Tips & Gratuities

Tips & Gratuity and Service Charges Explained

Customers can pay a gratuity or a service charge in addition to a hospitality bill to show appreciation for the people who served them. These are paid through different methods and can be a valuable addition to hospitality worker’s income. While the concept is relatively simple, there are some key differences between tips, gratuity and service charges and how they’re managed by businesses. It’s important hospitality operators understand the difference between the three and how to manage and distribute them fairly, and it can also be useful for customers to know where their money is going. In this article we will cover:

  • What is gratuity?
  • What are tips?
  • What is a service charge?
  • How do businesses deal with tips and gratuities?
Tips and gratuities

Gratuity is defined in the Labour Code as a tip, gratuity, or money that has been paid, given or left for an employee or patron of a business over and above the actual amount due for a service. Customers leave a gratuity to show appreciation for the people who served them. They can be paid in cash or by adding value to the bill when paying by card. Tips and gratuities are one in the same, although in the past the terms often differentiated whether the amount was left as cash (tip) or by card on the bill (gratuity). This distinction has now become blurred and they are best viewed as one and the same.

tips and gratuities

Customers leaving a gratuity or tip often assume that the money they leave goes to the employees who served them, but this isn’t always the case. Often operators would pool tips and distribute to the wider team who have been involved in delivering the service, such as the kitchen. In some cases, businesses also held back a proportion of the tips to cover ‘business administration’ or to boost profits. However, following recent changes in tip laws, employers will be required to pass on gratuity, tip and discretionary service charge payments to workers without any deductions. You can learn more here.

What is a service charge?

tips and gratuities

A service charge is an additional amount that is added to the customer’s bill before it is presented to them. Usually, this is a set percentage of the bill, and is calculated on the total, inclusive of VAT.

Even though the service charge has been added by the venue, it can be either discretionary or mandatory (like a cover charge). A customer must be made aware of it before they order (usually through a statement on the menu) and that it is discretionary. If they pay it, then this is usually treated as a replacement for a tip. If it is non-discretionary, it is classed as business income, just as the cost of the food is, and is subject to VAT, NI and corporation tax.

Service charges have been a murky area in the world of tipping as the money on a service charge is classed as income for the establishment, and therefore there is no legal requirement to pass it onto employees. This will all change in 2024, the long-awaited Employment Bill has been passed in parliament and will come into force. This will make sure 100% of tips and service charges go to the workers.

How do businesses deal with tips and gratuities?

There are two main ways businesses and hospitality operators deal with tips, gratuities and service charges:

1. Distribute some or all of the tips to staff via a tronc.

This is the fairest and most tax-efficient way of managing tips as it has taxation benefits for both the employer and employee. You can learn more about troncs here.

Businesses that don’t have time to manage a tronc internally can use a third-party service such as Troncmasters. We offer a range of different tronc schemes where we support businesses with tips and gratuity, taking the pressure of legislative compliance and administration off the business.

2. Distribute some or all of the gratuities to staff outside of a tronc scheme

This allows the business to control the distribution of tips but as it is not being managed via a tronc any National Insurance tax savings are forfeited.

If you would like to discuss tronc schemes with one of our Troncmasters, contact us