How to avoid tipping off the taxman

Hotel and restaurant staff who take part of their income as tips should be wary of the taxman. Paul Slade tots up the bill.

Many poorly paid staff in the restaurant and hotel trade rely on tips from satisfied customers to top up their weekly earnings. But, if they fail to declare these tips for tax, they could find themselves in trouble.

Mike Warburton, of accountants Grant Thornton, warns that staff and employers alike will face stiffer investigation by the Inland Revenue on the tax due from this income under the new self-assessment regime. "I wouldn't put it past tax inspectors to go and sit in a restaurant incognito just to see what's going on," he says. "Don't assume that the person sitting at that table who's just given you a tip is not a tax inspector."

Under self-assessment, the emphasis of the Revenue's work is shifting towards collecting tax which currently goes unpaid. Mr Warburton says: "You and I know that there is a lot of money that gets paid out in tips that never gets taxed. It's an obvious one for the Revenue to have a go at."

A Revenue spokesman confirms that the Revenue will be putting more emphasis on chasing unpaid tax, and that this will include pursuing individuals benefiting from untaxed tips. "We'll be putting more resources into dealing with recalcitrant taxpayers rather than people who are scrupulous," he says.

As far as the Inland Revenue is concerned, tips are part of the worker's income, and are liable to tax in exactly the same way as wages. Nor does this tough new stance simply affect staff. Employers who operate systems to share out accumulated tips may find the Revenue presents them with a bill for all the Paye and National Insurance contributions which he should have deducted from the tips pool before sharing it out.

If inspectors decide tax should have been collected by the employer, they can then go back as far as six years to collect outstanding payments, as well as making penalty and interest charges.

By the time all these elements are added up, Warburton says, the bill could come to pounds 3,000 or more per member of staff, even where each staff member takes an average of just pounds 20 a week in tips. "You could be talking about bankrupting some of these businesses."

His advice to employers who want to avoid Paye and NIC liabilities, is to take themselves out of the loop by arranging for staff to administer the sharing out of tips themselves, in what is known as a "troncmaster scheme". Warburton also advises employers to keep records of how much goes into the tips pool each week and which employees benefit. Without this, he says, the Revenue may not accept the employer is in the clear.

The other side of the coin, of course, is that the tax inspector then has the information he needs to pursue the individual staff involved. National Insurance liability is unlikely to apply, but penalties, interest and up to six years worth of back-tax may still be due. "You could argue this is just shifting the burden on to someone else," Mr Warburton says. "But it shifts the burden on to the person who has the liability."

Staff taking annual tips of more than pounds 500 a year - equivalent to just pounds 10 a week - should be declaring the income on their own tax return. As low wage earners with no investment income, waiters and similar staff are unlikely to receive a tax return without requesting one.

But the fact that penalties for failing to file on time become automatic under self-assessment means those penalties are far more likely to be used - and not just against the rich. Again, the bill could amount to several thousand pounds.

Tim Jones, a tax manager at Arthur Andersen, says: "It's a catch-all provision for the Revenue. Once they find out about someone with this sort of income, they can demand their returns for prior years. Then they fine them, they surcharge them, and they charge interest. Then they come to a back-duty settlement and make a lot of money out of it."

The Inland Revenue spokesman says: "If they have untaxed income, then it's their responsibility to tell us that. Someone who receives tips in excess of pounds 500 a year will need to be in self-assessment and get a tax return."

He adds that says anyone receiving tips income of under pounds 500 a year should inform the Revenue of this, and will be contacted once every three years to confirm the pounds 500 ceiling has not been breached. Where tips amount to less than pounds 500 a year, the individual's tax code is adjusted to take extra tax from his or her wage rather than the tips.

Mr Jones says: "They do raid restaurants now and again and, if you happen to come into their clutches, they're going to ask you about previous years. Once your name is on the Revenue's system, you'll never get out of it."