Service charges are becoming an increasingly common feature of the hospitality industry across the UK, with many businesses adding a percentage (typically between 10% and 15%, most commonly 12.5%) to bills. While this practice is widespread, there is an important distinction that not all business owners or customers are fully aware of: service charges come in two distinct forms, each with very different implications for how they must be handled legally and financially.
Mandatory vs. Discretionary Service Charges
A mandatory service charge is one that the customer is required to pay. It forms part of the contractual price of the meal or service and cannot be removed from the bill unless the customer has a clear and justifiable reason for doing so, for example, demonstrable failure of service. Because it is effectively guaranteed income for the business, it is treated differently from a tip or gratuity in the eyes of the law.
A discretionary service charge, on the other hand, is entirely optional. The customer has the right to reduce or remove it at will, and this must be made explicitly clear to them. Businesses can do this by including a note on their menus or bills, or by displaying a clearly visible sign within the premises. Transparency here is an absolute a legal requirement.
The Employment (Allocation of Tips) Act 2023
The Employment (Allocation of Tips) Act 2023 brought significant changes to how tips, gratuities, and service charges are treated in the workplace. Under this legislation, any discretionary service charge collected by a business must be treated in the same way as a tip or gratuity, meaning it must be passed on to staff in full, with no deductions made by the employer. This requirement must be reflected in your business’s written tipping policy, which all employers in hospitality are now legally required to have in place.
For a service charge to qualify as discretionary under the Act, customers must be made genuinely aware that the charge is voluntary and that they are free to reduce or waive it entirely. Simply describing it as a “suggested” amount is unlikely to be sufficient. The messaging must be clear and unambiguous, whether on your menu, your bill, or signage displayed prominently in your venue.
Service Charges and Tronc
One of the key financial advantages of handling service charges correctly is the ability to process discretionary service charges through your Tronc system.
When discretionary service charges are processed through a qualifying Tronc, neither the employer nor the employee is liable for National Insurance Contributions (NICs) on those amounts. This means businesses are not required to pay the 15% employer NICs that would otherwise apply, and employees benefit from not having the standard 8% employee NICs deducted from their share. For businesses operating at scale, this can represent a meaningful saving for both parties.
It is important to note, however, that mandatory service charges cannot be processed through Tronc. Because mandatory charges are considered guaranteed revenue rather than voluntary gratuities, National Insurance Contributions are always due on these amounts, regardless of how they are subsequently distributed among staff. Attempting to route mandatory charges through a Tronc scheme to avoid NICs would not be compliant with HMRC rules.
