Service charges in hospitality: what they are and how to handle them

Tipping culture has long been a part of the UK’s hospitality scene, but service charges are becoming increasingly common, popping up on restaurant bills more than ever before.

While the government’s Employment (Allocation of Tips) Act 2023 guarantees that tips, gratuities, and service charges are paid directly to employees, customers are likely to challenge the extra charges when it comes to settling the bill.

The last thing you want is for anyone to leave your establishment with a bad taste in their mouth. Therefore, it’s crucial to have a clear understanding of the service charge you are imposing and the difference between service charges and tips within business operations. This article will explore that separation, and also look at the different types of service charges, the rules around whether customers can refuse to pay it, and the tax implications involved.

What is a service charge?

A service charge is a fee collected by a business to pay for the services, admin, or processing costs associated with the main service being used by the customer. The main industries that charge them include restaurants, travel and tourism, banking, and property.

Service charges are usually added at the time of the transaction. Before, these charges were paid directly to the company, rather than its service staff. However, under the UK’s Employment (Allocation of Tips) Act 2023, which came into effect in October 2024, all service charges must now be given to the staff member who served the tipping customer.

What are the types of service charges?

There are two most common types of service charge – discretionary and compulsory:

• Compulsory service charge: this must be stated to the customer in advance of the service being given, and the customer can only refuse to pay it if the service was very poor.
• Discretionary service charge: this can be added to a bill after the service, but the customer can decide not to pay it, regardless of whether the service was good or bad.

For example, in a restaurant, service charges are imposed on food bills and are either a discretionary or compulsory fee.

Customers are within their rights to decline either, but for a compulsory service charge, the customer would have to show that they received poor service to get this removed from the bill. This could be demonstrated by speaking about their experience to the manager, for example.

For a discretionary service charge, a customer simply has to ask to have it removed from the bill before paying. A server may ask why this is, or they may simply do it without question – there is no right or wrong approach.

Asking the customer for their reasoning could provide the business with vital feedback to help improve their service going forward, but it can also create an uncomfortable situation for staff.

Legal rules on service charges

Last year, the government introduced the Employment (Allocation of Tips) Act 2023 (otherwise known as the Tipping Act) to ensure that tips, gratuities, and service charges were paid fairly and transparently to hospitality staff. This includes zero-hour and agency staff.

By law, restaurant businesses and other hospitality firms must:

• Allocate tips, gratuities and service charges directly to workers without deductions, aside from the usual tax and National Insurance Contributions (NICs).
• Share tips between staff fairly under the government’s new Code of Practice.
• Publish and distribute a clear policy on tip allocation and keep records of all tips received for three years.
• Pay tips and service charges no later than the end of the calendar month after they are received.

On the flip side, employers can no longer:

• Deduct income from these payments to cover administration costs (e.g. card transaction fees).
• Change an employee’s salary or hourly rate, and the tip income doesn’t count towards meeting the National Minimum Wage and National Living Wage.
• Use tips received in one venue or chain to pay employees in a different one.

If businesses fail to comply with these new rules, they could face an employment tribunal. This could result in potential prosecution or awarding the affected employee up to £5,000 in compensation, which could significantly harm your profit margins, staff morale and trust among customers if your case becomes known to the public.

How much should a service charge be?

The percentage of the service charge is ultimately up for the business owner to decide. However, in UK restaurants, service changes tend to range from 10% to 20%. In London, it was reported that the average service charge had increased from 12.5% to 15% in 2025.

Here’s a quick rundown of the typical service charge percentages that are found across hospitality businesses:

• A restaurant may add an 18% gratuity charge to the bill for a large party (eight or more).
• Nightclubs with VIP experiences offer bottle service at varying prices, allowing customers to purchase a bottle of premium alcohol – often with mixers included – and have it served directly to their private table or booth by dedicated staff.
• Hotel restaurants may charge 15% of the total bill for room service.
• Some luxury hotels add a discretionary service charge of around 5-10% of the bill.
• Food delivery platforms charge a service fee for online orders. For example, Deliveroo charges 5% of the basket value, ranging from 49p to £2. Delivery fees are also added, which depend on distance and time to deliver.
• A catering business may charge an 18-25% fee for its services, depending on the event’s location, size, and nature.

How to handle service charges in your business

As a business owner, it’s your responsibility to handle service charges properly, both legally and operationally. Here are some key ways you can manage them the right way.

Train your staff

It’s essential that your employees clearly understand your service charge policy so that they can communicate it to customers. Not only will this help improve the customer experience, but it also prepares staff for when they are questioned or challenged about service charges. Simple training sessions or meetings on this policy can help give your workers the knowledge and communication skills they need to implement and explain the policy correctly.

Use a tronc scheme

A tronc scheme is a system that pools and distributes tips, gratuities, and service charges among staff fairly, including tips paid via card transactions and any added service charges to the bill. The person who runs the scheme, known as the troncmaster, pays employee tips through a separate payroll run and PAYE scheme before reporting the details to HMRC. That way, tip payments won’t be liable for employer or employee NICs.

Show your policy clearly

Whether your service charges are discretionary or mandatory, it’s important to explicitly state them. This could be on your business website, menu, final bill, or even on a sign within your premises. Whatever you go for, make sure it’s clear and can be found easily (e.g. “A 12% service charge will be added to all bills to ensure fair compensation for our staff“).

Respect the customer’s choice

If you add a discretionary service charge, you must respect the customer’s choice if they decide they don’t want to pay. A mandatory service charge is a little harder to remove, but if the customer is able to show that they didn’t receive good service, then you should adhere to their request. Engaging with customer feedback, whether good or bad, can help improve your services and operations.

Maintain accurate records

Value-added tax (VAT) is charged on mandatory service charges (typically 20% for hospitality businesses), so it’s crucial that you accurately record these payments as part of your taxable income. You should use a good-quality accounting software so that your VAT records are accurate, up-to-date, and compliant with HMRC’s new Making Tax Digital (MTD) requirements.

Tax and payroll considerations

Mandatory service charges are taxed through VAT, income, PAYE, and NICs. Discretionary service charges, however, are not taxed as the payment is voluntary from the customer. HMRC will accept a payment as a discretionary charge if it is clearly presented to them as an optional payment.

Like food and drink sales, mandatory service charges are subject to VAT. If you are VAT-registered, you must charge the standard 20% on these charges and include them in your VAT returns.

Additionally, if you decide how service charges are distributed to staff (e.g. through employer payroll or by handling it manually), HMRC will consider it as earnings. In this case, you must deduct the income tax and employee NICs through pay-as-you-earn (PAYE). You must also pay employer NICs on those amounts.

It’s also important to note that if service charges are distributed through a properly-managed tronc scheme, then they are still subject to income tax through PAYE. However, they’re not subject to employer NICs, which can help you save money.

Conclusion

Adding service charges to your business offering is a smart way to increase income. However, business owners must be prepared to face challenges from customers, particularly if they don’t receive good service. Imposing service charges could be further motivation to ensure your company is offering the best experience possible to customers to avoid awkward conversations.