Received Any Tips Lately?
30 April 2010
Posted by: Author: Stephen Spamer
Received Any Tips Lately?
There could be substantial tax implications for waiters, car attendants, etc. receiving tips
A vast number of businesses in South Africa in industries, such as hospitality, transport, gambling and tourism, employ persons who, in addition to their salaries, also benefit to a large extent from gratuities (tips) received from satisfied customers.
These amounts upon first glance might seem insignificant, but the tax implications are substantial. This is largely because of banks encouraging patrons to use credit cards, at no additional charges, coupled with the effect which crime has on the general public, with the result that when a tip is given by a customer, rarely or ever does cash exchange hands.Instead, it has become standard practice that the tip payable to the employee is part of the payment when the bill is settled; leaving the employer with the responsibility to transfer such tips to the employees' bank accounts when it runs its weekly or monthly payroll.The question which arises is whether the tips which the employees receive from the customers during the performance of their duties will create a liability on the employer to withhold employees' tax from such amounts in accordance with the provisions of the Fourth Schedule to the Income Tax Act, 58 of 1962 (the Act).In addition, and more significant, is the question whether such amounts will result in an obligation on the employer to make additional contributions to the Skills Development Levy (SDL)and the Unemployment Insurance Fund (UIF), by including the tips in the calculation of its SDL and UIF liability.
Inclusion of the tips in the "gross income” of the employees"Gross income” is defined in Section 1 of the Act as "any amount, in cash or otherwise,received or accrued to or in favour of a resident, during a year of assessment that is not of a capital nature”.The gross in come definition is extended to provide for certain specific inclusions, and Paragraph (c) of the definition specifically includes in a person's income "any amount received or accrued in respect of services rendered or to be rendered, including a voluntary award, as well as any amount received or accrued in respect of or by virtue of any employment”. In order for an amount to be included as gross income under Paragraph (c), there has to be a causal relationship between the amount received and the services rendered. This is because of the words ’in respect of’, which require that the income should bear the necessary connection to the services rendered. Accordingly, the definition suggests that there must be a direct link between the cause(the services rendered) and the result (the tips received). It is important to note that the services need not be rendered by virtue of any contract, nor need the amount be received or accrued by reason of any contract or obligation.
Provided the amount is awarded in respect of services rendered or received in respect of or by virtue of any employment relationship, it will be taxable, irrespective of whether or not the amount is payable in terms of a contract of service.The first step in determining whether or not the amounts are to be included under Paragraph (c) is to establish whether the tips were acquired by the employee by virtue of his employment with the employer.It is important to note that being in the employment of the employer will not necessarily trigger the provisions of Paragraph(c).
What gives rise to the application of Paragraph (c) is the causal connection between the employment and the tips received.The phrase ’by virtue of’ means that there must be a direct or causal link between the tips received and the employment. In other words,notwithstanding the fact that the employment is the sine qua non for the receipt of the tips, it still requires a causal link between the employment and such receipt.
To determine such a causal link will depend on the facts of each case, and it will be necessary for the employer to carefully scrutinise the reasons why the tips are received by the employee.One of the critical questions to be asked is whether thereceipt of the tips was part of the expectation of the employees when they entered into and perform their employment duties to the employer,and in this regard the employment agreement and the company policies regarding the receipt of tips will be important.If it is the case that the employee expected a tip when he accepted the employment,the employment is linked to the receipt of the tips and Paragraph (c) will apply.
An example of the absence of a causal link is found in the case of Stander v Commissioner for Inland Revenue 59 SATC 212 where a taxpayer successfully argued that an award received was not by virtue of his employment. In this case, the taxpayer was employed by a franchisee in the motor dealer industry, and invited to attend a convention of the franchisor where he received an award for being one of the top accountants of all the franchise dealers in South Africa.
The court held that although the employment with the franchisee was the sine qua non for the receipt of the award, it was not sufficient to provide the necessary causal link between the services which he rendered to his employer and his obtaining of the award, as it was not those services to the franchisee which constitute the causa causans for the award.The court specifically held that the reason for the absence of the causal link is because the taxpayer did not seek the award or expect to receive anything from the franchisor for the work he performed for the franchisee.He merely performed his normal duties for which he was remunerated by his employer, and the fact that these duties were performed in a manner which the franchisor considered to be excellent was what qualified him to receive the award.
Applying the judgement in the Stander case, one needs to consider whether the employees, when they accepted their employment, had a reasonable expectation to receive tips from customers.If it can be shown that the employees did not have such an expectation but relied on and accepted only the remuneration which it will receive from the employer, there is a strong argument that, although the employment with the employer is the sine qua non for the receipt of the tips, it is not the services to the employer which constitute the causa causans for the award.If the tips are not included under the definition of Paragraph (c), the transfer of the tips by the employer to the employees would not constitute the payment of"remuneration” for purposes of the Fourth Schedule to the Act (as more fully explained below), and accordingly there is no requirement on the employer to withhold employees' tax on this amount.
On the other hand, and in our view, there appears to be a counter argument that, in the case of the receipt of gratuities, there would almost always be a sufficient causal connection between the services the employees render and the tips they receive. In this instance the tips will constitute "gross income” in the hands of the employees, and by virtue of the application of Paragraph (c), the amount received will be included in their taxable income.In this instance, we have to consider whether or not there is a liability on the employer to withhold employees' tax on the tips.Liability of the employer to withhold employees' tax on the tips
Employees' tax, also known as PAYE, is a withholding tax which is deducted from every employee's remuneration on a monthly basis.The deduction is made by the employer and is determined by using the tax rates issued annually by SARS.
In terms of the Fourth Schedule to the Act, every employer who pays remuneration to an employee has an obligation to register with SARS and deduct employees' tax.Failure to pay within the prescribed time period will result in a penalty equal to 10% of the amount of employees' tax payable or additional tax not exceeding twice the amount that the employer failed to pay, and/or interest being levied by SARS at the prescribed interest rate on the amounts that should have been paid.
In accordance with Paragraph 2(1) of the Fourth Schedule, the duty of the employer to withhold employees' tax is dependent on whether or not the employer pays or is liable to pay "remuneration” to an employee. Accordingly, if remuneration is paid or a liability to pay remuneration exists, there is a duty on the employer to calculate and withhold employees' tax on such an amount."Remuneration” is widely defined in Paragraph 1 of the Fourth Schedule to include all payments and amounts payable, in cash or otherwise, whether or not for services rendered and includes salary and wages, leave pay, bonuses, gratuities, commissions,overtime pay, and other amounts paid for services rendered as well as allowances and advances.The definition of ‘remuneration’ also expressly includes an amount referred to in Paragraph (c) of the definition of the term ‘gross income’, as more fully discussed above.
As a result, the tips will constitute "remuneration” for purposes of the Fourth Schedule to the Act. However, the fact that the tips are included in the definition of‘ remuneration’ does not automatically impose a liability onthe employer to wi thhol demployees' tax in respect of suchamounts. In order to establish if such an obligation exists, it is necessary to determine whether the employer will pay or is liable to pay the remuneration to the employees.
The meaning of the phrase ‘pay or liable to pay’ has not yet been evaluated by a South African court in the context of the Act, and for this purpose we consider the Dictionary of Legal Words and Phrases (Author: RD Claassen,Judge of the High Court of South Africa) in terms of which the phrase‘payment’ is defined as "the delivery of what is owned by a person competent to deliver to a person competent to receive, and when such a payment is made it operates to discharge the obligation of the debtor”.The phrase"liability to pay” is equally defined as "the state to be required to or accept legal responsibility to pay” (Oxford Advanced Learner's Dictionary, AS Hornby).
Therefore, even though the tips received by the employees constitute remuneration for purposes of the Fourth Schedule, in our view it could potentially be argued that the employer is not making a payment, nor does the employerincur a liability to pay an amount tothe employee.The above view is based on the fact that the amount that is distributed by the employer to the employee does not discharge a debt owed to the employees, and there is also no legal liability on the employer to pay the tips to the employees.As a result, it is not the employer paying the tips but, in fact, it is the satisfied customers who are making a payment, in the legal sense, to the employee.
The function of the employer is merely to receive and hold the amounts on behalf of the employees, as an agent, and to facilitate the transfer of the tips into the employees' relevant bank accounts. Accordingly, as the employer has no legal obligation to pay the tips to the employees, the subsequent distribution will not be a "payment of remuneration”, and for this reason the distribution of the tips will not create an obligation on the employer to withhold employees' tax on the amounts of tips transferred into the bank account of the employee.
Having said that, Paragraph 2(2)of the Fourth Schedule enables the employer to, at the written request of the employees, deduct or withhold employees' tax on the amount of tips received, in order to ensure that their tax liability is not underpaid at the end of the year of assessment. In this regard, subject to the receipt of a written instruction by the employee, the employer can continue to calculate and deduct PAYE from the tips transferred into the employees' bank accounts.
SDL and UIF liability
In terms of the Skills Development Levy Act, 9 of 1999, as well as the Unemployment Insurance Contributions Act, 4 of 2000, every employer is liable to contribute an amount equal to one percent (1%) of the remuneration it pays to its employees.
An employer, for the purpose of these Acts, is defined as to have the same meaning as in Paragraph 1 of the Fourth Schedule to the Act,which means it is any person who pays or is liable to pay to any person an amount of remuneration.As discussed above, even though the tips constitute‘remuneration’, the employer has no legal obligation to pay the tips to the employees.As a result, it is our view that the employer also does not have to account for SDL and UIF contributions in respect of the tips paid over to the employees.
Source: By Stephen Spamer (Tax breaks)