20,000 Visitors!

I started writing this blog in September, 2009.  At that time, there was very little useful information about restaurant tax audits in Canada (or anywhere).  In the 42 articles that I have written so far, I have tried to fill this gap with practical information geared towards restaurateurs.  Based on the comments I’ve received from a number of readers, I think I have succeeded.  There still isn’t much useful information about restaurant tax audits, other than what you will find in this blog.  That’s a shame, but it keeps me motivated to continue helping as many restaurateurs as I can.

Even though the title of this blog includes the word “Canadian”, it has attracted readers from 57 countries other than Canada.  That surprises me, even though much of the information written for Canadians does apply to most other jurisdictions.

While it’s hard to figure out which articles were the most popular (many readers land on the home page, which had different articles at different times), it is clear that anything to do with “zappers” was incredibly popular.  This subject attracted a lot of readers from Quebec, where zappers have been a hot topic for quite some time.  Based on some of the searches that led to my site, it appears that quite a few people wanted to know how to get a zapper!  My response was to write an article about How to Get Caught Using Zappers.  This is a site dedicated to helping restaurateurs legitimately minimize their taxes.  For those that don’t know, zappers are used to evade taxes!

The subject of theft was covered in my sister blog, Canadian Restaurateur.  Theft usually results in significant tax reassessments when restaurants are audited, because it is extremely difficult to prove to an auditor and they don’t provide any allowance for theft in Canada ( the IRS and many States do provide theft allowances).  Many readers found this blog from links in the theft articles.

Today, the subject of tipping is in the news quite a bit in Canada.  Who owns the tips received from guests?  How does the government ensure that they are reported for tax purposes?  Should they be considered employment income, subject to withholdings?  All good questions that will be resolved in the future.  Savvy restaurateurs are monitoring tip issues closely.

Discounts can cause significant problems during restaurant audits.  Groupon, Living Social and other daily deal promoters have exploded onto the market in the last couple of years.  No one  (except me) is writing about the tax implications of accepting these types of certificates at restaurants.  Yet this is a very serious issue that must be addressed by any restaurant that is considering these types of coupons.  You can read about the tax implications here.  Whether you should even consider Groupon deals is another matter.  If you really feel that you must use them, at least account for them properly (almost no one does).  You can read about these and other issues on the Canadian Restaurateur blog.

Another relatively recent phenomenon is the use of percentage discount coupons.  Promoters take reservations for member restaurants for a small fee, and the restaurants provide a percentage discount on the entire guest check (usually 30%).  This type of discount is much better for restaurants, because they can control the time of day when the discounted reservations are taken (slower periods).  However, there is a hidden trap that needs to be addressed.  Read about the tax implications of providing percentage discounts, here.

I have written about the major changes in how restaurant tax audits are being conducted and how taxpayer rights are being trampled upon on a regular basis.  Every owner needs to be aware of these aggressive new audit practices and take the necessary steps to protect themselves and their restaurants.  Unless you do, you’re needlessly increasing the risk of a major tax reassessment that could be devastating.  Fore warned is fore armed.  If you need help understanding the issues and what you need to do to protect your restaurant, please contact me about my short informational presentation, “Surviving a Restaurant Tax Audit”.

There is one thing I would like my readers to do.  Send me your comments about the various articles!  If there’s something that I haven’t explained clearly, let me know.  You can ask me questions about your situation on an anonymous basis, too.  That way, we can all learn from new situations that arise in the area of restaurant tax audits.

The Future

Governments will continue to aggressively audit restaurants for sales and income taxes.  They will intensify their efforts to ensure that employee tips are reported for tax purposes.  Ultimately, they will be controlled and reported by restaurants, and all tip income will be subject to withholdings, as is the case with wages.

Tax auditors will eventually figure out that restaurants providing Groupon certificates or percentage discount coupons are much more likely to have “unreported sales”, based solely on the method of auditing that is used.  Restaurants can prevent this, but only with proper documentation of such discount programs.  Few, if any, are doing this now.

Why not subscribe to this blog and receive updates as soon as they are published?  It is the best way to ensure that you stay on top of all major tax issues facing your restaurant, and it is free!  Soon, I hope to turn my Surviving a Restaurant Tax Audit presentation into a short webinar.  Please email me if you are interested in this.  If you think your restaurant might be at risk during a tax audit and you would like to avoid reassessments, please contact me for a no obligation consultation.

Finally, if you have friends or colleagues that would benefit from the information provided in this blog, please spread the word!

I hope you all have a great year and that it will be less taxing.

Taxing Tips

It was kind of fun trying to come up with a decent headline for today’s article.  Tips are in the news a lot, lately.  Servers, and others who receive tips, don’t like handing out a portion of their tips to other co-workers and especially not to the “house” (management).  Now, we find that they don’t like “tipping out” to the big house, either!  It’s not like we didn’t know this, but apparently, the CRA is just starting to take notice!

The CRA took a small sample of servers (145) at four restaurants in St. Catherines, Ontario, and conducted two-year audits of their personal tax returns, to see how much tip income had been reported.  Not very much, it seems.  Half of the servers didn’t report any tips at all.  On average almost $12,000 of tip income went unreported.  In total, $1.7 million of undisclosed income was found by CRA auditors.  You can read more about this in today’s Toronto Star article, Wait staff hiding tips from the tax man, auditors find.

Very interestingly, six months before the audits, the CRA sent out notices to servers and bartenders at 311 restaurants in the St. Catherines area, informing (warning) them that tip income must be reported.  Still, the amount of unreported tip income was rather staggering.  Apparently, the word on the street is that servers won’t get caught if they fail to report their tips, or under-report them.

This program was part of the CRA’s three-year investigation into fraud and tax evasion in the underground economy.  A lot of their effort was focused on the restaurant industry, because there is a high proportion of cash transactions.

So, what do these findings mean?  

The CRA knows that this is a fertile field that requires plowing.  The question is, who is going to do the plowing?  These individual audits must be pretty expensive to carry out, especially when the average income being evaded is only about $12,000.  While these types of audits send a message to other wannabe tax evaders, er, I mean servers, there’s still not much bang for the tax audit buck.  There must be a better way.

In the United States, the IRS requires employers to keep track of employee tip income and report it to the tax authorities.  While this creates a nasty piece of work for restaurant owners, who usually don’t receive any of this income, it is a very efficient way for the government to make sure tip income is being reported.  And, if the recordkeeping isn’t done properly, it’s much easier to go after a few restaurants than it is to audit hundreds of employees.    This is the where it is going, in Canada.  It’s just a matter of time, and given the number of recent media articles about tips, we can expect this to happen sooner, rather than later.

Recall from my earlier article, Tips on Tipping Policies, that the CRA has become much more aggressive in its attempt to hold restaurants responsible for tip income, where the tips are “controlled” (tip pooling, tip sharing, house tip-outs, automatic gratuities, etc…).  While there are defenses to the CRA position, it is an expensive proposition to take them on, and to date, no case has come before the courts on this issue.

If the crack-down continues and expands (looks likely), this could have pervasive effects on the restaurant industry.  As it is, most restaurants lose money, or make very little.  If tips are fully taxable (of course they are, but I mean if they really are fully taxable), servers won’t work for the current minimum wage, as they do now.  There will be incredible pressure to raise wages and/or attempt to work under-the-table.  Restaurants will have no choice but to raise prices to cover the additional costs.  But will they be able to do this in a depressed economy?

 

Percentage Discounts

A few months ago, Dining Date Night began offering customers a 30% discount at various restaurants in Toronto.  In order to get the discount, a customer books a reservation on a website and pays a $10 fee to Dining Date Night.  When the customer visits the restaurant, 30% of the total bill (before taxes) is deducted as a discount.  This type of promotion is relatively good for both the consumer and the restaurant that provides the discount, because the restaurant can restrict the hours when reservations may be taken.

Most of the restaurants that are included in this program are fairly high-end.  So, they’re not likely to attract too many “cheapskates” as do other discount programs like Toronto’s Summerlicious and other cities’ “Restaurant Weeks”.  As a result, the restaurants that take part have a fighting chance of winning over new loyal customers.  So far, so good.  But what about the tax consequences of this type of discount program?

At first blush, you might think there aren’t any tax issues.  The restaurant only has to collect HST on the net amount of sales, and they do.  They only have to record the net sales generated by the restaurant, too.  So there are no income tax issues.  So, if they’re collecting and remitting the taxes they’re supposed to, what’s the problem?

The Tax Man Cometh

Every few years, usually two to four years, the tax auditors will pay a visit to each restaurant.  If you’ve been following my other articles about restaurant tax audits, you know that the auditors have a unique method of auditing restaurants.  Rather than check to make sure that all sales have been reported, based on guest checks, they estimate the sales that should have been generated based on the restaurant’s purchases of alcohol and the markups that were applied.  The “expected sales” figure that the auditor calculates is the gross amount of alcohol sales that she thinks the restaurant should have generated.

Here’s the problem.  If the restaurant only records the sales net of discounts, it will need to keep track of all 30% discounts related to alcohol sales.  If not, the auditor will be comparing her gross expected sales with the restaurant’s net sales, inflating the amount of “unreported sales“.  The only way, that the auditor will consider the 30% discounts that the restaurant gave to customers, is to provide proof.

What kind of proof would be sufficient?  The restaurant will have to maintain a file of every guest check that had a 30% discount applied.  Since the auditor’s calculations only involve alcoholic beverages, the discounts given must be allocated between alcohol and non-alcohol sales.  Also, it would be a very good idea to summarize every guest check (with the discounts applied) on an Excel spreadsheet, so that the auditor will have all of the information needed to make the correction.

Even if the restaurant does report all sales at gross amounts and shows the discounts as either a sales discount or a promotional expense, the auditor may request proof.  So, restaurants should keep a file of all discounted guest checks.

This brings up another potential problem.  Most restaurant POS systems show price discounts separate from the menu items ordered on guest checks, which is the way it is supposed to be.  Recently, I came across an iPad based POS system that does it differently.  Rather than show the discount separately, it reduces the price of the menu items that were ordered, and it provides no evidence that the menu price has been discounted on the guest check.  This is a terribly bad practice, not only for restaurants offering percentage discount programs, but for any restaurant.  Unless the owner/manager is carefully monitoring discounts, unscrupulous servers could discount meals and drinks without authorization.  Of course, this will make the tax audit situation even worse.

This type of POS system’s handling of discounts makes it much more difficult to prove the discounts that were given by the restaurant.  Simply keeping the final guest check will not prove that a discount was applied, without also proving the correct regular menu price for every item on the guest check at that time.  The best way to do that would be to print the guest check immediately before applying the discounts and another copy after applying the discount.  Now, the paperwork has been doubled, and in a busy restaurant, how many times do you think the servers will forget to complete all the steps?

How Big a Problem Could It Be?

If you can’t prove the discounts related to alcohol sales, the auditor will consider the shortfall in sales to be “unreported sales”, pocketed by the owner.  If the average guest check includes $60 of alcohol (for two!), that auditor will calculate about 30% tax (HST plus corporate income tax) on this, payable by the company.  This will be about $5.40 for each discounted guest check.  The auditor will also reassess the owner with personal income tax on the unreported sales ($60 x 30% discount = $18).  Depending on the owner’s taxable income, the rate of tax to be applied could be as high as 44%.  Most won’t have that high of a marginal tax rate, but quite a few will be around 35%.  So, this will create another $6.65 of tax payable (by the owner).

Now, add penalties of at least 10% along with interest, and the tax bill to the restaurant and owner will approach $20 or more for each discounted guest check!  Now, if the restaurant has 10 such discounts each week, the tax cost will be about $10,000.  If the audit period is two years (typical), the restaurant and its owner can expect tax reassessments totaling $20,000 or more. 

Have I got your attention?

Best Practices

Always record gross sales (at regular menu prices).  Then, apply discounts as either sales discounts or promotional expenses.  Keep a copy of every guest check that has had a discount applied.  If your POS system doesn’t show discounts on the guest check, keep a copy of the check before and after the discount is applied.  Better yet, get the POS developer to update the software!

Groupon Taxes

I’ve written a couple of articles about Groupon on my sister blog, Canadian Restaurateur.  This is part of a series that will cover accounting for Groupon certificates, setting up your Point of Sale (POS) system to properly track coupons and discounts, using QuickBooks to enter Groupon transactions, examining the tax treatment of Groupon certificates (this one), and finally, determining whether your restaurant should consider Groupon.

Note that this article is written from a Canadian perspective.  Accordingly, I will only consider the GST/HST (Good or Harmonized Sales Tax) and income taxes related to Groupon certificates.  Sales and income taxes in other jurisdictions may not treat Groupon certificates in the same way.  If you are in doubt, please contact your tax advisor to confirm the proper treatment for your restaurant.

What are Groupon Certificates?

Groupon is a company that sells certificates that offer deep-discount deals.  Usually, the purchaser is entitled to receive at least a 50% discount from the retail or menu prices charged by the restaurant.  Essentially, they are gift certificates with a value of up to the face value of the certificate.  Customers pay about 50% of the face value for the certificate, which we call the promotional value.

Groupon is responsible for selling the certificates and collecting the proceeds.  By placing the deal on its website, Groupon provides the restaurant with “exposure” to a large number of potential customers.  In return, Groupon charges the restaurant a fee, which varies and is negotiable.  While the fee has usually been about 50% of the amount the customer pays for the certificate, I understand that competition has driven this percentage down to about 33% in some markets.  Still, it’s a hefty price to pay!

Under the Excise Tax Act (ETA), the tax treatment of gift certificates is covered in s.181.2.  Essentially, the sale of gift certificates is not considered to be a taxable “supply” (sale), and when they are redeemed, they are considered to be like money.  Since the term “gift certificate” is not defined in the ETA, the CRA issued a Policy Statement (P-202) to clarify the types of certificates and coupons that are considered to be “gift certificates”.

GST/HST Implications

Distributing Certificates

The Policy Statement, provides several tests to determine whether a coupon is to be considered a gift certificate.  In the case of Groupon certificates, it is clear that they are, in fact, considered “gift certificates”.  Consequently, s.181.2 of the ETA applies and the sale of gift certificates is not taxable.  Tthe restaurant sells these certificates at a discount to Groupon, who sells them to consumers and charges a fee for doing so.  The customer is not charged HST on the purchase, as any sale of gift certificates is not taxable.

Drawing on a previous example, the customer buys a certificate that can be redeemed for $100 of meals and drinks.  She pays only $50 for the certificate.  Groupon charges the restaurant $25 for marketing the certificate.  Note that the Groupon fee is a taxable supply of services to the restaurant.  Accordingly, Groupon has to charge the restaurant $3.25 (13% HST) on top of their $25 fee.  Groupon collects its fee from the proceeds from selling the certificate and remits the balance to the restaurant ($50 – $25 – $3.25 = $21.75).

The restaurant will be able to claim the $3.25 HST paid to Groupon as an input tax credit when it files its next HST return.

Redeeming Certificates

Now, customers go to the restaurant and redeem their certificates for food and drink.  Under the ETA s.181.2, the restaurant is required to charge HST on the promotional value of the certificate.  In our example, this is the $50 that was paid by the customer to Groupon, even though the restaurant did not actually receive this amount in cash.  Note that the restaurant did receive consideration of $50.  It got $21.75 in cash, a $3.25 HST input tax credit (recoverable from the CRA), and it received $25 of deductible promotional services from Groupon.

Restaurants will need to set up their POS systems to ensure that tax is only collected on the promotional value of the certificate.  This will require setting up a discount to record a discount that brings the amount charged down to the promotional value.  If the customer spends at least the face value of the certificate, the discount will equal the amount that the certificate was originally discounted.  In our case $50 ($100 – $50).  If the customer spends less than the face value, say $75, the discount to be applied will only be $25, leaving a $50 taxable amount on the guest check.

If the POS is set up, incorrectly, to deduct the face value of the certificate as a discount, in most cases, the guest check would not calculate HST on that amount.  The restaurant would still be responsible for paying the HST that should have been collected on the promotional amount, plus penalties and interest.

If the POS is set up, incorrectly, to deduct the face value of the certificate as if it were “money”, the guest check would calculate HST on the menu items at regular prices.  The customer would be over-charged HST, and the owner thinks he can pocket the difference.  Uh, no.  If the restaurant collects more HST than was required, the excess amount must be remitted to the CRA as additional tax.  It was a nice try, though.

Income Tax Implications

So far, we’ve only been concerned with the HST implications.  Now, let’s look at the income tax effects of Groupon transactions.

Note that the sale of gift certificates is not taxable for income tax purposes, just as it wasn’t taxable for HST.  Instead, the entry to record the distribution of certificates sets up a liability for outstanding certificates.  This is the value of meals and drinks that the restaurant has promised to provide to coupon holders prior to the expiry of the certificates.

Recall that the restaurant received $21.75 cash and paid Groupon $28.25 (including HST of $3.25), representing $50 or 50% of the face value of a coupon.  The restaurant can claim the $3.25 as an input tax credit, and it can deduct the $25 fee paid to Groupon as a promotion or marketing expense. The total of these is $50.  What about the difference between this $50 and the $100 face value?

That difference represents an expense, but it hasn’t been incurred just yet.  It will be incurred as each certificate is redeemed by customers.  So, we set up a deferred promotional expense as a current asset.  As each certificate is redeemed, $50 of this amount is transferred from the deferred account to the promotion expense account.  If all certificates are redeemed, the total promotional expense will be $50/certificate and $25 Groupon fee/certificate.

If 100 certificates had been issued and they were all redeemed, the restaurant would show $7,500 promotional expense on the income statement.  What about the sales amount?

Recording Sales

The best practice is to record sales at full menu prices (before discounts).  In this case, if every customer purchased $100 and used a $100 certificate, sales would be $10,000 and promotional expenses would be $7,500.  Here, we’re just considering the Groupon related expenses.  Of course, cost of sales would go up along with other variable expenses.  In this case, the restaurant made a “profit” (before variable expenses) of $2,500.

What if not all of the certificates are redeemed before the expiry date?  In this case, the liability for remaining certificates is eliminated along with the remaining balance of the deferred promotional expense account.  The net credit is deducted from the promotional expense as a recovery of promotional expenses.  This increases the “profit” on the Groupon transactions.

Some restaurants fail to record the gross amount of sales (full menu prices) in the accounts.  Instead, they record the sales net of discounts.  From a tax point of view, this is a bad practice, because when the restaurant is audited, the auditor will be estimating the restaurant’s gross sales and comparing it with the sales reported by the restaurant in tax returns.  To make the proper comparison, the restaurant will have to prove the amount of discounts related to the Groupon transactions and show how much related to liquor, wine, beer and draft.

Restaurants who follow this practice will need to maintain a meticulous file of guest checks and Groupon certificates that shows which items were discounted.  Depending on how the POS system shows the discounts and the type of reports available, you may need to have a copy of the guest check before the Groupon discount and another copy with the discount applied, together with the actual coupon!  Of course, these will have to be summarized, too.  A big HUGE, needless headache.

Who’s Responsible?

I had an interesting conversation with a restaurant owner the other day.  We were discussing tax audits and he mentioned that he wasn’t worried, because his accountant had signed off on his financial statements.  He thought that his accountant was responsible for paying any additional tax that might be reassessed by the CRA!

I explained to him that even though his accountant “signed off” on his financial statements, he was still responsible for their accuracy and completeness.  He looked at me like I was crazy!  His accountant had merely compiled the financial statements, meaning he had simply put the owner’s financial information into a financial statement format and checked it over for glaring mistakes.  In many cases, accountant’s don’t even take a close look at the general ledger entries to make sure that items have been recorded in the proper accounts.

The accountant wasn’t responsible for identifying fraud.  He wasn’t responsible for checking margins on food, wine, liquor and beer, to ensure they were reasonable, given the restaurant’s sales mix.  He wasn’t responsible for theft that took place under the owner’s nose.  He wasn’t responsible for the bartender’s over-pouring.  He wasn’t responsible for the chef’s drinking problem nor was he responsible for keeping track of the use of alcohol in recipes.  He wasn’t there when the owner gave drinks to his best customers and friends (no sense ringing it in, if it’s only going to come off the tab).  It’s clear to see that the owner is responsible for the things that cause tax reassessments.

Most, if not all, accountants obtain a signed engagement letters from their clients each year, which explains that the client is responsible for the accuracy and completeness of the financial statements.  Given the likelihood of clients not really reading them, accountants should try to point out the key terms of the engagement and repeat it again in the management representation letter that the owner signs prior to the release of his financial statements.

I guess the restaurateur’s accountant had not made sure that his client understood the terms of their relationship.  Both of them could be in for a nasty surprise when the client is audited.  The owner will get the tax bill and fire the accountant, because he wouldn’t pay it!  Yet another reason for restaurant owners to be proactive in preparing for future tax audits.  Don’t rely on your accountant to protect you, unless he has been asked to do so specifically.  If you are reassessed, it won’t be your accountant paying the bill!

Proving Automobile Business Use

Many restaurant owners use their automobiles for picking up supplies for the business, researching other restaurants, and making trips related to the restaurant’s operations.  In Canada, individuals are able to claim a reasonable portion of their automobile expenses against their employment income from the business.  Even if you don’t draw a salary, you’re still considered an employee, by being a director of the company.

A “reasonable portion” is usually considered to be the percentage that the business kilometres is of the total kilometres driven during the year.  This percentage is applied to all automobile related expenses, such as gas, oil, repairs and maintenance, insurance, licence costs, and leasing (or capital cost allowance and car loan interest).  There are some restrictions on leasing and capital cost allowance, but I won’t go into those here.

The Canada Revenue Agency has always required the use of a mileage log to keep track of the business use of each automobile.  In the past, they may have allowed automobile expenses without a mileage log, as long as the expenses appeared to be reasonable.  They always stipulated that if a log was not maintained in the future, all automobile expenses would be disallowed.

Well, it seems that they are now disallowing most automobile expense claims unless a proper mileage log is maintained.  In other words, you need to prove your business trips.  If you have ever tried to maintain a mileage log, it can be quite an annoyance.  We’re usually in a rush to be somewhere and it takes time to write down the details of each trip.  Other times, we forget to write the trips down, making the log incomplete.

There is a solution.  If you have a smart phone, there are apps available to help you keep track of your trips.  I found a pretty good app that works on my Android phone, and it’s free.  It’s called Driver Aid.  It works by using your phone’s GPS to track each trip (it has to be turned on).  If you have a Bluetooth device, the app will start a trip as soon as the device connects to your phone.  When you arrive at the destination, turn off or disconnect the Bluetooth device to automatically end the trip recording.  The app can also be started and stopped manually, by pressing a button on-screen.

You can add notes for each trip, and mark them as “Business” or “Private”.  The trip log can be exported to Excel for more detailed notes and summarizing.  Also, you can create an account with the developer (free) and log in from your desktop to view your trips and download monthly details into Excel.  I’ve been using it for the last three months, and I’ve found it to be quite a time-saver.  There are many apps on the market for all types of phones.  Find the one that’s easiest for you to use and start keeping track of your automobile usage.  Otherwise, you may be in for a big shock when the CRA denies your claim for automobile expenses!

Tips on Tipping Policies

If  your restaurant pools or shares tips, charges automatic gratuities, or receives a tip-out “to the house”, this article could save you thousands of dollars.

If you’re like most restaurateurs, you probably think that the Canada Revenue Agency’s only concern about tips and gratuities is that servers report them on their personal income tax returns.  While the CRA is concerned about this, now, they are even more interested in restaurants that fail to report certain types of tips.

The CRA’s policy on tips and gratuities can be found here.  The rest of this article may shock you.

CONTROLLED vs. DIRECT TIPS

The CRA makes a distinction between “controlled” tips and direct tips.  Direct tips are paid by the customer directly to the server.  Management of the restaurant does not exercise any control over the tips, which are paid directly to the servers who “earned” them.  The CRA does acknowledge that management must handle tips that are put on credit card and debit transactions.  If these are flowed-through to the individual servers, as if they had been received directly from the customers, the CRA will consider these to be direct tips.

Where tips come under the control of management, they will be considered “controlled tips”, and they will be taxable as income of the restaurant.  Controlled tips include automatic gratuities charged on guest checks.  If the owner collects a portion (or all) of the servers’ tips for re-distribution to other staff members, the portion that is collected from the servers will be considered “controlled”.

TAX IMPLICATIONS

Controlled Tips = Income

All controlled tips are income to the restaurant.  If the income had not been reported, CRA considers it to be “unreported income”, subject to income and sales tax, plus penalties and interest.  Similar to sales tax cases, the CRA may consider that the owner of the restaurant received the “unreported income” and charge him or her with personal income taxes, penalties and interest.  Note that even though the owner is charged with the income, the restaurant does not get the equivalent deduction.

An Expensive Deduction

If that seems unfair, there is a teeny, tiny bit of justice.  The restaurant is entitled to a deduction for the tips that it subsequently pays out.  As an owner, you’re probably breathing a sigh of relief.  Not so fast.  In order to get that deduction, you have to prove that you paid out the funds to the servers and/or other staff members.  We can cover that off, by paying them with cheques.  If you paid them in cash, the CRA may audit all of your servers and give you credit for the tips they declared in their tax returns.  They’re going to love you for this, by the way.

Unfortunately, you’re not out of the woods yet.  Tips and wages are taxable to employees.  Now, instead of just paying wages, you’re paying them both wages and tips.  Since they’re all taxable to the employee, the CRA figures that you should treat tips as remuneration, too.  Of course, that means that you must withhold CPP, EI and tax.  You also have to pay the employer portions of CPP and EI.  Employees will receive T4 slips that include wages and tips earned.

We’re not done yet.  If you haven’t been withholding taxes properly, the restaurant can be reassessed for both the employer and employee portions of CPP and EI.  You’re probably going to get hit with penalties of at least 10%, and of course, the CRA will charge interest from the time these remittances were due.

While there is a mechanism to get back some of the withholdings that you failed to withhold from employees, you can only do so if they are still employed with you.  Even then, you can only increase their withholdings by the amount you failed to withhold in a similar pay period.  Finally, you can’t get back any withholdings that are older than 12 months.  This is all moot, of course, because your employees quit and no one wants to work for a restaurant that makes their tips taxable!

Numbers to Think About

In my experience, servers often earned at least $20 per hour (and usually more) in tips.  Many of my full-time servers earned more than the CPP and EI maximum insurable earnings each year, yet very little CPP and EI was withheld, based on their minimum wages.  For 2012, the maximum CPP is $4,613.40 (both portions) and for EI it is $2,015.33.  If we consider that some of this was withheld from wages, you’re still going to be on the hook for as much as $6,000 per full-time employee, each year.

CRA Gets Paid

That’s an awful lot of tax to pay.  What if your restaurant isn’t in a position to make the payment?  Unless you can come to a satisfactory payment arrangement with the CRA, and stick to it, the CRA can decide to grab what they can, by making a demand at your banks.  Your accounts will be “frozen” until the full balance is accumulated and paid over to the CRA.  How long can your restaurant survive without any access to funds?

Finally, if the restaurant is unable to pay the source deductions owing, plus penalties and interest, the CRA can decide to go after the directors of the company, which usually means the owner, personally.  They can put liens on your home, cars and other assets, and they can freeze your bank accounts, until the debt is repaid in full.

CONCLUSION

Funny, you were just trying to do the right thing, sharing some of the tip money with the other staff in your restaurant, and now you find yourself in a terrible financial bind.

What can you do?  Stop charging automatic gratuities on the guest checks.  Instead, write the gratuity on the guest check.  If you still want to have tip pooling or tip sharing, make sure that the staff does this on their own, without management involvement.  You can still set the policies, but you can’t do the redistribution.  It would be a good idea to adjust your tip policies in your employee manual to reflect the new procedures.  Ideally, you should have your accountant review the wording to ensure that it doesn’t indicate that the tips are “controlled” in any way.