VAT – Tips and Service Charges

    Cash is by no means disappearing, but the long-term trend is that cash is being used less and less. Some hospitality businesses are making the move to cashless models, and trends in tipping are also changing. It’s important that with these changing trends business owners stay on top of the VAT rules for tips and service charges.

    Takepayments, a large UK payments merchant, published insights into tipping in 2021, showing that 91% of tippers preferred to do so in cash and that 35% would not consider tipping on a card. With people generally carrying less cash around, action is needed by hospitality business owners to combat these changes that are affecting their staff’s income.

    So, what’s everyone doing? Well, you may well have noticed that more and more businesses are opting to include an optional or compulsory service charge on customers’ bills instead of using the tipping model we’re used to in the UK.

    Inevitably, there are tax consequences, but don’t worry, we’ll cover this below.


    HMRC’s Standing on Service Charges

    HMRC’s VAT Notice 7091 states that “if you make a service charge, it’s standard-rated. But if the customer freely gives a tip above your total charge, no VAT is due on the tip”.

    That sounds simple, but as always, the devil’s in the detail!


    So, VAT or No VAT?



    Let’s break this down…


    Mandatory Service Charges

    Where a service charge is mandatory, most often used as a surcharge for larger parties, the charge will follow the same liability as the supply that has been made, which for most hospitality cases, will be VAT at the standard rate. This is straightforward but easily overlooked when setting up POS systems and recording sales. You’ll need to bear in mind the VAT amounts when passing this on to staff.

    i.e if someone pays a mandatory £12.00 service charge on a standard-rated service, it’s actually £10.00 that should be recorded in staff’s service charge pot as £2.00 needs to be paid to HMRC for the VAT.

    Optional Service Charges

    Simply put, optional service charges are Tips for VAT purposes. These are therefore outside the scope of VAT. The important distinction here is that the tip must be freely given.

    The communication of this charge is essential to ensure you don’t fall foul of HMRC.


    How to ensure you get it right!

    To ensure compliance, the language used on menus, bills, payment terminals, and by staff members should reflect the fact that it is a discretionary (optional) payment.

    VAT Tribunal cases have highlighted the importance of this in deciding on the VAT treatment. The key for all hospitality business owners is to remember that it is the menu that sets the contract between them and their customers. (The bill arrives after the supply has been completed).

    Whether a service charge is mandatory or optional should be communicated on the menu, where the contract is set. The language used on bills, payment terminals, and in communication by staff members should echo this. This will ensure you only need to pay VAT where it has been made clear that a mandatory service charge applies, ensuring your staff see as much of their discretionary Tips and Service charges as possible.

    This blog won’t dive into the world of Tips and Troncs. We’ll just stick to Service Charges today,but keep an eye out for a blog on this topic soon.


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