Marketing insights: June 2013

Everyone realizes that restaurant wait staff will often get much – if not most – of their income from their tips.

Everyone realizes that restaurant wait staff will often get much – if not most – of their income from their tips.

Traditionally, tips have been left as cash for servers to take home at the end of the night in their pocket. In the past, declaring these tips as income was based largely on the honour system. The taxman had neither the time nor the resources to trace what was untraceable – cash on the barrel. Then along came electronic payments. Debit cards and credit cards meant that gratuities could be more easily traced and therefore accurately taxed. The Canada Revenue Agency (CRA) has estimated that untaxed gratuities represent a massive financial resource for them to tap and it’s starting to go after it. Anyone who thinks the government isn’t serious about wrapping its arms around lost tax revenue can wake up and smell the audit. Government coffers have run dry. The public’s willingness to pay more tax has hit a threshold. The obvious solution is to root out those who are avoiding their tax obligation. Although the entire underground economy and the many wealthy Canadians hiding money offshore are on CRA’s hit list too, gratuities earned and undeclared as income are of great interest. In 2012, CRA decided to test the waters to see if going after undeclared gratuities would be worth its while. It proved to be a much larger gold mine than even the government had guessed it to be. CRA piloted a test project involving a handful of Ontario restaurants. Its estimates that servers were only declaring 50 per cent of their tips proved incorrect – according to CRA, the project indicated servers were declaring only zero to 10 per cent. To CRA’s surprise, the $750 million of undeclared income from tips across the country it had estimated was on the table was actually between $2.7 and $6 billion. CRA concluded its pilot project was a resounding success, which means the restaurant industry can expect more scrutiny.

Audits and surprise tax bills are bitter pills for serving staff to swallow if they’ve been underreporting their income from tips. Furthermore, restaurants can find themselves owing the employer portion of Employment Insurance (EI) and Canada Pension Plan (CPP) for tips that CRA deems to be “controlled” by the restaurant. If your establishment is dictating to the patron how much to tip (as is often done with autograts for groups of people), it’s considered to be controlled and you must pay the employer’s portion of EI and CPP on those tips. If your establishment dictates how tips are pooled and shared among the staff, then tips are also considered to be controlled. To have a direct tipping system, it’s best to allow the patron to decided how much to tip, let the staff decide how to pool and share the tips and get those gratuities into the hands of the employees as soon as possible after their shift. According to the Canadian Restaurant and Foodservices Association, “Direct tips do not form part of earnings from employment and are not subject to source deductions or payroll taxes (including EI and CPP). However, employees are still required to report these tips as income when they file their personal income taxes. If servers are required to pool some of their tips, servers would declare the tips they collect from customers minus the amount that they pay into the pool.” Once a tip is considered direct, the onus is on the employee to declare an appropriate amount. What employees consider to be appropriate however, is an important point
to discuss.

Your new recruits will often come to you with little or no experience concerning financial management. As Garth Whyte, president of the CRFA, points out, “The restaurant industry is the number 1 first employer.” More experienced employees will advise the new staff on everything from how to set a table to how much of their tips to declare. Servers often believe it’s OK to declare only 10 per cent of their tips on their tax returns. I recall asking a friend who worked as a waitress years ago what she would say if CRA ever questioned how little she made in tips, according to her tax return. “I’ll just tell them I’m a lousy waitress,” isn’t something the CRA will accept anymore: the proof is in the paper trail.

The first thing your employees need to understand is that all income is taxable and tips are income. They are required by law to report all of it. If it’s assumed that CRA can’t determine what someone’s really making, understand that CRA has many tools at its disposal to gauge what’s really going on. If someone declares that they make $25,000 per year, yet own two properties and drive a new sports car, CRA can conduct a lifestyle audit to see if everything adds up.

The penalties of not reporting are pretty stiff. They start at 10 per cent of the amount that was not reported, plus interest. A “repeated failure to report income” penalty, totalling 20 per cent of the amount not reported, can also be handed out if one doesn’t report income twice or more within a four-year period. If the charge is giving a false statement, the offender can receive a penalty of up to 50 per cent of the understatement of tax. Most serious of all, tax evasion is an offence that could incur prison time.

The restaurant industry is one based on fun, warmth and delightful sensory experiences. A messy tangle with CRA can be devastating to team morale. Keep your business and your employees safe from financial stress by understanding and clarifying the rules of engagement, for as Benjamin Franklin said in 1789, “In this world nothing can be said to be certain, except death and taxes.”

Michelle Brisebois is a marketing professional with experience in the food, pharmaceutical, financial services and wine industries. She specializes in retail brand strategies.