Are tips and gratuities given to a sole trader (no employees) counted as business income or personal income? i.e. are they recorded through the business as sales income or just on the personal tax return?
I would class it as personal income not a business income. Nothing has been sold within the business to get the money, its just based on the generosity of the customer and how good the service is.
Jo
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Jo Gillespie AICB
Thoughts are my own and must not be taken as professional advice.
Funny how things make so much more sense when we get a second opinion. I'll put it through as business (can't decide if it's sales or other income so will make a new nominal of "Tips and Gratuities" under "Other Income") then and then take it straight back out as drawings (as the cash is always kept and doesn't go into the bank).
Thank you very much for your help.
Best wishes
Hel
-- Edited by HellsBells on Thursday 21st of May 2015 09:26:34 PM
With my client he chooses to keep the money in the business, so I have never considered it as being personal income. Jo makes a valid point, and it's likely in your case to treat it as she describes.
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John
Any advice given is for general guidance and professional advice should be sought applicable to your circumstances.
Thats an interesting question with a fair bit of pondering to be had around it.
consider this from a VAT perspective (not saying that the business is VAT registered, just I find it easier to visualise things when thinking through worst case or most complex scenario's).
If one applies a service charge then VAT is payable but if a tip is freely given then there is no VAT.
So, in the case in question does the client give the tip at their own discretion in cash or is the tip added to the bill?
Whilst as I say this may not be a VAT case the same logic applies in that something freely given is to the individual (taxable personally), something added to the bill is to the business (taxed on the business as the tip is in reality an extension of the service).
If given freely for personal service above that being paid for then I would go with Jo's answer. If added to the bill as an extension of cost I would go with Johns as to treat any other way would be understating income.
Got me thinking now about the treatment of a credit card tip where an amount is added to the bill processed on the card supposedly for staff (known as a Tronc).
Such "should" be shared amongst the staff but that is not a reward to an individual who earned the tip so should not the argument be that tips taken and distributed in such a way are in fact an extension of salary rather than tips? (they are, I'm just showing how HMRC reached their epiphany). That would of course make the tips though freely given taxable income through PAYE. Their collection taxable as income on the business and their distribution an expense of the business.
So, where I was going with this is that it's not just that a tip is received. It is also how it is received that determines how it should be treated.
Shaun.
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Shaun
Responses are not meant as a substitute for professional advice. Answers are intended as outline only the advice of a qualified professional with access to all relevant information should be sought before acting on any response given.
Thank you very much for explaining all of that. I can see now why they would be treated differently depending on how the tip was received. My client's were freely given so I'll go that road
Thats an interesting question with a fair bit of pondering to be had around it.
So, in the case in question does the client give the tip at their own discretion in cash or is the tip added to the bill?
Whilst as I say this may not be a VAT case the same logic applies in that something freely given is to the individual (taxable personally), something added to the bill is to the business (taxed on the business as the tip is in reality an extension of the service).
If given freely for personal service above that being paid for then I would go with Jo's answer. If added to the bill as an extension of cost I would go with Johns as to treat any other way would be understating income.
You've got me wondering now Shaun if I've treated the tips correctly for my client. As a sole trader, he would present me with a weekly sheet with all takings marked on it and a column for tips. This money was banked every week and kept in the business. He would take a set weekly amount as drawings so he wasn't actually putting the tip money into his pocket, although at the end of the day any profit would still belong to him anyway.
So paragraph 2, it was a tip given solely at the discretion of the passenger, not added to the bill, thus making it personal income, but he's kept it in the business which muddies the waters. Also the majority of the cash work (a rough guess 70%)was done by his son, paid through PAYE, but tips added to the takings rather than pocketed or paid back through PAYE.
He's now a Ltd Company, does that make any difference? The majority of his work is now contracts, but he does rank work when he needs to. (son no longer employed)
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John
Any advice given is for general guidance and professional advice should be sought applicable to your circumstances.
John, I've done loads of research on this the last couple of days. Who would have thought that tips could be so complicated? There's a wee bit info at the HMRC link below. Many other private websites have further info but I'm always a wee bit unsure about quoting others (who might not even be accurate).
Update: I have today spoken to HMRC. The operator wasn't sure and had to go and check. She came back and told me the following (but even still, might just be hearsay, as she asked someone else rather than looking up the rules):
It must be declared as income through the business, but is not "Sales" income.
I can make an adjustment to the Class 4 NICs, but must put a note in to explain why (she only agreed this on pushing as she wasn't sure if self-employed people don't pay Class 4 on tips in the way that employees don't).
HellsBells wrote:There's a wee bit info at the HMRC link below. Many other private websites have further info but I'm always a wee bit unsure about quoting others (who might not even be accurate).
Hi Hel,
worth noting that HMRC's guidance is simply their interpretation and is not in itself the law which is why they end up in court so much trying to defend their stance against tax practicioners.
The law is the finance act, not HMRC's often dubious a regularly transient (#1) interpretation of what they would like the law to say rather than what it actually does say.
kind regards,
Shaun.
#1 if you depend on anything on an HMRC webpage always store a copy of it as it may not be the same (or even there at all) the next time that you come to reference it.
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Shaun
Responses are not meant as a substitute for professional advice. Answers are intended as outline only the advice of a qualified professional with access to all relevant information should be sought before acting on any response given.
Thanks Shaun. I have so much to learn. I'm always thinking HMRC are infallible and the epitome of authority on everything finance related (I'm not even being sarcastic) . I'll try to keep that in mind.
#1 if you depend on anything on an HMRC webpage always store a copy of it as it may not be the same (or even there at all) the next time that you come to reference it.
That is excellent advice. That never would have occurred to me.
Going back to tips, if they are received and put into the business, how would the bank feel if the business was applying for a loan say or an over draft and part of the takings was actually made up from gratuities? Would they include that when making their decision?
Jo
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Jo Gillespie AICB
Thoughts are my own and must not be taken as professional advice.
I imagine that a fair number of taxi driver tips are given with a comment such as "keep the change". I've never felt able to argue that the customer does Not intend this to be payment for the service provided. Chit-chat is to be expected in any commercial exchange where you're seated close to the proprietor for 5 or 45 minutes as is carrying luggage to the boot and opening the door for you. Whatever the HMRC guidance, I'd wish anyone good luck in excluding this from the accounts or self employment pages. My own preference is to place it in 'other income' to deter Enquiry.
"Voluntary payments designed in some way to augment the consideration payable for goods or services whether past, present or future, are taxable (see, for example, Severne v Dadswell [1954] 35TC649, and CIR v Falkirk Ice Rink Ltd [1975] 51TC42."
The case laws quoted are not exactly good examples of for this scenario but the text fits
My understanding is that if trader asks one price but you as the customer offer to pay more, you have changed the contract to one of an higher value. (That's from some vague recollection, of a case law I read once)
Thank you very much for shedding more light on this. It would seem sensible to be very transparent about it from the start. I've made three new nominals of a bank-type, other income-type and drawings-type. The printed P&L shows very clearly that the income was received as tips and was retained by the proprietor as drawings. The Tips "Bank" account always has a balance of zero but shows the money coming in and out. Hopefully that will satisfy anyone appraising the accounts?
Thanks so much to everyone for this help. It was most useful.
I'll put it through as business (can't decide if it's sales or other income so will make a new nominal of "Tips and Gratuities" under "Other Income") then and then take it straight back out as drawings (as the cash is always kept and doesn't go into the bank).
. I'll try to keep that in mind.
