June 18

Understanding PILON: Payment in lieu of notice

PILON is a payment made to an employee when employment is terminated without notice, instead of the employee working through a notice period and receiving pay in the normal way. It is different from ‘gardening leave’, in which the employee is still in employment during the notice period and is paid during that period, even though he or she is not present at work.

When does the termination date fall?

There’s some confusion about when the termination date falls in a PILON situation. To avoid disputes, it’s best to make this clear in the contract, whether it is:

1. the date notice of termination is given, or
2. the date the PILON is actually made, or
3. the end of what would have been the notice period.

Some employers prefer to give notice of termination and make the PILON at the same time so that there are no misunderstandings. Either way clarity in the contract is key to eliminating misunderstanding.

What are the rules on benefits in kind, bonuses and commissions?

The usual position is to provide, in the contract, that the PILON payment will cover basic pay only and that there will be no payment in respect of non-cash benefits, bonuses or commissions during the notice period and thus they will not need to be reflected in a payment in lieu.

However, if the PILON clause does not deal with such benefits and remains silent on the issue, the default position is that the employee should be compensated for the loss of any benefit under the contract for the duration of the notice that should have been given. Thus the PILON payment would include all and any benefits to which the employee may be entitled.

It is therefore important to be clear in the contract exactly how the PILON payment is calculated.

Does a PILON payment have to include holiday entitlement?

In general a PILON payment need not reflect holiday that would have accrued over the notice period, had the employee worked it. The reason for this is that, firstly, the employment legally comes to an end on the date of termination. Secondly, although holiday would have accrued during the notice period, it could also have been taken by the employee before the contract ended and there is an assumption that the employee would have performed the contract in the way most advantageous to him/herself.

Therefore, in general, the payment in lieu of notice need not reflect holiday that would have accrued beyond the actual date of termination (ie during the time that would have been the notice period), unless the contract provides otherwise. However, in practice, employers may decide to include this in the payment in lieu to avoid any dispute over the point.

Again, clarity within the contract is of paramount importance to ensure all parties are clear as to what the PILON incorporates.

Taxation of PILON payments

If the employer makes a payment in pursuance of a PILON clause, it will be a payment due under the contract and will fall to be taxed in the same way as other contractual benefits given to the employee.

If, however, there is no contractual right to a PILON and an employer terminates a contract without proper notice and simply makes a payment to the employee in lieu of the notice period, then that payment can be paid tax free. This payment is not a payment under the terms of the contract, which would be taxable, but instead is an advance payment of damages for breach of contract. Such a payment is tax free up to £30,000.

In conclusion

In dismissal situations there is plenty of scope for confusion surrounding pay, notice and termination of employment. Mistakes could be costly, and when it comes to payment in lieu of notice, having an up-to-date and clearly expressed contract could be the difference between a mutually respectful parting of ways and engaging in a costly process in the tribunal.