PILON (Payment in Lieu of Notice) and Termination Payments
Employees with more than one month’s service are entitled to a minimum statutory notice period upon termination of their employment contract.
The statutory notice provides that an employee must receive a minimum of one week’s notice for every full year that their employer has employed them for up to 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 the notice period from the statutory minimum under the employee’s employment contract terms. Contractual notice cannot be shorter than the employee’s relevant statutory entitlement.
An employer may wish to terminate an employee’s employment immediately, irrespective of the notice period they are entitled to. This may be because the employee has requested it or has access to sensitive or confidential information. 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 completing or working their notice period. Instead, the employer pays the exiting employee the amount they would have earned had they worked their full notice period.
PILON and different types of dismissal
If the employment contract makes the PILON, the contract will usually set out the payment terms, including what will be considered 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 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 holidays that would have accrued during the notice period, i.e., beyond the termination date, 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. 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.
Suppose 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 and the salary they would have been entitled to. 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 accrued during the notice period.
How does PILON apply in relation to redundancy?
Payment in lieu of notice is often 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 two 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 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, it is important to be clear as to what constitutes the PILON and what is a termination payment for tax reasons.
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 by 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 basic pay 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 to PENP will be classified as termination payment and taxed accordingly.
Typical termination payments will include compensation for loss of office, redundancy payments, damages for dismissal, payments in lieu of notice (PILONs) and certain payments made on retirement.
Termination payments will be fully taxable, partially taxable, or fully exempt, depending on the nature of the payment.
If a termination payment is given to the employee in return for services performed under the employment contract, the termination payment will be earnings and taxable in full. However, a termination payment will generally compensate the employee for loss of office rather than being rewarded for service performed.
Most termination payments are not earnings from the employment and are taxed differently than other payments such as salaries and bonuses.
National insurance implications
Class 1 NICs are paid on earnings from employment. As far as termination payments are concerned, where a payment is made to an employee under a contractual obligation, this payment will be regarded as earnings for Class 1 NICs purposes.
PENP is also treated as earnings for Class 1 NICs purposes.
Class 1 NICs are levied on both employees and employers. Employees have an upper earnings limit for Class 1 primary NICs which is currently £50,270 per annum. Suppose a termination payment is made to an employee who earns above this upper earnings limit. If the termination payment is chargeable to Class 1 NICs, there will only be a 2% additional charge on the employee. However, secondary NICs will be levied on employers in full.
Payments from an EFRBS will generally be subject to Class 1 NICs.
Where an ex-gratia payment is made – i.e., where there is no contractual obligation, and the payment is not PENP – the payment will not be regarded as earnings and will not be charged to Class 1 NICs. Therefore, where a termination payment is made such that the £30,000 exemption rule applies or income tax, Class 1 NICs are not due, even on any payment over £30,000.
However, where a termination payment is not regarded as earnings (and therefore not subject to Class 1 NICs), a Class 1A NICs charge will be levied on the amount of the payment subject to income tax. This means that the employer will be subject to Class 1A NICs at a rate of 15.05% (13.8%-2021/2022) on the amount of the payment over the £30,000 exemption. However, the full payment will continue to be free of NICs for the employee as Class 1A NICs are only payable by the employer. Where a termination payment is regarded as earnings, it is subject to Class 1 primary and secondary NICs as usual.
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