Tipping – all change

The tipping and service charge saga has been long and complicated. Peter Davies, senior manager at business advisory firm Vantis, explains where we came from, where we are now and what it all means.

The new rules on service charges may mean that more customers leave tips as cash, rather than with their card payment

It has been the subject of much discussion, debate and argument for some time, but on 1 October the Government's new laws concerning tips came into force. Businesses can no longer count payments of tips, service charges or tronc towards earnings for the national minimum wage (NMW). Additionally, a new code of practice encourages restaurants to tell their customers what happens to the tips and discretionary service charges that they choose to pay.

THE HISTORY

The background to these changes begins in 1998, prior to the introduction of the NMW. Ministers were keen to see businesses support the NMW and agreed with the hospitality industry that tips and service charges paid to staff by their employer through the payroll could count as earnings for the NMW. Contrary to what some people have subsequently suggested, this wasn't some arcane loophole discovered by devious accountants or greedy restaurateurs - it was a specific agreement set out in legislation and many businesses took advantage and structured their business costings accordingly.

Fast forward a decade. Unite the union has begun its "Fair Tips" campaign for changes to the law and is supported by parts of the national media. Some businesses are "named and shamed" for running what the union and media saw as unacceptable practices and customers start to question what is happening to their tips and why? The Government becomes involved and the outcome, inevitably, is a change to the legislation.

THE CHANGES

The legal change is simple. From 1 October, all employees aged 22 and over must be paid a basic salary of at least £5.80 per hour, before counting any tips, tronc or service charge. There are lower rates for younger staff. Additionally, it will no longer be possible for a business or an employee to pay national insurance contributions (NICs) on an amount lower than the NMW.

The Government has yet to publish its preferred code of practice, but the British Hospitality Association (BHA) has issued its own guidance, which incorporates three main concepts to be disclosed to customers. First, a business should tell its customers about any proportion of the tips or service charges that it retains to cover genuine costs and charges incurred. Typically, these will include card commission fees, bank charges, card fraud losses, payroll costs and the like. In the past, many businesses have not sought to recover these, but this is likely to change.

Second, any other amount retained by the business for any other reason (including helping to fund the wage bill) should be disclosed. It is important to remember that there is no change in law to the Nerva principle, which states that all discretionary service charges and tips paid by card become the property of the business and that a business can keep as much of these proceeds as it chooses. Calls for the Government to legislate to ensure that 100% of tips are passed to staff are, we believe, doomed to fail - Nerva was decided by the UK courts and has been upheld by the European Court of Human Rights.

Some people want disclosure to go further - to include details of how tronc monies are allocated and confirmation to customers that this has been done by agreement with staff. However, this could cause serious problems, as it may suggest that a business controls, or has some form of veto over, the methodology used by the troncmaster. That would compromise the exemption from NICs, which remains of paramount financial importance to both businesses and staff.

COMPLIANCE

So what steps should businesses take to comply with the new changes?

• All rates of basic pay must be increased to at least £5.80 per hour (for over 21s) regardless of whether the employee is paid hourly, per shift or by an annual salary. If a shift or salary is used, businesses must be certain that those rates break down to an average (over a 13-week period) hourly rate of at least the NMW. Employees' and employers' NICs must be operated on this higher level of basic pay.
• Businesses wishing to comply with the disclosure Code of Practice should ensure that their statements are factually correct and not misleading (deliberately or accidentally) and, importantly, do not compromise the exemption from NICs. Proprietors are advised to ask themselves "will this reassure or discourage our customers from tipping by card or paying a service charge?" Most businesses adopting the code of practice are expected to make a short statement on their menus.
• Restaurants should look carefully at the costs they incur in collecting and administering these payments and distributing them via the payroll. Recovering those costs is both legitimate and reasonable, but should not be used as a way of retaining unreasonable amounts - it is likely to be difficult to justify an administration charge exceeding 10% as doing no more than covering costs incurred.
• Businesses should ensure that staff are properly briefed on the policy being adopted and, if they are asked by customers, the consistent response they should provide. A more detailed explanation about what happens to the tips could, for example, be placed on the website and customers could be referred to it for further information.

IMPACT

So what might the overall effects of the new legislation be?

• The only unqualified winner is HM Revenue & Customs - which will see increased NICs.
• Customers may be better informed going forward, but the costs of providing this information may well result in higher menu prices.
• Employees will see more basic pay in their pay packets, but will pay more in NICs and may actually receive less tips than they were previously!
• Businesses will have to pay increased wage costs and employer NICs. These could end up forcing the closure of restaurants during these difficult economic times.

THE OUTLOOK

For many businesses, the costs involved in implementing these changes will be very significant. For some, it could erase any profitability this year. Others might have to consider reducing staff hours or even redundancies just to stay open. It will be interesting to see if many follow D&D London's decision to abolish the service charge completely and rely solely on the generosity of consumers - average UK tipping rates (for businesses without service charges) are around 8% as opposed to an average 12.5% service charge. If the gap is not met, businesses are likely to risk losing good staff to their competitors or having to increase prices.

If you would like any advice on the issues raised in this article, please contact Peter Davies at Vantis on 020 7417 0417 or e-mailpeter.davies@vantisplc.com.