Businesses that receive tips or charge their customer Service Charges may be unsure as to whether they are liable for VAT on the money they receive.  According to HMRC the treatment of the money received depends on whether the money is freely given by the customer o a compulsory charge by the business.

When a tip is given freely by the customer then the money is outside the scope of VAT.  This is because the money is not part of the consideration for the supply.

However in the case of Service Charges, if the Service Charge is a compulsory service which has been added onto the cost of the meal, then it is VATable at the same rate as the food/drink supplied.  This applies even if the service charges are passed on fully to staff as bonuses.

Optimal Service Charges were originally treated the same as Compulsory Service Charges.  However, this changed in may 1982.  From tribunal cases assessed by HM Revenue and Customs it was decided that when the Service Charge was st the discretion of the customer then it was outside the scope of VAT.

Therefore, in summary:

  • Tips given freely by customers are outside the scope of VAT;
  • Compulsory Service Charges are VATable at the same rate as the items supplied;
  • Optimal Service Charges are outside the scope of VAT.

This can be a very confusing area, so if you are not sure about any of these rules please contact us and we will be happy to advise you.