A Guide to PILON and When to Use It

Posted on 5 March 2024 by IRIS FMP

In the United Kingdom, Payment in Lieu of Notice – or PILON for short – is used when an employee’s relationship with their employer is terminated immediately. It excuses the employee from working their notice period by giving them an acceptable payout.

PILON is covered by the Employment Rights Act 1996 and is typically used following redundancy or dismissal for gross misconduct. It is often applied when it would be detrimental or unfavourable for an employee to work through their notice.

What is PILON?

PILON allows an individual’s employment to be terminated immediately, so they are not required to complete or work their notice period. The employee receives a suitable compensation payment equal to the amount they would have earned, including benefits, had they worked their full notice.

Payment in lieu of notice can apply to several different types of dismissal such as dismissal for gross misconduct, redundancy, or as part of an employee’s negotiated exit. Therefore, it is vital that employers pay close attention to PILON regulations and meet their legal obligations. If they don’t, an employee could launch a tribunal claim against the employer.

PILON should be covered by an employee’s contract of employment. Where it is not, the payment should cover any potential damages for the employer breaching the contract that subsequently arises from an employee’s termination without giving notice.

Who is entitled to PILON?

people discussing in a meeting

Any individual legally classed as an employee in the UK could be entitled to PILON. With that in mind, employers must pay attention to clearly defined rules around statutory notice periods for redundancy under UK Employment Law. These rules refer to a minimum notice period an employer must provide for employees. These include:

  • At least one week’s notice for anyone employed between one month and two years.
  • One week’s notice for each year of employment between two and 12 years.
  • Twelve weeks’ notice for anyone employed for 12 years or more.

Some employees may be entitled to a longer notice period than the statutory requirement if the terms of their employment contract say so. This is referred to as ‘contractual’ or ‘enhanced’ notice, where contractual notice cannot be shorter than an employee’s statutory entitlement. Similarly, employers can also offer longer notice periods than the statutory requirement to allow themselves more time to find a replacement hire and give an employee more time to find alternative work.

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How does PILON work in practice?

Circumstances can arise where it is preferable for an employer to have an employee off the premises, or locked out of work systems, because of the potential harm they may cause. For example, there may be a risk of the employee sharing confidential information if they remain on company property, despite any confidentiality clause that may exist in their contract. In such a case, payment in lieu of notice may be offered to an employee as a solution.

Similarly, other employers may offer PILON out of kindness to an employee who wishes to leave the business but is unable, or unwilling, to serve their notice period and where gardening leave cannot be applied, for instance, following redundancy. However, in the absence of a PILON clause in an employee’s contract, a company could be in breach of contract if the worker isn’t offered a satisfactory compensation payment.

As you can see, PILON can be complex for businesses to navigate, and many prefer to enlist the services of HR experts to guide them through the process. Employers should also review employment laws, contracts, and seek legal advice to ensure they fully comply with PILON and any legal requirements relating to employee termination and notice periods. In the same way, employees should always review their own contracts and consult with legal professionals to understand their rights and entitlements.

Employers should always:

1. Check the terms and conditions of an employee’s contract

An employee’s contract should clearly state if they are entitled to PILON, and when it is applicable. This could refer to the date when notice of termination is issued, the date when PILON is made, or when an employee’s notice period was due to end.

2. Provide a written notice of termination

An employer must provide an employee with written notice when they intend to offer a payment in lieu of notice. The written notice officially marks the termination of employment and their contract, and they are free to seek work elsewhere. However, even though employment has effectively ended, the employee may still be bound by contractual obligations and confidentiality. For instance, the employee may be excluded from joining a rival company, taking other colleagues with them, or exploiting client contacts.

In other circumstances, an employee may request a PILON if they resign and prefer to leave immediately without serving their notice period. An employer may also agree to PILON even when it isn’t included in an employee’s contract. There is no obligation to agree to PILON here, particularly if it would leave the employer short-staffed.

What does PILON cover?

When a contract includes a PILON clause there are several areas that should be covered to protect both the employer and employee. These include:

  • When a PILON clause will be enacted (for example, in the case of immediate dismissal.)
  • What the specific terms of PILON are (for example, how and when payments will be made.)

It is advisable that all employment contracts include details of PILON, although many contracts do not. The contract should clarify the terms of payment in lieu of notice including what has been considered when calculating PILON. For example, this could cover an employee’s basic pay but exclude benefits in kind, pension or private health care contributions, bonuses, or commission payments, including those that would have been earned during a normal notice period, had the employee been required to serve it.

However, PILON does not have to include annual leave allowances that would have been accrued during the notice period, unless this is clearly stated in the terms and conditions of their contract.

What if PILON is missing in an employee contract?

If PILON isn’t included in an employee’s contract but is still offered by the employer, the employee should receive full pay plus any additional contributions they would normally receive, such as pension contributions and holiday pay.

Importantly, where an employment contract does not include PILON, it is unlikely the employer will be able to terminate the contract with immediate effect without a notice period. Doing so may place the employer in breach of contract.  Similarly, it is unlikely PILON will be offered when an employee is dismissed for gross misconduct.

When is it right to offer PILON?

two people talking about specific matters

An employer may terminate an employee’s contract without them working their notice period for many reasons. They may want to deny the employee access to company systems, the employee could become disruptive, or they have requested to leave immediately without working their notice.

PILON may be justified in many situations, including:

1. Immediate termination of contract

If an employee has committed a serious breach of contract, such as gross misconduct, an employer may make a PILON payment and immediately terminate a contract, thus avoiding further disruption or damage to the business.

2. Constructive dismissal cases

Where an employer has breached an employment contract or engaged in conduct that has undermined an employee’s trust and confidence, the employee may have the right to resign and claim constructive dismissal. Here, PILON may be offered to the employee to avoid an unfair dismissal claim.

3. Contractual obligations

If an employment contract explicitly includes PILON, it is possible to make such a payment. An employee can agree to the inclusion of a PILON clause which gives their employer the right to follow the process through rather than offer a notice of termination.

4. Mutual party agreement

Employers and employees can mutually agree to a PILON and the immediate termination of a contract. This can be a preferred option for both parties as it will negate the need for expensive legal action or a lengthy notice period.

5. Business restructure

PILON may be offered by businesses going through a restructure or downsizing to avoid redundancy procedures and payments, or to provide financial compensation to employees who would be negatively affected by the changes being proposed.

What is the difference between PILON and gardening leave?

Many consider PILON and gardening leave to be similar, but they are very different. Under PILON, an individual’s employment contract is terminated immediately, and the employee receives payment for what they would have earned during their notice period. It also means the relationship between employer and employee ends immediately, and the employment contract is no longer binding, allowing the employee to seek alternative work.

However, gardening leave means that although an employee doesn’t work through their notice period, they are still technically employed by the company but are not required to go to work. During gardening leave the employee will continue to be paid, including benefits, in the usual way.

Is PILON pensionable?

people in a meeting

Under PILON, employees can receive additional payments including pension contributions or private health care insurance if these are written into the employment contract. These payments are in addition to the basic salary they would have received during their notice period.

Pensionable pay is that which an employee would normally pay pension contributions on such as salary, bonuses, or overtime. However, employees are not required to make pension contributions themselves on a one-off payment, such as PILON.

Is PILON taxable?

Yes, PILON is taxable, although calculations can be complicated. Employees are required to pay income tax and Class 1 National Insurance Contributions on any basic pay they would be entitled to if they remained in employment during their notice period. This is referred to as PENP (Post-Employment Notice Pay). Any additional payment to PENP is classed as termination pay and taxed accordingly.

Basic pay includes any amount an employee would be deducted through a salary sacrifice scheme. It does not include benefits, overtime payments, commission, or statutory redundancy payments, or even contractual redundancy payments, which are classed as termination payments.

The first £30,000 of any termination payment including redundancy is not taxable and not subject to employee National Insurance Contributions.

Does your company need help with PILON calculations?

At IRIS FMP, our international payroll services take care of your PILON provisions so that your business follows PILON regulations and remains fully compliant. Contact us today