If you work in a restaurant, hair salon, hotel, or spa, you know that as a customer in Canada, it’s common to leave a gratuity for good service. However, for many businesses in this industry, managing tips earned by staff is not always a top priority.
Additionally, the legal requirements regarding tips and gratuities can be rather cumbersome for hospitality business owners to understand.
This article will discuss how to treat tips and gratuities, the Canadian Revenue Agency’s (CRA) rules, and best practices for withholding taxes for tips.
Direct Tips vs Controlled Tips
At the end of the day, tips and gratuities earned by employees are considered income under the Income Tax Act.
That said, discerning whether or not tips are pensionable and insurable depends on how they were paid out.
In Canada, tips generally fall into one of two categories for tax purposes: direct tips or controlled tips.
Direct Tips
Direct tips are gratuities that customers give directly to the employee for their service, wherein the employee has no control over the amount. Direct tips can be left through cash or electronic payment.
According to the CRA’s current policy, examples of direct tips include:
- A customer leaves money on the table at the end of the meal, and the server keeps the whole amount
- A guest gives a tip directly to a bellhop, door person, car attendant, porter, etc
- The employees decide how the tips are pooled or shared among themselves without the employer’s involvement
- A customer includes an amount for a tip when paying the bill by credit or debit card, and the employer returns the tip amount in cash to the employee, generally on the same day.
Because these gratuities are paid to the employee by the customer and not the employer, direct tips are not subject to CPP or EI deductions.
Controlled Tips
Much like the term suggests, controlled tips are those that the employer controls until they are paid to the employee.
The CRA outlines the following controlled tip scenarios:
- The employer adds a mandatory service charge to a client’s bill to cover tips
- The employer adds a percentage to a client’s bill to cover tips
- Tips that are allocated to employees using a tip-sharing formula determined by the employer
- Tips that an employer includes in his business income, then expenses and redistributes to employees in the form of pay
- Tips that the employees turn over to their employer, who then distributes them to the employees
Given that the employer has controlled tips before distributing them to the employee, CPP contributions, EI premiums, and income tax must be withheld from these tips.
As you can see, businesses need to differentiate between direct and controlled tips, as the tax implications for both differ.
Electronic Tips
The waters become a bit murky regarding the taxation of electronic tips, and nothing proves this more than the 2022 Federal Court of Appeal (FCA) case Ristorante a Mano Limited v. Canada (National Revenue).
In this case, the restaurant argued that ‘due-back’ amounts resulting from electronic tips were simply a conversion to cash and not a controlled tip distribution. On the other hand, the FCA stated that the employer has possession because electronic tips are first routed through the employer’s bank. Ultimately, the FCA dismissed the restaurant’s appeal, concluding that electronic tips paid by the restaurant to its servers are considered controlled and subject to CPP and EI deductions.
It’s important to note that this decision is particularly impactful as more customers are tipping electronically.
Tips & Gratuities Best Practices for Hospitality Business Owners
To responsibly manage withholding deductions and taxes and accurately report for tips earned by their staff, business owners can implement the following best practices:
- Understand the difference between direct and controlled tips scenarios
- Track tips earned by staff using a point-of-sale system or have staff report tips earned daily
- Stay up-to-date with any changes in tax laws and regulations
- Review your tipping and gratuity policy with a reputable accounting partner who has proven experience in the hospitality industry
We’ve Got Tips for You
With such a convoluted subject, it’s important for business owners in hospitality to understand CRA rules regarding tips and gratuities to ensure they follow them correctly.
By working with an accounting firm specializing in the hospitality industry, business owners can create seamless processes for their employees, stay current with regulations, and rest assured knowing that they are properly managing withholding taxes and income reporting for tips.
Are you a business owner with questions regarding your gratuity policy?