Each year our firm receives questions about the tax implications of tips, both as an employee receiving them and an employer running a service business. The hospitality industry in Canada is a multi-billion dollar industry. From mega hotels to the corner bistro, many Canadians make their living in the service field. Canada’s culture has long rewarded great service with a tip or gratuity as a ‘thank you’ for a job well done.
For the Server:
As an employee in the service industry people generally receive two streams of income. The first is a regular paycheque based on hours worked. This is normally accompanied each year with a T4 slip prepared by their employer to use in filing their tax return. The second stream comes from tip money received on the job. There are many different myths and rules-of-thumb surrounding tip money but the hard truth is that tips are taxed just like any other form of income. Some servers may claim 10% of the tips they receive, others may pool their tip claims with their colleagues but in the end Canada Revenue Agency (CRA) takes the stance that any money received while on the job is taxable income.
Compliance with tip income has become an interest of the CRA in recent years, and technology has been helping along the way. More business being conducted by Interact Debit or credit card rather than cash, has increased the ability for the CRA to track tips as income. Simply leaving tip income out of a tax return is becoming harder and harder to do without attracting the attention of CRA auditors.
For the Employer:
As an employer or owner of a hospitality business there are additional responsibilities when it comes to tracking and reporting staff tips. The CRA has established two broad categories that tip money can fall into, those being “controlled” and “direct”.
A business owner is able to influence how controlled tips are distributed. For example, a system of tips being pooled and redistributed according to house rules would be considered controlled tips. Another example is if the employer automatically adds a tip to a customer’s bill (such as for large groups) and the customer has no say in whether a tip is paid. The CRA may also consider the tip controlled if it is simply deposited to the employer’s bank account before being paid to the employee.
In cases of controlled tips, the money is considered to be pensionable earnings to the employee. This is an important distinction because the burden then falls on the employer to calculate and remit Canada Pension Plan (CPP) contributions, Employment Insurance (EI) premiums, and income taxes on the employee’s paycheque. Failing to meet this responsibility will ultimately result in penalties and interest to the employer.
Tips that the employer has no real control over, or merely flows-through to the employee are direct tips. A cash tip left on a dinner table for example that the employee keeps would be a direct tip. Another example is a tip left by a customer’s credit card payment that is cashed out to the employee before their shift ends. Pooling of tips could also be considered direct, if it were the employees themselves arranging the pooling and deciding how the tips were to be redistributed.
In the case of a direct tip, the CRA views the income as non-pensionable. This means that the employer has no obligation to track the money, calculate deductions, or remit any portion of it to the CRA. The employee is still required to report the income on their income tax returns, but the employer faces no responsibility for them doing so.
The above examples only scratch the surface of the issues surrounding tips and their interaction with the tax system. Should you have any questions regarding this or any related topic, feel free to contact our firm.
This blog post was written by Derek Edelkoort CPA, CGA.