CRA wins tax case dealing with restaurant servers’ electronic tips

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If you’re an employee who gets a regular paycheque, you’ll be very familiar with the concept of source withholdings, which reduces your take-home pay.

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Put simply, your employer is legally required to withhold and remit federal and provincial income tax to the Canada Revenue Agency, as well as Canada Pension Plan (CPP) contributions and employment insurance (EI) premiums.

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Failure to withhold any of these can land an employer in hot water with the CRA, as one Nova Scotia restaurant recently found out. But before delving into details of the case, let’s review the basic rules governing CPP and EI deductions.

Under the CPP, the employer’s contribution is determined by applying a contribution rate to the “contributory salary and wages of the employee … paid by the employer,” less certain deductions. For 2022, employee CPP/QPP contributions are 5.7 per cent of earnings between $3,500 and $64,900, so the maximum amount of contributions for this year is $3,500. Employers are required to match employee contributions.

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For 2022, an employee’s EI premiums are 1.58 per cent of “insurable earnings” up to $60,300, so the maximum EI premium you may pay is $953. Insurable earnings are defined as “the total of all amounts, received or enjoyed by the insured person (i.e., employee) that are paid to the (employee) by the … employer in respect of that (insurable) employment.”

Under the EI Act, employers must contribute 1.4 times the employee premiums, or 2.21 per cent of insurable earnings, with a 2022 maximum premium of $1,334 per employee.

The recent case involved a popular, seaside restaurant in downtown Halifax that didn’t remit CPP and EI on part of its servers’ tips. Customers sometimes leave a tip in cash, which the servers are free to keep without advising their employer. Most customers, however, choose to pay their restaurant bills using a debit, credit or gift card, and include a tip in their electronic payment. The restaurant, in turn, shares these tips with its servers in a formalized, daily procedure.

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At the end of each shift, each server prints a “summary of sales” from the restaurant’s point-of-sale system. That summary shows each server’s food sales, beverage sales, cash received from patrons who paid in cash, electronic payments received and electronic tips. This info is used to prepare a “cash out sheet.”

On that sheet, the server records their electronic tips, the cash received, a kitchen staff “tip-out” (equal to one per cent of food sales), and an amount equal to two per cent of the electronic tips (the processing charge). The restaurant retains the tip-out to pass along to its kitchen staff and the processing charge to cover its credit-card fees. The net amount is the server’s “net electronic tip.”

If none of the server’s customers happened to pay their restaurant bills in cash that day, the restaurant simply transfers an amount equal to the server’s net electronic tip to the server, typically the next business day, via direct bank deposit. This is known as the “due-back.”

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In some circumstances, a server’s due-back is less than the server’s net electronic tip. This happens when a restaurant customer pays in cash, which the server retains and is taken into account in calculating the due-back. In these cases, the server’s net electronic tip is partially received in cash (from customers’ payment of their restaurant bills), and partly from the due-back received from the restaurant itself.

At the end of each shift, each server also prepares two envelopes in which they place cash to “tip out” the onsite restaurant manager and assistant manager — two per cent — and the support staff (bussers, hosts/hostesses and bartenders) at one per cent per support staff person (to a maximum of three per cent).

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Each server delivers their summary of sales, their cash out sheet, and the two envelopes to the onsite manager at the end of their shift who later distributes the cash tip-outs to the restaurant managers and support staff. The sales summary and cash out sheet were set aside and picked up the next morning by someone from accounting to facilitate payment of the servers’ due-backs.

The restaurant took the general position that due-backs received by servers were not considered to be “pensionable salary and wages” for purposes of CPP rules, nor “insurable earnings” for purposes of the EI Act. As a result, when it calculated its CPP and EI liabilities for 2015, 2016 and 2017, it did not consider any portion of the electronic tips.

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Needless to say, the CRA took a different view and assessed the restaurant on the basis that a portion of the servers’ electronic tips for 2015, 2016 and 2017 should have been considered. The taxpayer took the matter to Tax Court in 2020 and lost. It then appealed the decision to the Federal Court of Appeal (FCA), which heard the case earlier this year.

The key question the court had to decide was whether the due-backs were properly considered to be amounts paid by an employer to employees “in respect of” their employment. The restaurant argued the due-backs are not paid in respect of a server’s employment and are not insurable earnings because a server’s due-back bears “little or no relation to the server’s net tip. It is simply the difference between cash payments for meals and electronic tips owing.”

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The three-judge appellate panel disagreed, citing a seminal 1983 decision of the Supreme Court of Canada, which stated that the words “in respect of” have “wide scope and import such meanings as ‘in relation to,’ ‘with reference to’ and ‘in connection with.’ In other words, “but for” their employment as servers by the restaurant, the servers would not receive any tips paid to them in the form of due-backs.

The FCA, in a written decision released last month, concurred with the lower court’s decision, and concluded the due-backs were “contributory salary and wages of the employee paid by the employer” for purposes of the CPP and “insurable earnings” for purposes of the EI Act.

Jamie Golombek, CPA, CA, CFP, CLU, TEP, is the managing director, Tax & Estate Planning with CIBC Private Wealth in Toronto. Jamie.Golombek@cibc.com

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