Tax and Payments in Lieu of Notice

November 16, 2016


Tax and Payments in Lieu of Notice

Many employment contracts contain provisions which enable the employer, without breaching the contract, to pay salary in lieu of notice when terminating an employee’s contract.  These clauses are generally known as PILONs (Payments in Lieu of Notice).  But for such provisions, an immediate termination of contract followed by a payment in lieu of what the employee would have earned during the notice period would probably constitute a breach of contract by the employer.

When agreeing to make a final payment to the employee as part of a deal to close the book against any litigation, the tax treatment of compensation becomes of considerable significance.  The first £30,000 paid as compensation for loss of employment (and not as a contractual right) is exempt from tax.

However, where there is a PILON clause, the argument runs that any payment made pursuant to this clause is not compensation for loss of employment but in pursuit of a contractual right to make and receive such payment.  Thus, HMRC treats the compensation attributable to the notice period where there is a PILON clause as being taxable and subject to NI.

As is inevitable, much litigation has ensued as to what provisions amount to PILONs and what do not.

All this is due to change.  As part of a government review into various aspects of tax and termination, it is proposed that, as from April 2018, it will cease to matter whether a contract contains a PILON provision or not.  In future, any payment made in lieu of notice will be treated as earnings and subject to tax and NI.

The result of this change will almost certainly result in the average employee receiving far less than he or she would have done previously.  Most compensation packages for those who are not high earners are currently made up with a substantial proportion of what would have been notice payments.

If you need advice on any aspect of Employment law, please contact Julian Freeland at our Oxford office on 01865 244661.

posted by Julian Freeland | November 16 2016