If you are a restaurant owner, you know that you are required by law to deduct Canada Pension Plan (CPP) and employment insurance (EI) premiums from your employees’ earnings. What you may not realize, however, is that CPP/EI applies to restaurant tips as well, meaning that you also need to deduct these items from any tips and gratuities paid by your customers in the form of electronic transactions or gift cards. Learn how the experienced tax lawyer at Jeremy Scott Tax Law can help you navigate the complex tax laws involved in running your restaurant or other business. Contact us at (902) 403-7201 or online to schedule a consultation.
How Taxes Apply to Tips and Gratuities
According to Section 12 of the Canada Pension Plan and Subsection 2(1) of the Employment Insurance Act, all employers are required by law to deduct CPP contributions and EI premiums from their employees’ earnings to be submitted to the Canada Revenue Agency (CRA). The Income Tax Act defines all tips and gratuities as income earned as part of an individual’s employment. However, the way in which the tip is paid can affect whether CPP or EI applies.
Controlled tips are those that an employer either controls or possesses before paying them out to an employee. The law requires that CPP and EI be deducted from all controlled tips. In a restaurant, this most commonly occurs when a mandatory service or gratuity charge is added to a customer’s bill, when a customer adds a tip to their total payment amount when paying electronically, or when tips are pooled and then distributed evenly across the serving staff at the end of a shift. In all these cases, the restaurant owner (employer) controls and possesses the applicable tips before paying them to their employees.
Direct tips are paid directly by a customer to an employee of a business. This commonly occurs in a restaurant when a customer directly hands their server a cash tip or when serving staff share tips amongst themselves without their employer’s involvement. If a tip added by a customer to an electronic payment is paid out to an employee in cash at the end of their shift, this also constitutes a direct tip. Direct tips do not require CPP and EI deductions.
Declared Tips (Quebec only)
Tax laws for the province of Quebec require employees to declare their direct tips to their employer. EI applies to these types of declared tips.
Contact the knowledgeable tax attorney at Jeremy Scott Tax Law to better understand the tax laws that apply to the types of tips and gratuities your business receives.
How Collecting Tips on Behalf of Employees Affects Tax Liability
Tipping is a customary practice in the hospitality industry, particularly in restaurants where customers use tips to show appreciation for excellent service. A recent Federal Court of Appeal (FCA) decision relating to how CPP/EI applies to restaurant tips highlights the importance for business owners to understand how collecting tips on behalf of employees affects their tax liability. In Ristorante a Mano Limited v Canada (National Revenue), 2022 FCA 151, it was found that tips received electronically by an employer in the form of credit or debit card payments or gift cards are subject to CPP and EI premiums, even if they are disbursed to the employees later on.
This case is not the first to prove that tips possessed by an employer, even if just temporarily, are subject to CPP and EI premiums. Once a tip is received through an electronic form of payment, it is deposited into the employer’s bank account along with their other funds, and therefore it becomes a part of the employer’s property. According to the regulations of the Canada Pension Plan and the Employment Insurance Act, these tips become “contributory salary and wages of the employee” when paid out by the employer, and therefore, CPP and EI premiums apply.
How the FCA Decision Impacts Restaurant Owners and Employees
The restaurant industry in Nova Scotia and across Canada has been struggling for the last few years due to soaring food prices and a shortage of labour. As electronic methods continue to dominate the way that consumers pay for goods and services, fewer people carry cash with them, and electronic tipping is becoming the norm. The FCA’s decision to enforce CPP and EI deductions on tips and gratuities received electronically is likely to result in further losses for an industry that is already in a difficult situation.
Restaurant owners can modify their tipping and gratuity policies to ensure that more tips are paid directly to employees without being controlled or possessed by the business entity. These strategies can help protect their employees from losing a portion of their hard-earned money and thereby protect the business by increasing its chances of retaining valuable employees. Those who do not do so must ensure they correctly apply CPP and EI deductions to all tips and gratuities received electronically. Businesses that have not been withholding CPP and EI premiums from electronic tips may use the CRA’s Voluntary Disclosures Program to possibly fix these errors or omissions without penalty.
Doe the GST/HST apply to Tips and Gratuities?
The CRA’s long held administrative position has been that a tip or gratuity freely given by a customer is not subject to the GST/HST while a ‘mandatory’ gratuity included on a customer’s bill is subject to GST/HST. This administrative position was recently tested before the Tax Court of Canada. In 1410109 Ontario Ltd. v. The King, 2022 TCC 141 (CanLII), the Court was asked to consider this very issue. In ruling that ‘mandatory’ gratuities are subject to GST/HST, the judge stated:
The gratuity in this appeal is effectively non-negotiable, pre-calculated and arithmetically correlative to the taxable services. The gratuity is paid contemporaneously and indistinguishably from all other taxable services and supplies specified in the contract and included in the Invoice.
Based on this decision, restaurants requiring mandatory gratuities should ensure GST/HST is properly remitted. Alternatively, restaurant owners may wish to reconsider and mandatory tipping practices used in their operations.
How Jeremy Scott Tax Law May Be Able to Assist
Whether you are a restaurant owner or an employer in another industry, understanding tax laws and correctly applying them is essential for the ongoing compliance and viability of your business. The experienced team at Jeremy Scott Tax Law can assist with helping you understand how CPP/EI and GST/HST applies to restaurant tips. We can also help you to determine what strategies may be useful for protecting employees’ wages received in the form of tips, while also correctly applying tax laws. If you think you may have made errors or omissions in your tax filing in relation to tips and gratuities or other matters, we can help you understand your rights and options related to voluntary disclosure with the CRA. Contact us at (902) 403-7201 or online to schedule a consultation and discuss your business needs.