Tipping: compulsory or discretionary service charge?

"People can get confused in the UK," admits Martin Couchman, deputy chief executive of the British Hospitality Association (BHA). "You can have compulsory service charge, voluntary service charge, no service charge at all or an arrangement where you leave cash on the table; there's nothing standard in this country. However, I'm pretty sure that in most restaurants that have a service charge, most of the money will be finding its way to employees. Of course, we have no means of proving that as we don't have the data."

Peter Davies, employment tax director at accountancy, tax and corporate finance firm WMT, where he specialises in advising hospitality businesses, agrees.

"There are always going to be some businesses that will push the envelope, but certainly the overwhelming majority of businesses that I'm aware of don't

'cream off' tips or service charges; they seek to cover their costs and nothing more," he says. Indeed, standard practice in restaurants sees 5-10% of service charge (which is usually 12.5% of the bill, and is often compulsory in London, but rarely outside the capital) and tips go on administration fees to cover credit

card and bank charges, payroll costs and credit card fraud. "There are good reasons for some deductions being made to cover those costs," Couchman says.

After administration fees have been deducted, most operators, according to Davies, will then divide up the remaining tips and service charges among the staff through a tronc system, which is a central pool of funds, administered by an independent 'troncmaster', usually a restaurant's manager or assistant manager.

The only stipulation is that the troncmaster can't be a director of the business. Not only does this have tax benefits, as tips that go through a properly run tronc system are exempt from national insurance, it also rewards staff loyalty and means that all employees know where they stand.

"It goes one step beyond throwing the money into the hand of the person who's served you; it rewards the team, and rewards seniority and longevity," says David Moore, co-owner of Michelin-starred restaurant Pied Á Terre in London, where a small percentage of tips are taken to cover bank charges and other administration costs, and the rest of the money is divided up via a tronc system.

At London Thai restaurant chain Rosa's, which has a 12.5% mandatory service charge, a similar system is used. "We use software to manage the tronc; it makes it easy to divvy up the money and it's fair," says co-founder and managing director Alex Moore. "The manager grades the tips on experience and input, giving slightly more to the more experienced staff."

But while staff might know where they stand at restaurants where a tronc system is used, do the customers? According to Percy, more often than not, no.

"Consumers often do not know whether charges on a bill are mandatory or discretionary. They often have no idea of how much, if anything, the employee will

actually receive," he said in the House of Commons in September.

And Couchman tends to agree. He believes that while most restaurant chains do provide customers with the relevant information about service charges and tips, including how they are shared among staff, many independents probably don't. "This is simply because they're probably not aware of the code, whereas the

chains generally are aware of it," he says.

The code Couchman is referring to is the 2009 BHA Code of Practice on Discretionary Tips & Service Charges, which was released to encourage transparency across the restaurant industry. It not only explains the differences between discretionary service charges, tips and gratuities and how each should be dealt with, it also recommends that restaurants disclose whether an amount is deducted for handling costs and how much, how the remainder is shared between the restaurant and its employees, and the broad process for the distribution of this money.

This is a different voluntary code to the one that Percy referred to in the House of Commons, which covered sectors including hairdressing and taxis on top of restaurants, but the broad intention of both is the same.

"Overall, our view is that beyond handling costs, the restaurant or restaurant chain ought to tell the public what's happening," Couchman says.

David Moore, whose restaurant's tipping policy is explained on the menu, adds: "Customers need to know where the money is going; it gives them a better sense of security when they're leaving a tip. They don't want to leave 12.5% on a bill just for it to go to the bottom line of the restaurant."

But would a new law setting out a clear process for the distribution of tips, giving staff more power over how tips are shared, and mandating that restaurants display their tipping policy, as Percy has suggested, really improve the current situation?

David Moore thinks not. And Alex Moore, who also displays his restaurants' tipping policy on both menus and customers' bills, agrees that not only would this be going against the current government's promise to have less regulation by the end of its term than at the beginning, it would be very difficult to police.

Moreover, adds Davies, it might not be possible anyway. "From a legal perspective, the European Court has already ruled that this money belongs to the business and it's up to them what to do with it," he explains.

So, what about changing the system entirely - for example, by eliminating service charges, adding an appropriate percentage to dishes and paying staff accordingly? This, Davies explains, would bring significant extra taxation costs (national insurance and VAT) meaning that more than half of the price increase

would disappear in tax . If businesses and staff couldn't afford to absorb these tax costs this would mean diners paying up to an additional 9.5% on top of the 12.5% paid at present.

Adds Couchman, there is anecdotal evidence from countries that operate an all-inclusive system, rather than a tipping system, such as Belgium, France and Italy, that service standards have declined because there is no incentive to improve performance.

"That's obviously an anecdotal point, but it's a point that a lot of people make," he stresses. Clearly, the UK's system for tipping and service charges isn't perfect, and there's certainly a general consensus that transparency could be improved. But, Davies emphasises that new laws are not the way forward. "We already have far too many laws; there has to be encouragement from within the industry, explaining that giving customers that reassurance is not only the right thing to do, it's actually good for business because customers are happier," he says.

And the BHA is certainly on the case. "We want customers to be able to make rational decisions," Couchman notes. "And we will only be happy that we've succeeded [with the BHA's code of practice] if every restaurant tells the customers what's happening to the money from service charges, tips and gratuities.

Best practice tipping procedure

In 2009, the British Hospitality Association released a code of practice on discretionary tips and service charges, designed to both educate restaurateurs on current conventions by answering commonly asked questions and ensure they understand the importance of customers knowing where their money is going. Here are the key questions:

What is discretionary service charge? This is a payment suggested by the restaurant, which the customer is totally free to make or not. The payment is made to the restaurant (or similar establishment) by cash, card or cheque. It is not a cash tip.

What are tips and gratuities? These are additional payments given by the customer over and above the amount of the bill and any discretionary service charge. They fall into two categories: cash tips, given to an individual employee, or non-cash tips, being additions to the amount on the bill and paid to the restaurant, whether by card or cheque.

How should cash tips be dealt with? Cash tips are payments given directly by customers to individual employees. Any arrangement for sharing cash tips among

employees should be in accordance with their wishes. The restaurant owner will not be involved in this process. It is the responsibility of the employees receiving such cash tips to make proper disclosure to HM Revenue and Customs and to account for income tax in respect of these earnings.

What deductions may be made from discretionary service charge or non-cash tips paid to the restaurant before they are made available for allocation to employees? There is no legal requirement for the restaurant to allocate a particular proportion of the service charge or tip income to employees. However, a deduction for costs incurred in handling these sums would cover credit card and banking charges, payroll processing costs, and the average costs of credit card fraud.

The level of costs deducted will vary, depending on the nature of the business. Any deductions made by the restaurant over and above those for these costs should be disclosed to customers as part of the disclosure process.

How should discretionary service charge and non-cash tips be paid out? Where discretionary service charge and non-cash tips are paid to employees by the restaurant, they are most commonly paid from the restaurant's bank account, with income tax deducted under PAYE. The broad process for distribution of these amounts should be disclosed to customers as part of the disclosure process.

What disclosure should be made? Restaurants should disclose to customers how they deal with discretionary service charges and non-cash tips, at least by a written note available for inspection at each restaurant and on the restaurant's website, if there is one.

The disclosure should cover:

• Whether an amount is deducted for handling costs (and how much)
• How the remainder is shared between the restaurant and the employees
• The broad process for distribution - for example, that they are shared between the employees in the restaurant through a system controlled by a representative of the employees.