Payment in lieu of notice is where an employee is paid by their employer for the relevant notice period that they do not work when their employment is terminated without notice.
Payment in lieu of notice, or PILON, can apply to many different types of dismissal.
In this guide, we look at the rules on PILON and how employers can ensure they are applying the rules correctly in relation to different types of contract termination, such as dismissal for gross misconduct, redundancy or as part of a negotiated exit.
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 be able to bring a tribunal claim.
What is Payment in Lieu of Notice?
In some circumstances, an employer may wish to terminate an employee’s employment without requiring them to work their notice period. This may be because the employer is concerned about the employee continuing to be present in the workplace with access to systems and information; or the employee has requested to leave without working their notice; 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.
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. Through PILON, without breaching the terms of the employment contract.
Employers have to give employees the notice they are entitled to, whether under the statutory or contractual entitlement.
Under the statutory notice rules, 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 entitled to one week’s notice.
In many cases, employees may be entitled to a longer notice period than the statutory minimum under the terms of their employment contract; this is known as ‘contractual’ or ‘enhanced’ notice. Contractual notice cannot be shorter than the employee’s relevant statutory entitlement.
The employment contract should set out if an employee is entitled to PILON. 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 set out the terms of payment, including what will be taken into account in calculating the payment 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 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.
If the employee resigns and would prefer to leave immediately without working the notice period, they may also 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, but there is no obligation on the employer to agree to this. For example, if the employer has to recruit a replacement and ensure adequate staffing.
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.
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.
PILON & 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 remember that any settlement payment takes account of all of relevant employee entitlements that apply, such as PILON or any other figures such as redundancy pay and holiday pay.
Remember also that for a settlement agreement to be legally enforceable, the employee must have received independent legal advice before signing the agreement.
PILON & redundancy
Payment in lieu of notice is often made in redundancy situations.
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.
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.
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.
Is PILON taxable?
PILON is taxable, 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.
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: 11 August 2023