In Canada, taxation of tips and gratuities can be quite complex, since the Canada Revenue Agency (CRA) distinguishes tip income as: controlled or direct based on certain factors.
Although all tips are taxable to the recipient, depending on the tip income’s type it may or may not be subject to Canada Pension Plan (CPP) and Employment Insurance (EI). The differentiation can be tough since in some situations even though the tip or gratuity may appear as ‘controlled tip’ it could actually be ‘direct’.
The following is an article by A.G. Tax Canadian tax professionals on CRA’s treatment of tip income to help restaurant owners understand the difference between the two types of tips and their taxation in Canada
Direct and Controlled Tips
When the employer exercises any type of control over the tips, and later distributes it to the employees, it is considered as ‘controlled tips’. Some examples include:
- a mandatory service charge, or a percentage of the dining bill added to the clients’ bill by the employer
- a service charge that gets added to the business income and is later deducted as business expense
- tips distributed amongst the employees based on a certain formula.
- tips given to the employee, but if he/she is required to hand it over to the employer who will later distribute it amongst the employees
- tips deposited in the employer’s bank account before being paid to the employees.
Direct tips are tips or gratuities that are handed directly to the employee by the client or the tips are pooled and/or shared among employees in a manner determined by the employees (as opposed to the employer). The employer exercises no control over it. Direct tips are considered to have been paid by the client and not the employer.
In the following situations, the employer is considered to be merely a conduit for the tip from the client to the worker if the employer immediately returns the tip amount in cash to the employee.
- When paying the bill by credit card, a client includes an amount for a tip on the credit card and the employer returns the tip amount in cash to the employee;
- When paying the bill by debit card, a client includes an amount for a tip and the employer returns the tip amount in cash to the employee;
CRA’s Taxation of Tip Income
Gratuity or tip income is taxable regardless of whether it is controlled or direct.
If it is directly received, then the employee needs to report it on their Canada personal income tax return. However, if it is controlled tip income, then the employer needs to deduct Canada Pension Plan (CPP) contributions and Employment Insurance (EI) premiums from the tip before giving it to the employee and remit it to the CRA. This is because the CRA requires all employers to deduct CPP contributions and EI premiums from payments made to employees, whether it is wage, tip or any other income.
Keep in mind, that the company or organization should be a participant to the Canada Pension Plan and Employment Insurance plan.
Having said that, if an employee receives both controlled and direct tips, only the controlled tip income is subject to the CPP and EI deduction. Also, if an employee wishes to have CPP contribution or EI premium withheld from their direct tips, they can do so by speaking to their employer and filing CRA Form CPT20 to elect to pay the CPP contributions.
As tax practitioners, we at AGT suggest business owners not to take control over tips and to opt for direct tips option, by not co-mingling tips received with business revenues, having employees discuss between each other to determine the share of other employees involved and paying tips out of debit and credit card transactions separate from their payroll as soon as possible.
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