A few months ago, Dining Date Night began offering customers a 30% discount at various restaurants in Toronto. In order to get the discount, a customer books a reservation on a website and pays a $10 fee to Dining Date Night. When the customer visits the restaurant, 30% of the total bill (before taxes) is deducted as a discount. This type of promotion is relatively good for both the consumer and the restaurant that provides the discount, because the restaurant can restrict the hours when reservations may be taken.
Most of the restaurants that are included in this program are fairly high-end. So, they’re not likely to attract too many “cheapskates” as do other discount programs like Toronto’s Summerlicious and other cities’ “Restaurant Weeks”. As a result, the restaurants that take part have a fighting chance of winning over new loyal customers. So far, so good. But what about the tax consequences of this type of discount program?
At first blush, you might think there aren’t any tax issues. The restaurant only has to collect HST on the net amount of sales, and they do. They only have to record the net sales generated by the restaurant, too. So there are no income tax issues. So, if they’re collecting and remitting the taxes they’re supposed to, what’s the problem?
The Tax Man Cometh
Every few years, usually two to four years, the tax auditors will pay a visit to each restaurant. If you’ve been following my other articles about restaurant tax audits, you know that the auditors have a unique method of auditing restaurants. Rather than check to make sure that all sales have been reported, based on guest checks, they estimate the sales that should have been generated based on the restaurant’s purchases of alcohol and the markups that were applied. The “expected sales” figure that the auditor calculates is the gross amount of alcohol sales that she thinks the restaurant should have generated.
Here’s the problem. If the restaurant only records the sales net of discounts, it will need to keep track of all 30% discounts related to alcohol sales. If not, the auditor will be comparing her gross expected sales with the restaurant’s net sales, inflating the amount of “unreported sales“. The only way, that the auditor will consider the 30% discounts that the restaurant gave to customers, is to provide proof.
What kind of proof would be sufficient? The restaurant will have to maintain a file of every guest check that had a 30% discount applied. Since the auditor’s calculations only involve alcoholic beverages, the discounts given must be allocated between alcohol and non-alcohol sales. Also, it would be a very good idea to summarize every guest check (with the discounts applied) on an Excel spreadsheet, so that the auditor will have all of the information needed to make the correction.
Even if the restaurant does report all sales at gross amounts and shows the discounts as either a sales discount or a promotional expense, the auditor may request proof. So, restaurants should keep a file of all discounted guest checks.
This brings up another potential problem. Most restaurant POS systems show price discounts separate from the menu items ordered on guest checks, which is the way it is supposed to be. Recently, I came across an iPad based POS system that does it differently. Rather than show the discount separately, it reduces the price of the menu items that were ordered, and it provides no evidence that the menu price has been discounted on the guest check. This is a terribly bad practice, not only for restaurants offering percentage discount programs, but for any restaurant. Unless the owner/manager is carefully monitoring discounts, unscrupulous servers could discount meals and drinks without authorization. Of course, this will make the tax audit situation even worse.
This type of POS system’s handling of discounts makes it much more difficult to prove the discounts that were given by the restaurant. Simply keeping the final guest check will not prove that a discount was applied, without also proving the correct regular menu price for every item on the guest check at that time. The best way to do that would be to print the guest check immediately before applying the discounts and another copy after applying the discount. Now, the paperwork has been doubled, and in a busy restaurant, how many times do you think the servers will forget to complete all the steps?
How Big a Problem Could It Be?
If you can’t prove the discounts related to alcohol sales, the auditor will consider the shortfall in sales to be “unreported sales”, pocketed by the owner. If the average guest check includes $60 of alcohol (for two!), that auditor will calculate about 30% tax (HST plus corporate income tax) on this, payable by the company. This will be about $5.40 for each discounted guest check. The auditor will also reassess the owner with personal income tax on the unreported sales ($60 x 30% discount = $18). Depending on the owner’s taxable income, the rate of tax to be applied could be as high as 44%. Most won’t have that high of a marginal tax rate, but quite a few will be around 35%. So, this will create another $6.65 of tax payable (by the owner).
Now, add penalties of at least 10% along with interest, and the tax bill to the restaurant and owner will approach $20 or more for each discounted guest check! Now, if the restaurant has 10 such discounts each week, the tax cost will be about $10,000. If the audit period is two years (typical), the restaurant and its owner can expect tax reassessments totaling $20,000 or more.
Have I got your attention?
Always record gross sales (at regular menu prices). Then, apply discounts as either sales discounts or promotional expenses. Keep a copy of every guest check that has had a discount applied. If your POS system doesn’t show discounts on the guest check, keep a copy of the check before and after the discount is applied. Better yet, get the POS developer to update the software!