A Tip Concerning Tax and Tips
31 October 2011
Posted by: Author: Steven Jones
A Tip Concerning Tax and Tips
They are taxable—it’s just a question of when the tax must be paid
Valentine’s Day is a time when many couples like to go out for a romantic meal in a fine restaurant, and so it’s rather fitting that SARS chose to issue a Binding Class Ruling (BCR 027) dealing with tips received by waiters on that particular date.Yet it seems that a number of tax practitioners must have eaten something that disagreed with them, judging by the diverse opinions of late on this matter.
One gets the impression that a simple tax issue has been escalated to something resembling Top Gear’s Jeremy Clarkson handing a brace of the latest super cars over to their "tame racing driver”. Some say that thanks to BCR 027, tips are no longer taxable in any way or form,while others maintain that it is simply an employees’ tax matter that the BCR is dealing with.All we know is … given all the conflicting views out there, perhaps the Stig is now giving tax advice instead of driving fast cars around a track …?
One does not need to be a rocket scientist to interpret what has been written in BCR 027. In fact, as far as such rulings go, it is written in fairly straightforward and clear English. The key is to understand (and keep in mind) two simple principles covered by this ruling,namely (1) when an amount accrues to (or is received by) a taxpayer for the purposes of the "gross income”definition; and (2) if the amount thus accrued or received is taxable,when the tax should be paid over to SARS.
Allow me to illustrate by means of a simple example. Suppose that you have money invested in a call account, which attracts interest at 6% per annum.The interest is calculated on the daily balance, and capitalised on the last day of each month.However, if the account were to be closed at any point, the bank would calculate any interest earned between the last day of the previous month and the date of closure, and add that to the amount paid out to the bank’s client.
At no point does the bank withhold any amount as tax and pay such amount over to SARS. As far as the bank is concerned, the legal requirement is for the bank to issue a letter at the end of the tax year (called an IT3(b) certificate) indicating how much interest has been earned during the year, and forward copies thereof to the client and to SARS. It is incumbent on the client to disclose such interest to SARS when completing their tax return for the year.
Five key questions now need to be asked concerning the interest that is paid by the bank to its client:
1. When does the interest accrue to the client? In this example,since interest is calculated on the daily account balance, interest accrues daily.
2. When is the interest paid to the client? The agreement between the bank and the client in this case stipulates that interest is paid into the account monthly.
3. Is this interest taxable?
Section 1 of the Income Tax Act defines "gross income” as, inter alia, "the total amount, in cash or otherwise, received by or accrued to or in favour of such resident” ("resident” being a South African resident for tax purposes), and would certainly include interest. Ignoring for the moment the basic interest exemption available to individual taxpayers, interest income is indeed taxable.
4. Is the bank liable to withhold any tax on interest paid?
Interest income does not fall within the definition of"remuneration” as contained in the Fourth Schedule to the Income Tax Act, and therefore there is no obligation on the part of the bank to withhold any PAYE. In the case of South African tax residents, the bank is also not obliged to withhold any other form of withholding tax.
5. If the answer to Question 4 is "no”, when must the taxpayer account to SARS for the tax on the interest? The taxpayer is obliged to take taxable interest earnings into account when completing their provisional tax returns. However, the actual amount earned as interest is to be declared when the annual income tax return is completed,and any shortfall in tax will be payable to SARS upon assessment.
Let us now apply these principles to the specific income that is the subject of BCR 027, being that of tips paid to waiters.Most people,when visiting a restaurant, will add a gratuity to the amount of the bill when settling (based, of course, on how satisfied the patron is with the service).And if the average restaurant patron is anything like me, the thought of how such tips are administered by the restaurant concerned probably never even enters their thoughts.Restaurants, on the other hand,face their own particular risks concerning the handling of cash,especially since (with few exceptions) patrons settle their restaurant account directly with the waiter serving them.Because of such risks, the applicants (a group of restaurants) implemented a policy whereby waiters were not permitted to carry any cash on their persons whatsoever whilst on duty.
With regard to tips earned by the waiters, the policy of the applicants is that such tips will be held by the restaurant as a creditor balance,which will then be paid directly into the waiters’ bank account at month-end, together with their normal salaries.
However, if the restaurants were to process such tips through the payroll system, the only way it could do this would be to either do multiple payroll runs, or hold over the tips earned in Month 1 and pay them to the waiter in Month 2.While BCR 027 is silent on this aspect, one can imagine that such an arrangement would be unsatisfactory for both the employers and their staff.
The subject of the application,therefore, was whether the restaurants (as employers) would be required to withhold any employees’ tax from the monthly accumulated tips paid over to the waiters. SARS ruled that employees’ tax need not be withheld on such tips paid.
This led some commentators to conclude that, because of BCR 027,tips were no longer regard as taxable income.However, it was never SARS’ intention to declare tips to be tax-free—the ruling dealt only with the withholding of employees’ tax.The situation is thus similar to that in my bank interest example above.Because of the hullabaloo around this issue, however, SARS re-issued an amended BCR 027 on 12 August 2011, stating clearly that"this ruling does not mean that tips received by employees under the circumstances as described in this ruling, nor for that matter tips received in general, are not taxable.
Amounts received byway of tips constitute "gross income” as defined in section 1 of the Act and will, therefore, be subject to income tax in the hands of the recipient. The fact of the matter is that tips as described above will not constitute "remuneration” as defined in the Fourth Schedule which merely releases an employer from the obligation to withhold employees’ tax from these amounts, but does not release the recipient from the obligation to declare such tips for income tax purposes” (BCR 027, Paragraph 9, my emphasis).
The ruling applies specifically to the specific (unnamed) employers who made the application to SARS, as well as their employees, and is valid for five years starting from August 2010.However, while other employers in the hospitality industry having similar arrangements concerning the payment of tips would need to make specific application to SARS for a ruling (failing which, the requirement to withhold employees’ tax remains in force), it is likely that SARS will make a similar ruling to BCR 027 should the circumstances be similar to those of the applicant.
The ruling is however silent on whether the employer is still obliged to disclose the aggregate amount of tips paid during the tax year on their waiters’ IRP5 certificates at the end of the year.I would submit, though, that such disclosure should be made; failing which, the obligation rests with the waiter concerned to declare such income to SARS.Given the high likelihood that many will be tempted not to declare their tips, SARS probably erred in not making such disclosure by the employers a condition of the ruling contained in BCR 027.
Source: By Steven Jones (Tax breaks)