Allocating workers’ tips – getting ready for the new regime!

The Employment (Allocation of Tips) Act 2023 comes fully into force on 1 July 2024. From that date, businesses in England, Scotland and Wales must meet new legal requirements for how they allocate and pay certain tips, gratuities and service charges (referred to collectively as ‘tips’ below) to their workers. The Government is currently consulting on a statutory Code of Practice that businesses must take into account when complying with their new obligations. This consultation will close on 22 February 2024. Though the new Act and draft Code do not change the tax or social security treatment of tips, any changes that businesses make to their systems and processes might affect the PAYE and NIC position. This article summarises the new rules on the allocation of tips, the draft Code of Practice, and what businesses should consider concerning the related employment tax compliance issues.

The new rules for how businesses deal with qualifying tips aim to ensure that workers (including qualifying agency workers) receive the full benefit of those payments.

In summary, the new rules provide that businesses must:

• Allocate qualifying tips etc. to workers in a fair and transparent manner;
• Pay qualifying tips etc. to workers within one month of the end of the month in which they were received, subject only to authorised deductions (e.g. PAYE where relevant – see below);
• Have a written policy on allocating qualifying tips that is available to workers; and
• Maintain records of all qualifying tips etc. distributed and make this available to workers on request.

Workers will be able to enforce these new obligations through an Employment Tribunal.

Broadly, ‘qualifying’ tips are those received by the business which are then distributed to workers, or those received directly by workers, but whose final distribution amongst the workforce is subject to the business’s control or significant influence.

Tips received directly by workers, and whose distribution amongst workers is not controlled or influenced by the business, are not within the scope of the new rules.

The statutory Code of Practice will set out overarching principles on what constitutes ‘fairness’ for the purposes of the new rules, the areas in which businesses must make decisions on how they will comply with their new obligations, and how these principles should be applied in their places of business.

Any failure to consider the statutory Code of Practice when designing and implementing policies, systems and processes to comply with the new obligations may be taken into account by an Employment Tribunal.

The Department for Business & Trade is running a consultation until 22 February 2024 on a draft statutory Code of Practice, which covers:

• Qualifying tips and qualifying workers;
• Fairness: factors and methods;
• Transparency; and
• Addressing problems.

The consultation questionnaire contains 34 questions that ask respondents to set out: (i) how tips in their workplace are currently distributed; (ii) how tips are currently divided or allocated between workers; (iii) the transparency of their current tipping practices and policies; and (iv) how they will implement any necessary changes to comply with their new obligations.

Responses to the consultation questionnaire can be submitted using an online form, and views on the draft Code of Practice can be submitted by email.

Neither the Employment (Allocation of Tips) Act 2023 nor the statutory Code of Practice change the tax and social security treatment of tips. It will therefore remain the case that how income tax on tips is reported and paid, and whether employee and employer National Insurance Contributions (NIC) are due, depends on who makes the payment to the employee and how the tips are managed or allocated.

However, businesses should bear in mind that any changes they make to their systems and processes to comply with their new employment law rules could affect their PAYE and NIC withholding obligations. For example, following the draft Code of Practice’s suggestion to instruct a troncmaster to change its operation if the employer become aware of unfair practices could have potentially detrimental NIC consequences (see below).

How tips are subject to income tax and social security is summarised below:

Where employees receive and retain tips directly from customers (e.g. cash tips left at a bar), employees should report the associated income through their personal tax account (or self-assessment), and no NIC is due. In these circumstances where there is no organised pooling or distribution arrangement, there are no employer payroll withholding obligations.

In contrast, if an employer allocates tips to employees (e.g. by aggregating discretionary service charges added to bills and distributing them in line with their tip policy), PAYE and both employee and employer NIC obligations arise.

A tronc is an arrangement for collating and distributing tips and discretionary service charges run by a ‘troncmaster’, who must be independent of the leadership/ownership of the business (e.g., a site general manager or a head waiter) and is responsible for deciding how tronc funds are allocated to participants. Employers can appoint, replace or remove a troncmaster, but cannot direct how they allocate the funds (but the employer can provide certain practical and administrative support to the troncmaster).

Tips and voluntary service charges allocated through a properly operated tronc are subject to PAYE but not NIC. This treatment is increasingly important as employers look for ways to support employees with the cost of living. However, the potential NIC savings mean that tronc arrangements can be scrutinised by HMRC in employment tax compliance reviews.

Where tronc arrangements are incorrectly structured or operated, liabilities such as additional student loan deductions, apprenticeship levy and pension contributions can arise in addition to underpaid NIC. It is therefore important to take tax and legal advice when implementing a new tronc arrangement or changing an existing one. 

Businesses should act now to review their current arrangements for administering tips etc. and determine what actions should be taken to ensure they will be compliant with their new employment law obligations from 1 July 2024.

Points to consider include:

• How will you identify and track your affected workforce? The new rules will apply to employees, limb (b) workers, and qualifying agency workers in Great Britain – they will not apply to individuals with other statuses for employment rights purposes or to individuals in Northern Ireland (where employment law is devolved);
• How will you identify arrangements within the new rules? Identifying tips that are collected and allocated by the employer might be straightforward, but where tips are collected and allocated by employees, how could you demonstrate that the business doesn’t exercise control or ‘significant influence’ over that process?;
• Can you demonstrate that your current policy allocates tips fairly and transparently? How do the principles that underpin your current practices compare with those in the draft Code of Practice? Is there any risk of indirect discrimination in how tips are allocated? How should any necessary changes be communicated to maintain workforce confidence?;
• What current practices will need to change? For example, recovering costs incurred providing administrative and payroll support to a troncmaster from the tronc fund may become an unlawful deduction from wages on and after 1 July;
• Will your PAYE and NIC position be affected? As discussed above, the payroll withholding obligations associated with employee tips is determined by the collection and distribution arrangements – could changes to your systems and processes to fulfil your new employment law obligations affect your employment tax position?; and
• Can you demonstrate that your tax compliance is robust? More generally, could you demonstrate that your historical tax compliance position on tips etc. is correct? Given the requirement to review current arrangements in preparation for the new employment law regime, HMRC might view any failure to identify any historical compliance issues at this stage as a failure to take reasonable care – this review should extend to all relevant taxes (e.g. by ensuring that VAT has correctly been accounted for on any mandatory service charges or on any amounts retained to cover administrative support provided to a troncmaster) – additionally, are you comfortable that your workers are aware of their personal tax reporting obligations?  

Businesses should consider whether they wish to respond to the consultation on the draft Code of Practice before it closes on 22 February.

The Government expects to publish a summary of the responses received and the final statutory Code of Practice in spring 2024, and further non-statutory guidance on implementation is also expected in due course.

Once available, businesses should review both the final Code of Practice and additional non-statutory guidance before finalising their new compliance processes.

Please contact Sarah Haynes, Dot Giret, Laura Brown, or your usual KPMG in the UK contact, to talk through how the prospective new obligations concerning tips, gratuities, and services charges could affect your business.

For further information please contact:

• Sarah Haynes
• Dorothée Giret