Payment in lieu of notice is where an employee receives notice pay from their employer instead of working their notice period when their employment is terminated without notice.
Payment in lieu of notice, or PILON, can apply to many different types of dismissal. In this article, we look at the rules on PILON and how employers can ensure they are applying the rules correctly.
If an employer fails to meet their obligations by not paying the correct amount or dismissing unfairly without notice and without pay, the employee may bring a tribunal claim.
What is Payment in Lieu of Notice?
Employees with more than one month’s service are entitled to a minimum statutory notice period upon termination of their employment contract.
Statutory notice provides that an employee has to receive a minimum of one week’s notice for every full year that they have been employed by their employer up to a maximum of 12 weeks.
If they have been employed for less than one year, but more than four weeks, they are statutorily entitled to one week’s notice.
In many cases, employers will extend the length of notice period from the statutory minimum under the terms of the employee’s employment contract (‘contractual notice’). Contractual notice cannot be shorter than the employee’s relevant statutory entitlement.
On occasions, an employer may wish to terminate an employee’s employment immediately, that is, irrespective of the notice period to which they are entitled. This may be because the employee has requested it or because the employee has access to sensitive or confidential information or because the employer is concerned that the employee may disrupt the rest of the workforce or not carry out their job properly if they work their notice period. Pay in lieu of notice (or PILON) is one way to achieve this.
PILON or payment in lieu of notice allows an individual’s employment to be terminated immediately without them needing to complete or work their notice period. Instead, the employer pays the exiting employee the amount they would have earned had they worked their full notice period.
The employment contract should set out if they are, or may be, entitled to PILON. If they have been dismissed or resign and would prefer to leave immediately without working the notice period, they may request PILON from their employer.
Even if there is no reference in the employment contract to a PILON, it may be that the employer is happy to agree to the request for the individual to leave straightaway. However, this may not always be the case.
PILON and different types of dismissal
If the PILON is made in accordance with the employment contract, the contract will usually set out the terms of payment, including what will be taken into account in calculating the payment. Benefits and other payments may not be included.
The contractual term should stipulate when PILON takes effect, e.g. whether it is on the date notice of termination is given, the date the PILON is actually made, or the end of what would have been the notice period. The contract should also stipulate the amount that will be paid, which could, for example, cover basic pay but not benefits, bonuses or commissions during the notice period. Payment in lieu of notice does not have to include holiday that would have accrued during the notice period, i.e. beyond the date of termination, unless the contract provides otherwise.
If the employment contract does not provide for PILON, the employer would generally not be able to terminate the contract with immediate effect without the notice period and they may be in breach of contract for dismissal with pay in lieu of notice. This also means any post-employment restrictive covenants would no longer be legally binding on the employee.
If the payment is in breach of the employment contract, the employer will usually need to pay an amount equivalent to any benefits or other payments that the employee would have received had they worked their notice period as well as the salary to which they would have been entitled. This is because, in the case of a breach, the payment is, essentially, an advance damages payment, or compensation to the employee for the breach. The employer may also include an amount for holidays which would have accrued during the notice period.
If an employer decides to make a PILON, they must provide written notice of this decision to the employee. The employee’s employment will then have terminated, their employment contract will have ended, and they are free to look for work elsewhere. It is, however, important to remember that even though the employment contract has ended, the employee may still have duties under it, such as confidentiality obligations and restrictive covenants, which may prevent them from working for certain competitors or taking other employees with them.
Where an employee is summarily dismissed for gross misconduct, it is usually unlikely that a PILON will be made.
How does PILON apply in relation to redundancy?
Payment in lieu of notice is often be made in redundancy situations.
If the employee has worked for the employer for more than one month, they will have a statutory right to be given a certain amount of notice. This has to be the minimum notice period by law:
- At least one week’s notice if employed between one month and 2 years
- One week’s notice for each year if employed between 2 and 12 years
- 12 weeks’ notice if employed for 12 years or more
They may be entitled to more notice if the employment contract provides for this.
In the case of redundancy, employers can terminate the contracts of employees being made redundant immediately, meaning the employees do not have to work their notice period. In such cases, the employees should still by law be paid for the notice period. This should be communicated to the employees as part of the redundancy consultation process.
Payment in lieu of notice would be in addition to the employee’s statutory redundancy pay entitlement. Payment may be wrapped up with any redundancy or termination payments made by the employer to the employee. However, for tax reasons, it is important to be clear as to what constitutes the PILON and what is a termination payment.
How does PILON differ from garden leave?
PILON is not to be confused with garden leave which is a separate concept. Where PILON applies, the employee’s employment is terminated immediately, and the employee is paid the amount they would have earned had they worked their notice period. Because the employment has terminated, the relationship between the employer and employee has ended, the employment contract terms are no longer binding and the employee is free, for example, to find work elsewhere.
If an employee is placed on garden leave, their employment contract will remain effective for the duration of the period of leave until the date the contract is terminated. This means they are still employed by their employer for the garden leave period but are not required to go into their place of work. They will continue to be paid and accrue their rights and benefits in the usual way during the garden leave period and technically they could be required by their employer to undertake work.
Is PILON taxable?
PILON is taxable and this is the case regardless of whether the payment is made in accordance with the employment contract or otherwise. The rules and calculations are however complex. Essentially, an employee will pay income tax and Class 1 National Insurance Contributions (NICs) on the amount of basic pay which they would have been paid had they continued to be employed during their notice period. This amount is known as PENP or post-employment notice pay. Any amount paid in addition to PENP will be classified as termination payment and taxed accordingly.
In calculating PENP, the notice period to be taken into account is that to be given by the employer, not the employee (if they are different) and is the longer of either statutory notice or contractual notice. The term ‘basic pay’ includes any amount which the employee would ordinarily give up through a salary sacrifice scheme but does not include any commission payments, overtime payments, benefits in kind or bonus payments. In addition, it does not include any statutory redundancy payment (and possibly any contractual redundancy payment), which will be deemed a termination payment.
The first £30,000 of any termination payment is not taxable and termination payments are not subject to employee NICs.
So, by way of example, Emma is told that she is being dismissed with immediate effect. Her employment contract provides for payment in lieu of notice at her employer’s discretion. Emma has a 90-day notice period and her gross basic salary is £2,500 per month. In the previous pay period, there were 30 days. Emma is paid £10,000. Emma’s PENP is therefore (2,500 x 90)/30 = £7,500 and this amount will be subject to tax and NICs. The remaining £2,500 termination payment will be exempt from income tax as it falls within the £30,000 exemption.
PILON and settlement agreements
Payment in lieu of notice is commonly used as part of settlement agreements and negotiated exits. Since such agreements tend to arise as a result of, or for the avoidance of, workplace disputes or redundancies, it may be in both parties’ interests for the employment contract to be terminated quickly and without the notice period being worked. It will be important to understand that any settlement payment takes account of all of your entitlements that apply, such as PILON or any other figures such as redundancy pay and holiday pay.
If you have been asked to discuss or sign a settlement agreement, take legal advice. The agreement will not be legally binding on your employer unless you have taken independent advice on the terms of the agreement.
DavidsonMorris are experienced employment law specialists offering guidance and support to employers with all aspects to dismissal and entitlements on termination of an employment contract. If you have a question about PILON, contact us for advice.
What does PILON mean?
PILON stands for Payment In Lieu of Notice. It is a payment made to an employee when dismissed instead of the individual having to work their notice period.
Do I pay tax on Pilon?
Yes, employees are taxed national insurance and income tax in the usual way for earnings for any PILON payments, both contractual and non-contractual.
What does PILON mean in redundancy?
In a redundancy situation, PILON means you will be paid not to work your notice period. Payment should cover your usual salary for the period of notice as well as any other payments due.
Last updated: 20 February 2020