Court of appeal finds 'optional' gratuities to be mandatory payments under the state's tax laws

By Nicholas Echevarria | Mar 23, 2018

SACRAMENTO – On March 9, the 3rd Appellate District for the Court of Appeal of the state of California found the California Department of Tax and Fee Administration was justified in collecting tax on the gratuities added by GMRI Inc. and its subsidiary restaurants.

GMRI Inc., operator of well-known restaurants like Olive Gardena and Red Lobster in the state, appealed the Sacramento County Superior Court's judgment favoring the California Department of Tax and Fee Administration. At issue was the 15 or 18 percent gratuity automatically added to parties of eight or more without first conferring with the customer and its taxable status, the opinion states.

The opinion states the trial court concluded the gratuity amounted to a “mandatory payment designated as a tip, gratuity, or service charge” despite being labeled as optional on restaurant collateral, a conclusion the court of appeals affirmed.

The appeals court made it clear this case was not about GMRI Inc.’s failure to pay the tax – this was not in question. What was concerned was its appeal to have paid it in the first place. The plaintiff argued the tip was just that: a tip. To it, it warranted categorization outside of the company’s taxable gross receipts.

In opposition, the Department of Tax and Fee Administration held that since the gratuity was automatically added without conferring with the customer and despite it being labeled optional, the gratuity was added 98 percent of the time during the period in dispute. To the department, this constituted mandatory payment under California code and should be treated as such.

While the gratuity is labeled as “optional” on company collateral, a sample of receipts analyzed showed that a majority of customers not only paid the large gratuity but added to it. In only two cases was the large gratuity not paid, making it evident that it wasn’t handled like a traditional tip in which customers fill in their desired amounts on a receipt, the opinion states.

The examples and defenses presented by GMRI Inc.’s were not sufficient in proving these mandatory payments were treated in any other manner supporting its appeal, the opinion states. As such, court affirmed the judgment and the California Department of Tax and Fee Administration is entitled to costs on appeal.

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