Every sector has its benefits and challenges. In the hospitality sector, tips are a way of showing appreciation for the service offered. Be it a restaurant, café, hotel, or spa, customers often give tips in cash or add them when swiping the card. As a business owner in the hospitality sector, you might have overlooked these tips. But did you know they are income and are subject to taxes, and as a business owner, you are responsible for withholding tax on specific tips?
This article will discuss how the Canada Revenue Agency (CRA) categorizes tips and gratuities for tax purposes.
How The CRA Classifies Tips and Gratuities in the Hospitality Industry
The CRA looks at tips in three ways: how they are routed, who controls them, and the parties involved. It divides tips into two categories: direct tips and controlled tips.
As the name suggests, there are tips that an employee receives directly from their customers for their service, and the employer has no control over it. The CRA has listed some examples of such tips:
Scenario 1: A customer leaves some money at the table after the meal or hands a dollar bill to the car attendant. It is a direct tip if the employee pockets this money and does not give it to the employer. Here, the employer has no control over the tip.
Scenario 2: Instead of cash, the customer adds the tip amount at the point-of-sale (POS) when paying the bill via credit or debit card. Here, the employer does not report the tip amount in his books as business income and returns the tip to the employee in cash on the same day or the next day.
However, if the employer reports the tip amount as business income, it becomes a controlled tip. We will discuss this later in the article.
Scenario 3: Employees create a tipping pool and contribute the tips they receive from customers (full or partial) to the pool. They then distribute the tips without the employer’s involvement. As the employer was not involved, these tips are considered direct tips.
Here again, the name speaks for itself. If the employer controls how much tip will be given to whom, it is a controlled tip. The CRA listed some scenarios of controlled tips.
Scenario 1: The employer can include a certain percentage on the bill or add a mandatory service charge to cover tips. Here, the employer is collecting the tip on employees’ behalf and redistributing them, which makes it a controlling tip.
Scenario 2: Employees give the tips they receive from customers to the employer, and the latter distributes them among employees using a tip-sharing formula. Here again, the employer is the decision maker, controlling who gets what.
Scenario 3: Employee gets electronic tips through debit/credit card payments. If the employer includes the tip in his business income and then redistributes it to employees after deducting certain charges and tips for other staff, it becomes a controlled tip.
Remember, these are just scenarios. Some scenarios could be complicated and open to debate on the employer’s control over the tip. Why does that matter? Because controlled tip has different tax treatment.
The Tax Treatment of Tips and Gratuities in the Hospitality Industry
While all tips are taxable, controlled tips are considered a part of the wage and receive the same treatment as salary. In salary, the employer deducts income tax, Canada Pension Plan (CPP) and Employment Insurance (EI) and reflects it on the employee’s T4 slip.
On the other hand, direct tips are considered as Other Income and not salary. Here, the onus falls on the employee to declare the direct tip and pay applicable tax. Such tips are not subject to pension and insurance deductions.
An employee can receive both controlled and direct tips. For instance, Jerry is a server and receives tips directly from the customer. He keeps a portion and contributes the remaining to the tip pool. The employer redistributes the amount from the tipping pool to all employees. In this scenario, Jerry will report the tip amount he kept as a direct tip and the amount he got from the tipping pool as a controlled tip.
As a business owner, you are responsible for withholding CPP, EI, and taxes and reporting them in T4 slips. An expert accountant can help you set up tipping and gratuity policy, periodically review the system, keep track of the changes in tax laws and tweak the process accordingly.
Contact KSSP Partners LLP in the GTA to Help You with Hospitality Accounting Systems
A professional accountant can help you set up systems and policies for reporting different types of transactions and guide you in identifying areas of discrepancy. To learn more about how KSSP Partners LLP can provide you with accounting services, contact us online or by telephone at 289-554-5997.