Taxes on Tips: Judge Is Happy, Israeli Restaurateurs Are Not

A year after a labor court made its controversial ruling, everything is confusion and cash is king for Israeli waiters

A waitress is seen in a photo taken for illustrative purposes only.

When our friendly waitress arrived at our table with the check we had asked for, she asked in a whisper if we could possibly leave the tip in cash rather than putting it on a credit card and adding to the bill.

Requests like that were long standard practice. The waiters preferred tips in cash to avoid having to pay tax or social security and other deductions taken from them. But in March 2018, the National Labor Court raised the stakes considerably.

In light of the Knesset’s failure to act on the matter, the court decided that tips should be regarded as part of a restaurant’s revenues and as part of the server’s regular wages. It now became part of the employer’s calculations for vacation days, health benefits and pension.

The decision was made by a three-judge panel headed by Yigal Plaitman in what was to be his last ruling before retiring.

“We were faced with two rulings with contradictory arguments, and we had to decide how we would put them into effect in the real world,” he said a year since the decision went into force at the start of 2019. “We examined the real world of restaurant management, in which tips in practice constitute compensation for labor, so they should be considered salary with all the social benefits that come with it.”

The first of the cases was brought by Omri Kis, who challenged a decision by the National Insurance Institute not to include his tip income when calculating unemployment benefits due him after he was fired as a waiter, even though his tips didn’t appear in his official paycheck. The second was brought by Yehiel Bodeh, a waiter who sued his restaurant employer and demanded he be paid the minimum wage and be entitled to social benefits. Most of the money he was getting from tips never appeared in his paycheck stub.

Because the issues involved so many people and so much money – an estimated 200,000 restaurant workers and tips valued at as much as 2 billion shekels ($580 million) a year, the court decided to hand the cases over to an expanded three-judge panel.

From a tax point of view, the operative significance of the court’s ruling has been to put tips in the hands of the employer, including the requirement to pay tax on them. The waitress asking for her tip in cash is a case of small-scale tax evasion for everyone involved – both the waitress and the restaurant owner. They also avoid the cost of deductions for social benefits.

In fact, it’s a little more complicated than that. The restaurant can’t use tip income to pay for employees’ social benefits, except when they increase the waiter’s income above the minimum wage – and the only part of them and only with express written consent.

The problems began immediately when the ruling went into force just over a year ago. Some restaurants, for instance, started to deduct 20% of their waiting staffs’ tip income to cover the cost of social benefits so they wouldn’t have to pay them out of their own income. Others tried to take advantage of the exception by insisting they sign away their rights not to pay the deductions.

Serving at restaurants is a job for young people, who don’t see it as a long-term career and don’t care about the social benefits they are accruing. They want to make as much money as they can now. Many complained about the new system and left the job to find other work. Restauranteurs complained, too, about the extra financial burden, especially the issue of paying value-added tax on tips. The tax authorities hadn’t yet arranged a system for that to be paid.

“We recognize the argument of a student who’s not interested in a pension but in earning money. But that’s not a reason not to impose labor laws on him,” said Plaitman. “What happens if he’s in an accident or he does reserve duty? He doesn’t get sick days or a pension? Why aren’t they considered their real wage? Our conclusion was that we would solve the problem by requiring restaurants to treat tips as wage income. From our perspective, the ruling was firmly grounded in reality. Maybe the waiter is getting less on a net basis, but in terms of benefits he’s equal to every other workers.”

The court had called on the NII and Israel Tax Authority to put some regulatory order into the new system, but that hasn’t yet happened. Plaitman has no regrets. “The court can’t address every aspect,” he said. “Once you have made your ruling to the best of your ability you can be satisfied. As far as the entire system goes, I hope the problem will be solved.”

In the meantime, the tax authority is in negotiations with the Israel Restaurants Association trade group on the issue of collecting VAT in tips. Last Thursday, the authority proposed a compromise under which VAT would not be collected on all tips, only those over the waiter’s minimum wage.

Estimates are that such a system would generate about 200 million shekels of tax revenues for the government.

The association indicated that it didn’t look favorably on the compromise.

“At the meeting, we again made it clear to tax authority officials that the restaurant industry cannot absorb additional taxes,” it said in a Facebook post. “The current legal situation has created huge legal problems for the tax authorities to collect VAT in light of previous judgments of judicial courts, including by the Supreme Court.”

The tax authority has delayed making any decision on VAT collections since the labor court ruling nearly two years ago. Restauranteurs fear that without any firm rules, they will be subject to retroactive assessments that could add up to millions of shekels.

For its part, the restaurants association believes that at the end of the day, the issue will end up back in the courts for a decision.

With reporting by Sivan Klingbail.