Payment in lieu of notice, usually shortened to PILON, is your employer ending your employment straight away and paying you for the notice you would otherwise have worked. It is common, it is often the outcome everyone prefers, and the tax treatment changed significantly in 2018 in a way that still catches people out when they read their settlement figures.
Your employer needs the right to do it
A PILON clause in your contract gives the employer an express right to terminate immediately and pay instead. If that clause exists, using it is simply the contract operating as written.
If there is no such clause, ending your employment on the spot is a breach of contract. The money you receive is compensation for that breach rather than a contractual payment. In most cases you are no worse off financially, so it rarely turns into a dispute on its own. It can matter for one reason though: where an employer breaches the contract, post-termination restrictions in that same contract may become unenforceable. If your contract carries non-compete or non-solicitation clauses and you have been walked out without a PILON clause, that is a point worth taking proper advice on rather than assuming either way.
What the payment has to cover
GOV.UK states that a payment in lieu should give you all of the basic pay you would have received during the notice period, plus anything else your contract provides, such as employer pension contributions or private medical cover.
What it does not automatically include is discretionary bonus, or commission you had not yet earned, unless the contract says otherwise. Read the PILON clause itself, because clauses vary a lot on exactly which elements they capture. Some are drafted as basic salary only, deliberately.
The tax position since April 2018
There used to be a route by which a non-contractual payment in lieu could fall inside the £30,000 termination payment exemption and escape tax. That route closed on 6 April 2018 with the introduction of post-employment notice pay, or PENP.
The effect is straightforward once you see it. HMRC now works out how much of any termination package represents notice you did not work, and that slice is taxed as ordinary earnings whatever the package calls it. Labelling it compensation, ex gratia or a severance payment makes no difference.
| Element of a termination package | Income tax | National Insurance |
|---|---|---|
| Statutory redundancy pay | Covered by the £30,000 exemption | No |
| Enhanced severance and non-cash benefits | Only above the combined £30,000 | Employer Class 1A above £30,000 |
| Payment in lieu of notice | Yes, in full | Yes |
| Holiday pay | Yes, in full | Yes |
| Unpaid wages | Yes, in full | Yes |
The £30,000 figure is a combined allowance across statutory redundancy pay, enhanced severance and non-cash benefits. It is not a separate £30,000 for each element, and it is not an allowance you can point at a PILON.
How PENP is actually calculated
The formula sits in section 402D of the Income Tax (Earnings and Pensions) Act 2003, and HMRC's Employment Income Manual sets it out as:
((BP × D) ÷ P) − T
- BP is your basic pay in the last full pay period before the trigger date.
- D is the number of calendar days in the notice period you did not work.
- P is the number of calendar days in that last pay period.
- T is any part of your termination package already taxable as earnings, such as a contractual PILON.
If the result comes out negative, PENP is nil. It is also capped at the total of the relevant termination awards, so it can never exceed the money you actually received.
A worked example
Someone on £48,000, paid monthly at £4,000, with three months' notice. They are dismissed without working any of it and offered a £40,000 package described as compensation for loss of office, with no contractual PILON clause.
- BP is £4,000, the basic pay in the last monthly pay period.
- P is 30, the days in that pay period.
- D is 91, the calendar days of unworked notice.
- T is nil, because nothing else in the package is already taxed as earnings.
- PENP = (£4,000 × 91) ÷ 30 = £12,133.33.
So £12,133.33 of the £40,000 is taxed as earnings, with income tax and National Insurance deducted through payroll. The balance of £27,866.67 sits under the £30,000 exemption and comes to them free of income tax and employee National Insurance.
Had the package been £60,000 instead, the PENP would still be £12,133.33, £30,000 would still be exempt, and the remaining £17,866.67 would be taxable, with the employer liable for Class 1A National Insurance on it.
Two things people get wrong
The first is assuming a settlement agreement changes the tax. It does not. A settlement agreement is a contract that stops you bringing claims. It cannot make notice pay tax free, and a solicitor advising on one will say the same.
The second is what date your employment actually ends. With a PILON, it usually ends immediately, which starts the clock on employment tribunal time limits straight away rather than at the end of the notional notice period. For some statutory purposes the relevant date can be treated as the date statutory notice would have expired, which occasionally tips someone over another complete year of service. If you are close to an anniversary, or close to a deadline, ACAS on 0300 123 1100 is the right first call and early conciliation has to be started before a tribunal claim in any case.
Checking the figures yourself
Work out what your notice period actually is before you look at anything else, because every figure above depends on it. Use the notice period calculator and compare it with the contract, then check that the package covers the full notice length and not a rounded-down version of it. If your employer has chosen to have you serve the notice at home instead of paying it out, our garden leave article explains how that differs.
This page is general information about how payments in lieu of notice work in England, Wales and Scotland, not legal or tax advice, and Northern Ireland differs in places. Termination packages of any size are worth running past a solicitor, and for a settlement agreement to bind you the law requires independent advice anyway, which the employer usually contributes towards.