What is Payment in Lieu of Notice?

Sometimes, employers may need to let people go from their business.

When they do, they must give them any pay rights they're owed. This includes payment in lieu of notice (PILON).

PILON has many legal rules linked to it. If you ignore them, you could face serious business damages and fines.

In this guide, we’ll look at what PILON is, who receives it, and how to work out the payment. Peninsula offers expert advice on any HR issue you have, contact us today for more information and stay compliant.

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What is PILON?

Payment in lieu of notice (PILON) is given to an employee when you don't need them to work for you anymore.

Firstly, the employer informs the individual that their job is being terminated immediately. This must only be done after following a fair dismissal procedure. Payment in lieu is offered instead of a notice period.

There are many reasons why an employer chooses to use payment in lieu of notice. But it's usually because an employee's work contract has to end. For example:

• When you let them go to protect sensitive company information.
• When their continued employment causes discomfort for other team members.
• When they resign through a negotiated agreement.

When do you give PILON?

Employers give payment in lieu when an employee resigns or is let go from their job.

Usually, the employee has a statutory or contractual right of a notice period. The length will depend on how long their continuous employment is:

• One month or more: At least one week’s notice.
• Between one month to two years: One week's notice per year.
• Two to twelve years: One week’s notice per year (limited to twelve weeks).

For example, an employee has worked for one year; so, they're entitled to one week of notice.

But if an employee signs a PILON clause, their full notice period may not count. The contractual clause will say how much pau in lieu they'll receive.

A PILON clause only covers salary; it doesn’t cover other payments. For example, they won’t receive pay for pension contributions.

You must not breach these contractual terms. If you do, you could face compensation payments. Here, any restrictive covenants will not be enforceable as they’re 'no longer binding' in law.

Using payment in lieu of notice during job terminations

PILON is often confused with other termination payments. But it has its own separate rules and rules. Let's look at using PILON during different employment terminations:

Dismissal

You cannot use PILON as a form of dismissal. If you want to end an employee's contract, you'll need to follow the proper rules.

Ending their contract like this could lead to unfair dismissal. (Unless you've dismissed them because of gross misconduct).

Redundancy

PILON and redundancy pay is given together; it's often paid as a lump sum. They're both separate payments but can be paid at the same time. Statutory redundancy pay is tax-free.

You need to have a fair reason for making someone redundant. And you've got to choose them fairly, compared to other employees. Payment in lieu of notice is paid when an employee is made redundant.

Settlement agreement

Most employers add PILON clauses to an employment contract. But they may also add them to settlement agreements.

Normally, such agreements are paid after workplace disputes or redundancy. That's because the employer pays them to leave with immediate effect.

Settlement agreements tend to reduce any hostile behaviours. It also ends the individual's employment contract on a professional note.

Garden leave

PILON and garden leave are often seen together, but they aren't the same. The main difference comes from when the employee actually leaves.

Usually, if an employee gets PILON, they don't need to complete their notice period. They can start working at a new job - unless they're on .

Here, they won’t receive PILON if they’re on garden leave. That’s because they remain technically employed during their notice period.

Employees can look for a new job, but they can’t start them during the garden leave period. Once you offer payment in lieu of notice, their employment has ended.

Is PILON taxable?

It's often thought PILON is tax-free - but that's false. Under UK employment law, the employee has to pay tax on it.

Tax payments are usually made in the same way as basic salary. (Like national insurance contributions or income tax).

You need to work out what the employee's salary would be during their notice period. Then, you'll be able to present payment in lieu of notice and tax deductions.

How do you calculate payment in lieu of notice?

You calculate PILON based on whether an employee earns a salary (monthly or hourly).

The calculation is called post-employment notice pay (PENP). To work out PENP, there are two formulas to use:

The simple formula

Sometimes, PENP is higher than the PILON amount, like through tax deductions. Other times, an employee's notice tax amount isn’t higher than PENP. The formula is:

(BP x D) – T

• BP is Basic Pay.
• D is an unworked notice period (PENP).
• T is taxable earnings during termination.

Example 1:

Employee A is paid £3000 (monthly) and has a three-month notice period (with no PILON clause). They’ve worked for one month of their notice period. And their employer gives a relevant termination award (RTA) of £10,000.

PENP: (£3000 x 2 months) – 0 = £6000.

The complex formula

Here, the notice period is calculated in weeks. Or when an employee works part of their notice, rather than all of it. The formula is:

(BP x D) / P – T

• BP is basic pay: It’s the last pay period that ends when notice is given.
• P is the paid period.: It’s the number of days in the pay period.
• D is the unworked notice period (PENP).
• T is taxable earnings during termination.

Example 2:

Employee A gets £1000 every two weeks and has an 8-week notice period (with no PILON clause). They’ve worked three weeks of their notice period. And their employer decides to give a relevant termination award (RTA) of £5000.

PENP: (£1000 x 35) / 14 days – 0 = £2500.

Because PENP is lower than RTA in both examples, it’s considered as earnings and therefore taxable.

How to manage payment in lieu of notice in the workplace

It’s important for employers to follow the right rules when it comes to PILON.

That way, you'll be able to comply with legal needs, as well as employee ones. Let's take a look at ways to manage payment in lieu of notice in the workplace:

Include clauses to individual employment contract

The first step to take is to include a PILON clause to every employment contract.

You can make the decision to start including them to new employment contracts. But, if you want to amend a current contract, you need to follow a consultation process with the employee.

If not, the employer could be in breach of their contract. And the employee may raise this as a tribunal claim.

Outline pay rules in your policy

You should add your rules on PILON payments to your contract policies.

Make sure you outline what it is, how it's calculated, and when it's given. These rules should be clear and made available to every employee. It's also important to have unambiguous terms in their contract, as well.

Remember, the position will change based on how you're ending an employee's employment contract. For example, if they're on garden leave or if you're making them redundant.

Calculate the payment amount

Usually, employees will receive a different amount of payment in lieu of notice.

Make sure they know how it's calculated, according to their contract terms. You'll need to cover basic pay, including non-cash benefits (like holiday pay or commission payments).

You'll also need to consider any tax deductions, like National Insurance and Income Tax deductions. And any other termination payment when ending their job contract.

Be understanding during terminations

You might have to end an employee's contract for many reasons. Some might even be out of your control. That's why it's important to be understanding during these times.

Make sure you protect employee wellbeing and welfare. Give them as much information about ending their contract as possible. You can even offer them referrals to external support, like career counsellors.

Get expert advice on payment in lieu of notice with Peninsula

When you want to end employee contracts, you need to do it with great care.

For an employer, this means following all the correct legal procedures. If you fail to do this, you could end up facing fines or letting employees go unfairly.

Peninsula offers expert guidance on payment in lieu of notice (PILON). Our teams provide bespoke HR documentation and contract services. We can help with everything; from notice periods to terminating an employee’s employment contract legally.

Our 24/7 HR advice is available 365 days a year; with multi-lingual support and fully trained counsellors ready to help. Contact us on 0800 028 2420 and book a free consultation with an HR consultant today.