particular, he:

  • could not be required to pay the money back to the employer once it was in his hands;
  • held the money on trust for the employees from time to time
  • distributed those funds in accordance with the agreed formula, which he could change but subject either to consultation with, or agreement by, the members of the tronc. The employer had no power to control how or to whom the funds were allocated.

In the circumstances, the tribunal was wrong at law to conclude that the employer controlled the tronc and the money in it. As the money payments were not "paid by the employer", the appeal was allowed and the enforcement notices reinstated.

Implications of the case

  1. Discretionary cash tips from customers to employees or left on tables for employees to retain without any involvement from the employer are exempt from PAYE and NIC. The employee must notify HMRC of such receipts and tax will usually be recovered by an adjustment to his or her PAYE tax code. Such tips do not count towards the NMW.
  2. Discretionary cash tips that are pooled and distributed via a tronc collection scheme are exempt from NIC, but income tax is payable by the troncmaster. Such tips do not count towards the NMW.
  3. Discretionary tips by way of card or cheque payments to the employer, which are then paid into a dedicated troncmaster's bank account for subsequent distribution by the troncmaster in accordance with a tronc scheme agreed between the troncmaster and employees, are exempt from NIC but income tax is payable by the troncmaster. As such payments are not payments "made by the employer", they do not count towards the NMW.
  4. Discretionary tips (whether cash, card or cheque) paid by the employer to the employees via the employer's payroll and shown on payslips issued by the employer are subject to income tax and NIC. Such payments count towards the NMW.
  5. Discretionary tips, which are independently operated by a troncmaster but the net payments (following PAYE deductions by the troncmaster) are passed to the employer and paid by the employer to the employees through the employer's payroll and reflected in the employer's payslips, count towards the NMW; see example 16 in the E24 guidance. However, no NIC is due as the employer is not involved in the allocation of the tips.
  6. Mandatory tips - for example, a mandatory service charge that is automatically added onto a customer's bill and which is paid out to employees - are subject to income tax and NICs regardless of the arrangements in place for sharing out the money. Such a payment will count towards the NMW if the employer paid the employees via its own payroll.

The commercial reality for employers in the hospitality sector is balancing the costs savings from NICs in relation to tips and the risk of receiving an enforcement notice from HMRC for breaching the National Minimum Wage Act 1998 (NWMA) and consequential claims for arrears in wages and outstanding NICs. Employers cannot generally treat tips independently operated by a troncmaster as discharging its obligations under the NMWA unless they can usher in the arrangements within scenario (v).

Employers that already pay the NMW but wish to retain the NICs exemption in relation to tips should:

  • review their current arrangements and ensure the tronc system is independently operated by the troncmaster
  • ensure employees do not have the contractual right to tips - the contract should simply allow employees to participate in the scheme
  • notify HMRC when a new troncmaster has been appointed so that HMRC can set up a PAYE scheme for the tronc in the troncmaster's name.

Published in ELA Briefing, August 2008