The Employment (Allocation of Tips) Act 2023 (the “Act”) received Royal Assent on 2 May 2023. The Act makes a number of changes to tipping payment practices in the UK. The commencement date hasn’t been announced yet, but the UK government expects this to be in around 12 months’ time. The UK government estimates that the new legislation will affect around 2 million hospitality sector workers in the UK, with potentially significant cash flow implications for employers within the sector.
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.
The current legal regime applies different treatment to tips and service charges.
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:
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.
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:
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.
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:
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.
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.