TW Ed points out that HMRC's best VAT guidance on service charges is to be found in its... employer guidance.
As I have already mentioned, I find HMRC’s guide E24 Tips, Gratuities, Service Charges and Troncs to be most useful, on a topic that is relatively simple in theory, but whose implementation in practice can become quite tortuous, given the wide variety of arrangements that can arise in catering.
It is not perfect; I am not sure I can wholly endorse the assertion that:
“In most cases where you [the employer] pass tips to an employee, you are liable for both Employees’ and Employers’ NICs because neither of [the conditions for NI-free treatment] are satisfied”
But there are many useful scenarios in the booklet, that can assist.
One area where E24 excels, however, is in terms of VAT. Ironic, given that it is a booklet aimed primarily at employers, rather than VAT.
Tips are outside the scope of VAT where genuinely freely given. This is so regardless of whether:
- The customer requires the amount to be included in the bill
- Payment is made by cheque or credit/debit card
- Or not the amount is passed on to employees
Restaurant service charges are part of the consideration for the underlying supply of the meals if customers are required to pay them and are therefore standard-rated.
If customers have a genuine option as to whether to pay the service charges, it is accepted that they are not a consideration (even if the amounts appear on the invoice) and therefore fall outside the scope of VAT.
Now, this is guidance with which I am relatively familiar, and I am also on nodding terms with the underlying concept in relation to whether or not something is within the scope of VAT – critically, a gift by a party (not in business) would by implication be something given otherwise than for consideration and could not therefore be a supply for the purposes of VAT.
But I like to see things in black and white, so I trotted off to see this backed up in either of the VAT Notices 700, or 709/1.
I was astonished to find the following
8.14 Service charges and tips
If you make a service charge it is standard rated. If a customer freely gives a tip over and above your total charge no VAT is due on the tip - it is outside the scope of the tax.”
2.3 Service charges
If you make a service charge, it is standard-rated. But if the customer freely gives a tip above your total charge, no VAT is due on the tip.”
It may be to the credit of the E24 booklet that it expands on this guidance, but I should have expected far more detail on VAT, in the VAT guidance. E24 excels against a poor field of competitors.
Perhaps most importantly, the VAT guidance fails to clarify that a suggested service charge may be included in a bill by default but, so long as it is clearly optional, then VAT does not have to be charged.
The correct position is fairly well known amongst veterans in the industry, but catering is a particularly mobile sector. What concerns me is that, as many practitioners will testify, HMRC officers increasingly tend to concern themselves more with their internal guidance, or “scripts”, and less with the actual rules or legislation. Brevity like this may result in misinformed officers incorrectly challenging (or incorrectly advising) businesses.
Clearly, there is also a risk that caterers, who make the effort to read the VAT guidance, incorrectly charge VAT on service charges. HMRC will happily collect anything that is described as VAT; which will simply mean that those businesses will pay more VAT and lose more money than they should.
VAT consultant Andrew Needham of VAT Specialists Ltd. adds:
"VAT on service charges is a confusing area and HMRC will always look at it on a visit. I would recommend that businesses decide on a system for dealing with tips, document it and maintain accurate records which will reduce the chance of a challenge by HMRC."