How to Report Tips and Gratuities: Tax Compliance for Restaurants and Bars – A Complete Guide by a Montreal CPA Firm Near You

Introduction

Tips and gratuities are a major part of compensation in the restaurant and bar industry — and one of the biggest CRA audit triggers. Whether paid in cash, through POS terminals, delivery apps, tip pools, or service charges, tips must be handled properly to avoid payroll penalties, GST/HST errors, or source deduction reassessments. Many restaurants unknowingly misreport tips and expose themselves to thousands of dollars in CRA liabilities. This guide explains exactly how to report tips in Canada, the difference between controlled and direct tips, how to structure tip pooling, and how to stay compliant with CRA payroll and GST/HST rules.

Legal and Regulatory Framework

Tip reporting rules fall under the Income Tax Act, Canada Pension Plan (CPP), Employment Insurance Act (EI), Excise Tax Act (for GST/HST on service charges), and Quebec’s Taxation Act and QST rules. CRA divides tips into two categories:

• Direct Tips – controlled by employees

• Controlled Tips – controlled by the employer
  This distinction determines whether restaurants must deduct CPP, EI, and income tax at source. Restaurants must keep accurate payroll, POS, and tip distribution records to avoid reassessments, penalties, and interest.

Key Court Decisions

In Rizzo v. CRA, the court upheld that controlled tips must be included in pensionable and insurable earnings, meaning restaurants must withhold CPP/EI. In The Keg Restaurants Ltd. v. Canada, tip pools administered by management were ruled “controlled,” reinforcing employer responsibility. In R. v. Ling, indirect verification methods (like comparing POS tips to employee income) were approved for restaurants with incomplete records. These cases show that CRA aggressively audits hospitality businesses for tip compliance.

Direct vs Controlled Tips: CRA’s Distinction

Direct Tips (Employee Controlled)

These include:

• Cash tips handed directly to the server

• Tips received through customer-to-employee digital payments

• Tips pooled voluntarily by employees
  Characteristics:

• Employer does NOT control distribution

• Employer does NOT withhold CPP/EI

• Employees must self-report the income

• Employer must still issue a T4 with zero CPP/EI on these tips, but CRA may ask for proof

Controlled Tips (Employer Controlled)

These include:

• Tips distributed through payroll

• Mandatory service charges

• Tips pooled and redistributed by management

• Automatic gratuity on large tables
  Characteristics:

• Employer MUST withhold CPP/EI and income tax

• Tips must be included in pensionable and insurable earnings

• GST/HST may apply if it’s a mandatory service charge
  CRA expects strong documentation to prove whether tips are direct or controlled.

How Restaurants Should Report Tips

1. Direct Tips

Employees must:

• Report tips as income on their tax return

• Add tips to total employment income (line 10100)
  Employers must:

• Track tip amounts for compliance

• Report them in Box 14 (employment income) IF processed through payroll

• Not deduct CPP/EI (if truly employee-controlled)

2. Controlled Tips

Employers must:

• Add controlled tips to wages

• Deduct CPP, EI, QPP, QPIP

• Remit payroll source deductions

• Include tips on T4 and RL-1

• Maintain detailed records of distribution

Controlled tips are treated exactly like wages.

GST/HST Obligations on Tips

• Voluntary tips: NO GST/HST

• Mandatory service charges: GST/HST applies
  Restaurants must separate these amounts in POS systems to avoid misreporting.

Tip Pools: Compliance Requirements

Tip pools must be structured clearly:

• Employee-run pools → direct tips

• Employer-run pools → controlled tips
  CRA expects written policies outlining:

• Who contributes

• Who distributes

• How amounts are calculated

• Who controls the funds
  Poorly documented tip pools almost always produce reassessments.

Record-Keeping Requirements for Tips

Restaurants must keep:

• POS summaries of tips

• Delivery app payout records

• Tip pool distribution sheets

• Payroll reports

• Cash-out logs

• Employee acknowledgments for direct tips
  Without documentation, CRA assumes tips are controlled — leading to payroll reassessments.

CRA Audit Triggers for Restaurants and Bars

• POS reported tips lower than industry norms

• Payroll does not include controlled tips

• Delivery app income not reconciled

• High cash sales without documentation

• Missing tip pool policies

• Large fluctuations in tip-to-sales ratios

• Anonymous employee complaints to CRA
  Tip audits often expand into GST/HST and payroll reviews.

How to Correct Past Tip Reporting Errors

Restaurants may:

• File amended payroll remittances

• Correct T4 and RL-1 slips

• Adjust GST/HST filings for service charges

• Recalculate CPP/EI based on controlled tip amounts

• Use the Voluntary Disclosures Program (VDP) if CRA has not contacted them yet
  VDP can eliminate penalties and reduce interest for past non-compliance.

Mackisen Strategy

At Mackisen CPA Montreal, we help restaurants and bars structure tip policies, classify tips correctly, prepare payroll systems, reconcile delivery app reports, and defend against CRA tip audits. We also reconstruct missing records and file corrections through VDP when needed.

Real Client Experience

A Montreal bar avoided $63,000 in payroll reassessments after we reclassified tip pools and reconstructed records. A family restaurant reversed CPP/EI penalties during an appeal. A café corrected GST on mandatory service charges and recovered ITCs. A steakhouse survived a CRA tip audit with zero reassessment thanks to our documentation package.

Common Questions

Do I have to pay payroll taxes on tips? Only for controlled tips. Are tips taxable to employees? Yes — 100%. Are delivery app tips direct or controlled? Usually direct — unless processed by the restaurant. Should tip pools be in writing? Absolutely. Does CRA audit tips? Constantly.

Why Mackisen

With more than 35 years of combined CPA experience, Mackisen CPA Montreal ensures restaurants and bars stay compliant with CRA tip rules, avoid payroll liabilities, and structure tip systems that withstand audits.