If your restaurant pools or shares tips, charges automatic gratuities, or receives a tip-out “to the house”, this article could save you thousands of dollars.
If you’re like most restaurateurs, you probably think that the Canada Revenue Agency’s only concern about tips and gratuities is that servers report them on their personal income tax returns. While the CRA is concerned about this, now, they are even more interested in restaurants that fail to report certain types of tips.
The CRA’s policy on tips and gratuities can be found here. The rest of this article may shock you.
The CRA makes a distinction between “controlled” tips and direct tips. Direct tips are paid by the customer directly to the server. Management of the restaurant does not exercise any control over the tips, which are paid directly to the servers who “earned” them. The CRA does acknowledge that management must handle tips that are put on credit card and debit transactions. If these are flowed-through to the individual servers, as if they had been received directly from the customers, the CRA will consider these to be direct tips.
Where tips come under the control of management, they will be considered “controlled tips”, and they will be taxable as income of the restaurant. Controlled tips include automatic gratuities charged on guest checks. If the owner collects a portion (or all) of the servers’ tips for re-distribution to other staff members, the portion that is collected from the servers will be considered “controlled”.
Controlled Tips = Income
All controlled tips are income to the restaurant. If the income had not been reported, CRA considers it to be “unreported income”, subject to income and sales tax, plus penalties and interest. Similar to sales tax cases, the CRA may consider that the owner of the restaurant received the “unreported income” and charge him or her with personal income taxes, penalties and interest. Note that even though the owner is charged with the income, the restaurant does not get the equivalent deduction.
An Expensive Deduction
If that seems unfair, there is a teeny, tiny bit of justice. The restaurant is entitled to a deduction for the tips that it subsequently pays out. As an owner, you’re probably breathing a sigh of relief. Not so fast. In order to get that deduction, you have to prove that you paid out the funds to the servers and/or other staff members. We can cover that off, by paying them with cheques. If you paid them in cash, the CRA may audit all of your servers and give you credit for the tips they declared in their tax returns. They’re going to love you for this, by the way.
Unfortunately, you’re not out of the woods yet. Tips and wages are taxable to employees. Now, instead of just paying wages, you’re paying them both wages and tips. Since they’re all taxable to the employee, the CRA figures that you should treat tips as remuneration, too. Of course, that means that you must withhold CPP, EI and tax. You also have to pay the employer portions of CPP and EI. Employees will receive T4 slips that include wages and tips earned.
We’re not done yet. If you haven’t been withholding taxes properly, the restaurant can be reassessed for both the employer and employee portions of CPP and EI. You’re probably going to get hit with penalties of at least 10%, and of course, the CRA will charge interest from the time these remittances were due.
While there is a mechanism to get back some of the withholdings that you failed to withhold from employees, you can only do so if they are still employed with you. Even then, you can only increase their withholdings by the amount you failed to withhold in a similar pay period. Finally, you can’t get back any withholdings that are older than 12 months. This is all moot, of course, because your employees quit and no one wants to work for a restaurant that makes their tips taxable!
Numbers to Think About
In my experience, servers often earned at least $20 per hour (and usually more) in tips. Many of my full-time servers earned more than the CPP and EI maximum insurable earnings each year, yet very little CPP and EI was withheld, based on their minimum wages. For 2012, the maximum CPP is $4,613.40 (both portions) and for EI it is $2,015.33. If we consider that some of this was withheld from wages, you’re still going to be on the hook for as much as $6,000 per full-time employee, each year.
CRA Gets Paid
That’s an awful lot of tax to pay. What if your restaurant isn’t in a position to make the payment? Unless you can come to a satisfactory payment arrangement with the CRA, and stick to it, the CRA can decide to grab what they can, by making a demand at your banks. Your accounts will be “frozen” until the full balance is accumulated and paid over to the CRA. How long can your restaurant survive without any access to funds?
Finally, if the restaurant is unable to pay the source deductions owing, plus penalties and interest, the CRA can decide to go after the directors of the company, which usually means the owner, personally. They can put liens on your home, cars and other assets, and they can freeze your bank accounts, until the debt is repaid in full.
Funny, you were just trying to do the right thing, sharing some of the tip money with the other staff in your restaurant, and now you find yourself in a terrible financial bind.
What can you do? Stop charging automatic gratuities on the guest checks. Instead, write the gratuity on the guest check. If you still want to have tip pooling or tip sharing, make sure that the staff does this on their own, without management involvement. You can still set the policies, but you can’t do the redistribution. It would be a good idea to adjust your tip policies in your employee manual to reflect the new procedures. Ideally, you should have your accountant review the wording to ensure that it doesn’t indicate that the tips are “controlled” in any way.