Tips & payroll: what the CRA actually expects
Every restaurant, café and salon handles tips. Most handle them by habit, and habit is exactly what a payroll review reclassifies. The controlled-vs-direct distinction, the court case that sharpened it, and the setup that survives scrutiny.
The distinction that decides everything
The CRA sorts gratuities into two kinds, and the sorting decides whether CPP, EI and income tax withholding apply:
Controlled tips: employer money, briefly
Tips that pass through your business's control before reaching staff. You collect them, pool them, decide the split, and pay them out. Classic examples: card and POS tips paid out through payroll or by the house, mandatory service charges on large parties, banquet gratuities, any tip-out arrangement the employer administers.
Controlled tips are treated as pensionable and insurable earnings: you withhold income tax, CPP and EI, you pay the employer's share of CPP and EI, and the amounts belong on the T4.
Direct tips: never yours
Cash a customer hands the server, or tips staff pool and distribute entirely among themselves with no employer involvement. Those never belong to the business, so no source deductions apply. The employee is still required to report them as income on their own return; that's their obligation, not yours.
The case that settled it: Ristorante a Mano
A Halifax restaurant collected electronic tips, converted them to cash and paid servers their "tip-out" nightly, arguing these were direct tips outside payroll. The Federal Court of Appeal disagreed (Ristorante a Mano Ltd. v. Canada, 2022 FCA 151): because the amounts passed through the employer's hands and the employer determined and paid them out, they were paid by the employer, and therefore pensionable and insurable. CPP and EI applied, retroactively.
The takeaway isn't subtle: electronic tips that flow through your account and your process are, in most setups, controlled tips. A nightly cash-out doesn't change that; it just makes the trail messier.
What getting it wrong costs
- A payroll review reclassifies your tip pool as controlled, then assesses back CPP and EI, both the employer and employee shares, plus penalties and interest, typically across multiple years.
- T4s get amended, staff returns get touched, and morale takes the hit right along with cash flow.
- If a service charge was mandatory (the 18% on parties of 8+), it also attracts HST, unlike a voluntary tip. Miss that and the HST return is wrong too.
Setting it up properly
Practically, that means: tips flow from the POS into a gratuities-payable liability (never revenue), out through payroll with CPP, EI and withholding applied, and onto the T4. Your payroll software handles the math once it's configured; the configuring is the part that gets skipped.
While we're on classification: your "contractors"
The same review that checks tips checks worker status. The CRA weighs control, ownership of tools, the right to subcontract or hire a substitute, financial risk, and integration, not the label on the invoice. The kitchen porter on your schedule using your equipment is probably an employee whatever the arrangement says; the true freelancer with multiple clients and their own gear probably isn't. Misclassification carries the same flavour of retroactive assessment as tips, so audit your grey cases before someone else does.
What to do this week
- Trace one week of card tips from POS to pocket. If they touch your account and your rules on the way, treat them as controlled.
- Check your payroll setup has a controlled-tips earning type with CPP, EI and tax applied, and that tips are NOT sitting in a revenue account.
- Confirm mandatory service charges are charging HST and flowing through payroll.
- List workers you pay without deductions and score them against the CRA factors. Fix the obvious ones now, cheaply.