When an employee exits an organisation, one area that frequently causes confusion is payment in lieu of notice (PILON) and if not applied correctly, it can lead to breach of contract claims, tax errors and costly disputes.
For many employers, questions often begin with: What is PILON and how does payment in lieu of notice work? This practical guide explains what PILON is, when it applies and how to calculate payment in lieu of notice. It also highlights the key risks employers face if they get it wrong under UK employment law.
What is Payment in Lieu of Notice (PILON)?
Payment in lieu of notice (PILON) is a payment made to an employee instead of requiring them to work their contractual or statutory notice period. It allows employment to end immediately while compensating the employee for the pay they would have received had they worked their notice.
For employers managing payment in lieu of notice, it is important to understand how contractual rights and tax obligations apply.
When is Payment in Lieu of Notice Used?
Payment in lieu of notice allows employers to manage swift exits while reducing legal and operational risks. It is often used when:
- There is a breakdown in trust or confidence, such as concerns about misconduct.
- The employee has access to sensitive information and a lengthy notice period could pose a business risk.
- A clean and immediate exit is required to maintain operations and team morale.
In many employment situations, payment in lieu of notice is used to avoid disruption while remaining compliant with contractual obligations.
Contractual vs Non-Contractual Payment in Lieu of Notice
A contractual PILON clause allows the employer to terminate employment immediately. The clause should clearly specify when payment in lieu of notice can be used and what payment is included. It can also limit the portion of the total pay that counts toward basic salary by excluding other payments, such as commission and bonuses. Contractual PILON clauses are recommended to help employers avoid breach of contract claims.
Without a PILON clause, making a payment in lieu of notice upon dismissal may constitute a breach of contract. This is more likely where the employee would have been entitled to other benefits during their notice period, as well as pay, and it can particularly be an issue where the employee would have earned commission or bonuses had they been in work. This approach carries a higher legal risk and may lead to claims if not handled correctly. To manage risks, employers often combine non-contractual PILON with settlement agreements.
How to Calculate Payment in Lieu of Notice
If the employment contract includes a PILON clause, the payment should be calculated in accordance with the contract terms. Some clauses will specify that payment in lieu of notice includes only basic pay and excludes the value of any non-contractual benefits or bonuses.
If there is no contractual clause, the payment should be calculated based on the value of the employee’s pay and other benefits they would have received had they worked the notice period.
Under UK tax rules, payment in lieu of notice is considered taxable earnings and is subject to income tax and National Insurance deductions, whether contractual or not. Payment must be processed correctly through payroll in line with HMRC requirements. Benefits such as health insurance or pension contributions may have separate tax rules.
Employer Risks of Getting it Wrong
Even a straightforward exit can cause implications for employers if:
- Payment in lieu of notice is applied without a contractual right.
- Notice periods are miscalculated.
- Tax is handled incorrectly.
- There is a failure to clarify what PILON covers.
- Restrictive covenants that may be affected by breach of contract are overlooked.
It is crucial for employers to calculate and report payment in lieu of notice correctly. As well as damaging employee relations, getting it wrong can expose employers to penalties, back taxes, interest payments and HMRC scrutiny.
Expert HR Advice on Payment in Lieu of Notice
If you’re an employer handling terminations and payment in lieu of notice, taking expert guidance can save time, reduce costs and minimise legal risks. If you are unsure about what PILON is or how the rules apply under UK employment law, professional support can reduce the risk.
Contact EML’s HR experts on 01942 727200 or email enquiries@employeemanagement.co.uk to find out how we can support you.