January 17, 2024
Understanding Tips and Gratuities
While the topic of tips can be complex and confusing for a business owner or manager, understanding a few key principles will help keep your team engaged and ultimately save you time and money. It all starts with developing a Tip Policy, engaging your staff on the development of the policy, and ensuring that it’s clearly communicated to all staff and management.
When developing a Tip Policy, you need to take into account both the Employment Standards Act (ESA) and the Canada Revenue Agency (CRA) guidelines. Note that substantive amendments were made to the ESA in 2019 that affect how employers may handle gratuities.
Generally speaking, there are two approaches to handling tips: direct tips and controlled tips.
Direct tips fall into these three groups:
- A customer leaving money on the table at the end of the meal and the server keeps the entire amount.
- A customer pays by Credit or Debit card, and the employer gives the entire tip in cash and pays it out to the employee at the end of that shift.
- Tips that are shared and pooled, where the employees determine how the tips are collected/distributed.
- NOTE: It is critical in this scenario that you quickly and consistently pay out tips as determined by your workers. An inconsistent payment schedule or excessive delays could allow the CRA to decide that these tips are controlled if they sit too long in the employer’s bank account.
Direct tips are not subject to payroll tax deductions from the employer. However, tip-earning employees are responsible for declaring tip income on their personal tax returns.
Controlled tips fall into three categories:
- The employer controls how much gratuity is paid by the customer. This is typically done by adding a mandatory service charge or a percentage to a client’s bill to cover tips.
- Tips that stay in the employer’s bank account after the end of the shift and are paid out the next day or later.
- Pooled tips where the employer maintains control over the distribution between employees.
Controlled tips are subject to payroll tax deductions. Employers must report the amount of controlled gratuity on the employee’s T4 and withhold the employee’s portion of source deductions for CPP, EIA and Income Tax.
Frequently Asked Questions (FAQs) on Tipping
Can the employer collect for cash shortages or breakage?
No. Since changes to the Employment Standards Act were made in 2019, an employer is prohibited from withholding, deducting or requiring an employee to return or give their gratuities to the employer except to redistribute tips amongst other employees. The Employment Standards Act also dictates that shortages (e.g. dine-and-dash), breakages and other business expenses are considered the costs of doing business. Attempting to recover these costs from tips is illegal and you may be subject to re-payment of these wages with penalties and interest.
Is there an industry standard for tip-sharing?
There is no industry standard for tip-sharing; however, it is customary to show appreciation and fairly distribute the tips to employees who have contributed to earning the gratuity, including but not limited to kitchen staff, servers, bartenders and hosts. While the Employment Standards Act prohibits withholding, deducting or requiring an employee to give the employer gratuities earned, the Act does allow employers to redistribute gratuities among some or all of their employees.
My employees prefer Direct Tips with no deductions. How do you do this with electronic payments?
There are two ways to keep all electronic tips directly to the worker without deductions.
You can pay them out in cash at the end of the shift. For most businesses that are not cash intensive, this will often require a cash float to handle daily tips and gratuities. There are other practical considerations to make this work such as cash flow fluctuations, theft potential from increased cash on hand and the operational ability to calculate tips before an employee’s shift ends.
The second option is to give your employees control over the distribution of tips and gratuities, which allows the business to pay out electronic tips at a later date and still be considered direct tips without deductions.
How do you give employees control over the distribution of gratuities?
It can be done by establishing an Employee Committee or another democratic process that gives representation to your workers and makes sense for your workforce.
This process of giving employees control over the distribution of pooled tips must be documented, laminated and visible on your bulletin board or somewhere similar in your business. As years go on and your employee pool turns over, they must retain the knowledge that the tip distribution was set by employees, not the business. Ensure that the names of employees on the committee/representative group is documented and visible to all, as well as the date and distribution they decided upon.
The committee or representative(s) determine the distribution of gratuities, and the employer takes the role of Trustee of the Gratuities and collects/disperses pooled gratuities at the direction of the Employee Committee/Representative(s).
It is also critical that the payout is quick and consistent. For example, paying out tips and gratuities once per week would almost certainly be interpreted by the CRA as too slow and they would consider those tips to be controlled instead of direct due to the amount of time the employer held the money, even if the distribution and timing were determined by employees. The same goes for tips that are paid out ‘every few days’ or some other inconsistent time frame.
The best practice is to consistently pay the tips out according to the distribution determined by your employees on the next business day. Any time frame longer than that invites the CRA to decide regarding ‘who has control’ of tips and gratuities based on their judgement, which may or may not go the direction you prefer.
For more guidance on setting up an Employee Committee, please refer to the Tips & Gratuities Toolkit by Restaurants Canada (link).
Can owners and management be part of tip-sharing?
No. Employers are specifically excluded by the Employment Standards Act from sharing in redistributed gratuities. However, a manager, director or shareholder of an employer may share in redistributed gratuities if they perform “to a substantial degree” the same work as certain employees.
Do employees need to pay income taxes on their tips?
Yes. Regardless of how an employee receives their tips (either controlled or direct), they should be educated and reminded that they are responsible for declaring tip income on their personal taxes.
For more information on the CRA’s policy click here or call 1-800-959-5525.
Any questions?Our HR Team is here to help. Contact your Regional HR Consultant today.
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