Payment in lieu of notice (PILON)

Offered a lump sum instead of working your notice? Since 2018, how that payment is taxed no longer depends on what your settlement letter calls it.

Is a payment in lieu of notice always taxed in full?

Since 6 April 2018, the post-employment notice pay (PENP) rules mean the basic pay you would have earned during any unworked notice period is treated as taxable earnings, subject to income tax and National Insurance in the normal way, regardless of how the payment is labelled in your settlement or termination letter.

Does the £30,000 tax-free exemption apply to a PILON?

No. The £30,000 exemption that can apply to genuine compensation for loss of employment does not apply to post-employment notice pay. PENP is carved out and taxed as normal earnings first, and only the remaining part of a termination payment, if any, can potentially benefit from the £30,000 exemption.

What is the difference between a contractual PILON and PENP?

A contractual PILON clause simply gives the employer the right to end employment immediately and pay in lieu of notice instead of requiring the employee to work it. PENP is the separate tax calculation used to work out how much of any termination payment counts as taxable notice pay, and it applies whether or not the contract contained a PILON clause.

How is PENP actually calculated?

In broad terms, PENP compares your basic pay for the period you would have worked as notice against any contractual notice payment already being treated as earnings, using a formula set out in the tax legislation. The result is the amount treated as post-employment notice pay and taxed accordingly.

Does PENP apply if my employer makes me work my full notice?

No. PENP only arises where there is an unworked period of notice being paid off — if you work your full notice period in the normal way, your pay for that time is simply ordinary earnings, taxed as usual, and the PENP rules have nothing to bite on.

Is a payment in lieu of notice the same as garden leave?

No. On garden leave you remain employed and are paid as normal during your notice period, simply not required to attend work. A payment in lieu of notice instead ends the employment immediately, with a lump sum paid instead of requiring any notice period to be worked at all.

Does a PILON affect continuity of employment for other statutory rights?

It can. Ending employment immediately with a PILON, rather than working notice, generally brings the employment relationship to an end on that earlier date, which can affect calculations such as length of continuous service for other statutory purposes — worth checking carefully where service length is close to a threshold.

What a PILON is and when it is used

Rather than requiring an employee to work out a full notice period, many employers instead end the employment immediately and pay a lump sum covering what the employee would have earned during that notice period. This is common where an employer wants a clean break — for example after a dismissal, a redundancy, or as part of a settlement agreement — without the practical or reputational complications of an employee working through their notice.

The PENP rules: why wording no longer avoids tax

Before April 2018, whether a payment in lieu of notice was tax-free often turned on technical drafting — whether the contract contained an express PILON clause, and how the payment was labelled. The post-employment notice pay rules, introduced by the Finance (No.2) Act 2017, largely closed that route. They deem an amount equal to the basic pay for any unworked notice period to be taxable earnings, taxed in full alongside employer and employee National Insurance, regardless of whether the contract had a PILON clause or what the payment is called in a settlement agreement or termination letter.

Critically, the usual £30,000 tax-free threshold for genuine termination payments does

apply to this portion — PENP is carved out and taxed first, before the exemption is considered for whatever, if anything, is left.

How PENP is calculated

The calculation broadly compares the employee's basic pay for the period of notice they did not work against any amount already being treated as earnings under the contract for that period, using a statutory formula based on basic pay, the length of the unworked notice period, and the employee's usual pay period. The result is the amount taxed as post-employment notice pay; only genuine compensation on top of that — for example damages for other losses arising from the termination — can potentially still benefit from the separate £30,000 exemption.

PILON clauses versus no clause at all

Whether a contract contains an express PILON clause used to matter far more than it does now. Without one, an employer ending employment immediately and paying instead of notice was, strictly, in breach of contract — though the practical effect on tax treatment today is limited, since the PENP rules tax the unworked notice element in much the same way whether or not a PILON clause exists.

A clear PILON clause still matters for other reasons: it can set out how the payment is calculated, confirm the employer's right to end employment immediately without being in breach, and clarify whether benefits such as pension contributions or bonus accrual continue during the notice period being paid off.

An employee with a basic monthly salary of £3,200 and an eight-week contractual notice period is dismissed with immediate effect and offered a settlement including a payment in lieu of the full eight weeks. Under the PENP rules, the amount representing that eight weeks of basic pay is treated as taxable earnings and taxed in the normal way, including National Insurance — it makes no difference that the settlement agreement describes it as "compensation." Only any additional sum genuinely compensating the employee for something beyond the unworked notice period can potentially be set against the separate £30,000 exemption.

Settlement agreement

HMRC Employment Income Manual — post-employment notice pay

Payment in Lieu of Notice (PILON) — Employment Tribunal Glossary

What a payment in lieu of notice is, how the post-employment notice pay (PENP) rules tax it since 2018, and how it differs from garden leave.