Tips are a significant part of restaurant compensation. But how they're handled from a tax perspective is something many restaurant owners get wrong. The CRA has clear expectations, and not meeting them creates risk for both you and your employees.
Tips are taxable income
All tips, whether cash, credit card, or electronic, are taxable income for the employee who receives them. This is true whether the tips go directly to the server or are pooled and distributed by the restaurant.
The distinction that matters for you as the employer is whether the tips are controlled or direct.
Controlled tips vs. Direct tips
Controlled tips are tips that the employer collects, pools, and redistributes. If you take in all the tips and decide how they're allocated (to servers, kitchen staff, bussers), those are controlled tips. As the employer, you are required to include controlled tips on the employee's T4, withhold CPP and EI, and remit the source deductions to the CRA.
Direct tips are tips that go straight to the employee without the employer's involvement. If the server keeps their own cash tips and you have no role in the process, those are direct tips. The employee is responsible for reporting them on their own tax return. You don't include them on the T4 and you don't withhold source deductions on them.
The challenge is that many restaurants operate in a grey area. Tips are pooled informally, or the POS system distributes tips but the employer considers them "direct." If the CRA determines that you had control over the tips, they can reassess you for unpaid CPP, EI, and penalties.
What the CRA looks for
The CRA looks at whether the employer had any involvement in collecting, calculating, or distributing the tips. If your POS system automatically calculates tip-outs, if you have a written tip pooling policy, or if tips flow through your bank account before reaching employees, the CRA may consider those controlled tips.
What you should be doing
Determine your tip structure. Are your tips controlled or direct? If you're not sure, get professional advice. The distinction has real financial consequences.
Document your policy. Whatever your tip structure is, have it in writing. A clear tip policy protects you if the CRA ever asks questions.
Report properly on T4s. If you control the tips, they need to be on the T4 with the appropriate source deductions. If tips are direct, the T4 should reflect only wages. But employees need to know they're responsible for reporting tips on their own return.
Keep records. Track tip amounts consistently.
