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Service charge or tip: VAT, tax and your menu ​

A guest can pay you something on top of the bill in three ways: a service charge they must pay, a service charge they can decline, or a tip. Guests rarely notice the difference. HMRC does, and so does the law on how prices are shown. Each one is treated differently for VAT, for PAYE and National Insurance, and on your menu. This guide sets out the differences using the official sources, so you can choose deliberately and tell your accountant what you do. To try it on one bill, use the service charge calculator.

Three kinds of payment ​

HMRC’s guidance on tips (E24) uses these definitions:

  • A tip or gratuity is “an uncalled for and spontaneous payment offered by a customer”: cash, a tip added to a card payment, or a tip paid by app.
  • A voluntary (discretionary) service charge is an amount added to the bill where it is made clear to the guest that it is “a purely discretionary amount and there is no obligation to pay”.
  • A mandatory service charge is one the guest is obliged to pay.

HMRC accepts a service charge as voluntary only if it is “clearly presented to the customer as an entirely optional payment”. What your menu and bill say should match what your staff tell guests. An amount a guest writes on an open card slip is likely to be a tip.

VAT ​

  • Tips freely given on top of the bill are outside the scope of VAT, even when they appear on the bill or are paid by card.
  • An optional service charge is not part of the price of the meal, so it is outside the scope of VAT too, as long as guests have a genuine choice whether to pay it, even if it is printed on the bill.
  • A compulsory service charge is part of the price of the meal and follows its VAT treatment. HMRC’s tips guidance says restaurant service charges that customers are required to pay are standard rated.

So the same 12.5% line on a bill can carry VAT or not, depending only on whether the guest really can say no.

How the service charge appears on your menu ​

Since 6 April 2025, the consumer protection part of the Digital Markets, Competition and Consumers Act 2024 has applied to how prices are shown. The Competition and Markets Authority’s guidance on price transparency says:

  • A menu is an invitation to purchase, including a printed menu card and a digital menu reached by scanning a QR code. It must give the total price.
  • Mandatory charges belong in the price. The guidance names “mandatory cover or service charges at a restaurant” as an example. Showing a charge separately, or calling it an extra service, does not make it optional.
  • A genuinely optional service can be shown separately and does not have to be included in the headline price.
  • You cannot charge extra for paying by card. The Consumer Rights (Payment Surcharges) Regulations 2012 stop a business adding a fee because of the way the guest chooses to pay.

If your service charge is compulsory, the prices on your menu should already include it. If it is optional, say so plainly on the menu and the bill, and make it easy for a guest to have it removed.

Income Tax and PAYE ​

  • Cash tips staff receive and keep themselves, with no involvement from you, are outside PAYE. Tax is still due: each employee tells HMRC, usually through their tax code or a Self Assessment return.
  • Tips you pay out, such as card tips passed on through your payroll, must go through PAYE. That stays your responsibility even if you ask a member of staff to do the sharing.
  • A tronc run by an independent troncmaster has its own PAYE scheme in the troncmaster’s name, and you must tell HMRC about it unless it was set up before 6 April 2004. If you, a business partner or a director runs the tronc, its payments go through your own payroll.

National Insurance ​

A payment of a tip is free of National Insurance only if one of two things is true: you do not pay it to the employee, directly or indirectly, and it never passed through your business; or you do not decide, directly or indirectly, who gets how much.

  • You pass card tips to the person who served the table. National Insurance is due, because the tips came through you and you decided the allocation.
  • You collect cash tips and share them out yourself. National Insurance is due.
  • An independent troncmaster decides the shares, and you have no say in who gets what. National Insurance is not due on what the tronc pays out, even on card tips that first came to you.
  • You require the troncmaster to use a points system you devised. That counts as you allocating indirectly, so National Insurance is due.
  • A mandatory service charge paid out to staff always carries National Insurance, however it is shared.

None of these count towards the National Minimum Wage. Tips, service charges and cover charges paid to staff cannot make up minimum wage pay.

The tipping law applies to both ​

Whatever the tax treatment, the tipping law treats tips and service charges, automatic or voluntary, the same way: they must reach staff in full, less only the VAT in a compulsory service charge, and be shared fairly under a written policy. HMRC says that law “does not change how these payments should be assessed for tax and National Insurance”. See our guide to the tipping law.

A short checklist ​

  • Decide whether your service charge is compulsory or optional, and make the menu, the bill and what staff say match that decision.
  • Compulsory: include it in your menu prices, and charge VAT on it.
  • Optional: say so plainly, let guests remove it easily, and treat it as outside the scope of VAT.
  • No extra fee for paying by card.
  • Tips you pay out go through PAYE. Ask your accountant whether National Insurance is due, based on who decides the shares.
  • Tips and service charges reach staff in full (less the VAT in a compulsory service charge), under your tipping policy.

How this works in Yumee POS ​

A service charge can be added to a bill as a percentage or a fixed amount, set separately for each room and for takeaway, and staff can remove it from a bill when a guest asks. It shows as its own line on the X and Z reports and in the figures your accountant downloads, and it is not treated as VAT-able unless you set it up that way. Guests can add a tip on the PAX card machine once you switch tipping on, and card tips are recorded with each payment.

Sources ​

This guide is general information, not tax or legal advice. For your own business, ask your accountant.