AUGUST 2012
Employment Guides
PAYMENTS IN LIEU OF NOTICE (“PILONS”)
Introduction
The main and most obvious reason that an employer would seek to
include a PILON clause in an employee’s contract of employment is
that it allows the employer to terminate the employee’s contract and
pay all monies immediately without being in breach of contract.
Without a PILON clause, an employer who does not pay a dismissed
employee throughout his/her notice period is effectively in breach of
contract. The presence of a PILON clause means that an
immediately dismissed employee can be paid in accordance with the
contract and he/she has no right to insist on being paid throughout
his/her notice period as he/she would have in the absence of such
a clause. This is most useful in the scenario where an employer is
dismissing a senior employee whilst wanting him/her to be removed
from the premises immediately. Therefore, having a contractual right
to do so is obviously crucial in avoiding being in breach of his/her
contract of employment.
immediately pay them their notice monies to prevent them doing any
In lower level dismissals, it is unlikely that employers will encounter
harm to the business. It will not be acting in breach of contract in
problems in breaching an employee’s contract because, in the
doing so, thereby allowing it to rely upon and enforce any post-
majority of cases, they will be able to make a compensatory
termination restrictive covenants in that employee’s contract.
payment for the breached notice period and there will be nothing in
Tax implications
the contract upon which the employer would want to rely following
the termination.
This is a frequently misunderstood area. The position is relatively
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straightforward where a contract incorporates a PILON clause. The
However, where a contract is fundamentally breached, employers
Income and Corporation Taxes Act 1970 stipulates that where a
will not be able to rely upon any ongoing clauses within that
payment is made in the course of employment, the entire payment is
contract, particularly where the breach relates to such fundamental
subject to tax. What that means is that if a payment is made in
terms as pay and notice periods.
accordance with the contract of employment then it will be taxable.
Where a senior level dismissal is necessary, it is highly likely that
Obviously if there is a PILON clause and a payment is made
employers will want to rely upon contractually imposed post-
pursuant to it, it cannot be anything other than an emolument from
termination restrictive covenants. These restrictive covenants may
that employment and, therefore, taxable.
be vital to protect the business interests of the organisation in
Where there is no PILON clause in the contract and an employee
question. So, the point of having a PILON clause is that an employer
has been dismissed with immediate effect for a fair reason such as
can legitimately remove senior employees from the organisation and
redundancy, that employee has a contractual right to a period of pay
in respect of his/her notice period. Making a payment in lieu in the
absence of PILON clause is a breach of contract, so what is in effect
being paid is damages for that breach. Those damages are payable
tax free up to a maximum of £30,000.
Where an employer is going to pay an employee tax free in lieu of
his/her notice period, it is important to phrase the payment in the
correct terms. Nearly all employers will say that what they are
paying is a payment in lieu of notice and confirm this in writing. In
fact, what they are actually paying is compensation for breach of
contract. There is a possibility that a very thorough tax inspector
might argue that where a payment has been negotiated as a
payment in lieu of notice prior to the date of termination (and
particularly where payment is made before that termination) those
negotiations have resulted in a contractual amendment by
agreement so as to introduce a PILON clause into the contract. Once
a PILON clause exists, it is highly likely that where the payment sum
relates directly to the notice period that sum will be taxable. One
way to minimise this risk is always to describe such payments as
applying the monthly equivalents of the limits on the basic and
higher rate bands.
compensation for loss of office and to make the actual payment after
the date of termination.
Does the employer have to pay gross or net salary in lieu
of notice?
What is the applicable rate of tax?
Where an employer is making a payment in the absence of PILON
The only obligation on an employer to deduct tax is to deduct it in
accordance with an employee’s tax code at the point at which the
payment is made.
clause, whether or not it pays the gross or net amount is a point for
negotiation. An employee only has a right to recover net pay if
he/she is successful with a tribunal claim. In most cases, where no
It was previously the case that where the employee had been given
tax is payable in the absence of a PILON clause, an employer is
his/her P45, he/she effectively no longer had a tax code applicable
happy to pay the gross amount because it is no more than it would
to his/her status. The default rate to be paid was the basic rate,
have had to pay in any event. It is also useful to say that the gross
even where the employee was formerly a higher rate tax payer.
amount incorporates any benefits which would otherwise be
However, for PILONs made on or after 6 April 2011, employers now
payable in the notice period.
need to deduct tax using a new 0T code, which does not allow for
any personal allowance, and means that income tax is withheld on a
non-cumulative basis at the basic, higher and additional rates of tax,
Where circumstances arise where an employer only wishes to
provide the legal minimum payment (i.e. the net amount), this is
certainly a hard line to take but it is possible and leads to obvious
savings, although compensation for lost benefits will also need to be
assessing whether or not to pay the employee the net amount
paid.
he/she would otherwise have received or to pay the entire gross
Difficulties emerge when the amount paid is in excess of £30,000
and a calculation has to be carried out in order to ascertain what the
amount as being no more than its liability would have been in any
event.
grossed-up amount of money is to be after tax has been deducted
In most cases where lower grade employees are concerned, who
on the amount in excess of £30,000 so that the employee actually
do not have post-termination restrictive covenants, it is unnecessary
receives the net amount to which he/she is entitled.
to include a PILON clause in their contracts because employers will
What about mitigation?
As the amount payable in the absence of a PILON clause is actually
damages for breach of contract, the usual contractual duty of
mitigation is applicable. It is usually only appropriate to start having
these arguments where the notice period is, for instance, over six
months, because a Court would not necessarily expect a dismissed
employee to mitigate his/her losses immediately and may give up to
six months’ contractual loss as a fair period. If an employer knows
not be seeking to enforce post-termination restrictive covenants.
This is intended to be a general guide to payments in lieu of
notice and is not a substitute for taking advice before reaching
a decision on individual circumstances. If you would like any
further information on this issue please contact a member of
the Employment Group.
Jane Byford, Partner and Head of Employment
T: 0800 763 1378
that an employee has secured another equally well paid job, starting
immediately, then that employee has fully mitigated his/her loss and
E: [email protected]
the employer could argue that, in the absence of the PILON clause,
no notice money is payable.
Summary
The main advantage to incorporating a PILON clause in an
employee’s contract is so that the employer can rely upon posttermination restrictive covenants to protect its legitimate business
interests and also to remove the employee from the business with
immediate effect rather than requiring him/her to work his/her
notice period.
The knock on tax implications are generally that where a PILON
clause is present, the payment will be taxable. However, where a
payment is made in the absence of a PILON clause, it is usually safe
to assume that the amount will be payable tax free up to a limit of
£30,000. The only difficulty for most employers will come in
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