Navigating the World of Tips in Canada: What Employers and Employees Need to Know

For many in Canada's service industry, tips and gratuities form a significant part of their income. However, understanding how these amounts are treated for tax purposes, specifically concerning the Canada Pension Plan (CPP) and Employment Insurance (EI) premiums, can be complex. Whether you're an employer managing payroll or an employee receiving tips, it's crucial to understand the distinctions. This guide, drawing on information from the Canada Revenue Agency (CRA), aims to shed light on this often-confusing area.

All employers are legally obliged to deduct CPP contributions and EI premiums from most amounts paid to their employees, remitting these to the CRA along with their own share. While tips and gratuities are always considered income earned from employment for Income Tax Act purposes, their treatment for CPP and EI varies significantly depending on how they are paid and controlled.

The sources highlight three main categories of tips: Controlled Tips, Direct Tips, and Declared Tips (specific to Quebec).

Controlled Tips: When the Employer Takes Charge

Controlled tips are those that an employer controls or possesses before paying them to the employee. Essentially, if the employer has any say in the amount or distribution of the tip, it's likely a controlled tip.

Examples of controlled tips include:

• An employer adding a mandatory service charge or a percentage to a client's bill to cover tips.

• Tips that are allocated to employees using a tip-sharing formula determined by the employer.

• Tips that an employer includes in their business income, expenses, and then redistributes to employees as pay.

• Cash tips that employees turn over to their employer, who then distributes them.

• Cash tips that are deposited into the employer's bank account, becoming or commingling with the employer's property, and then paid out to employees.

Why this matters: Because the employer controls these tips, they are considered to have "paid" these amounts to the employee. This means that CPP contributions and EI premiums must be deducted at source from controlled tips, provided the employment is pensionable or insurable.

Direct Tips: Straight from Customer to Employee

In contrast, direct tips are paid directly by the customer to the employee. The defining characteristic here is that the employer has no control over the tip amount or its distribution; they are merely a conduit.

Examples of direct tips include:

• A customer leaving money on the table for the server to keep the entire amount.

• A guest giving a tip directly to staff such as a bellhop, door person, or porter.

• The employees themselves, not the employer, deciding how tips are pooled or shared amongst staff.

• When a customer includes a tip amount when paying by credit or debit card, and the employer returns the full tip amount in cash to the employee, typically at the end of the shift.

Why this matters: Direct tips are not subject to CPP contributions or EI premiums. However, employees do have the option to make CPP contributions on direct tip amounts earned from pensionable employment if they choose to do so, by filling out Form CPT20.

It's also possible for an employee to receive both controlled and direct tips in their role; in such cases, only the controlled tips are part of their pensionable or insurable earnings.

Declared Tips: The Quebec Exception

The province of Quebec has a unique requirement: declared tips. In Quebec, provincial law mandates that employees working in a regulated establishment declare their direct tips to their employer, alongside any controlled tips they receive.

Why this matters: For the purposes of the Employment Insurance Act, the amount of these declared tips is included in the employee's insurable earnings, in addition to their controlled tips. Quebec is the only province with tax legislation requiring employees to declare their tips to their employer.

Key Takeaways

Understanding the distinction between these types of tips is essential for both compliance and financial planning.

• All tips, regardless of type, are income and must be reported for income tax purposes.

• The employer's level of control over the tips dictates whether CPP and EI deductions apply at source.

• Employers are responsible for correctly identifying controlled tips and making the necessary deductions and remittances.

• Employees need to be aware of how their tips are classified and their own reporting responsibilities, whether the tips appear on a T4 slip or not.

Navigating these nuances can be complex, and getting it wrong can lead to issues with the CRA. If you’re an employer unsure about your payroll obligations for tips, or an employee looking to understand how your tips affect your CPP and EI, professional guidance can make all the difference.

Don't let the complexities of tip taxation trip you up! Reach out to us today for expert advice tailored to your specific situation.