In my role as a settlement agreement solicitor I advise and represent employees in the resolution of claims and disputes with their employer, in many cases a 'Payment In Lieu Of Notice', a PILON is arranged.

A PILON is a payment made by an employer to an employee that covers the period of notice the employee would otherwise have worked. Instead of working their notice period, the employee's employment terminates immediately, and they receive a lump sum payment equivalent to their salary and benefits for that notice period. It’s essentially a contractual term or an agreement that allows for a swift exit, benefiting both parties in different ways.

When Can a PILON be Agreed?

A PILON can be agreed upon in several scenarios:

Contractual PILON Clause: The most straightforward circumstance is when the employment contract explicitly includes a PILON clause. This clause gives the employer the contractual right to terminate employment immediately and pay the employee in lieu of their notice period. In this case, the payment is a contractual entitlement.
Mutual Agreement: Even without a specific clause in the contract, an employer and employee can mutually agree to a PILON. This often happens when an employer wants an employee to leave immediately, perhaps due to sensitive information, a difficult working relationship, or to facilitate a quick transition. The employee might also prefer to receive payment and move on to a new role without delay.
Unfair Dismissal Avoidance: Sometimes, an employer might offer a PILON as part of a settlement agreement to avoid potential claims of unfair dismissal. While not strictly a PILON in the traditional sense, it serves a similar purpose of immediate termination with financial compensation for the notice period.

When Should a PILON be Paid?

Ideally, a PILON should be paid on or very soon after the date of termination. When a PILON clause is invoked, the employment ends on the day the PILON is paid. The payment is designed to compensate the employee for their immediate loss of earnings due to not working the notice period. Therefore, it should be treated as a final payment related to the termination, alongside any accrued but untaken holiday pay and outstanding salary.

Tax Considerations for Employees

The tax treatment of PILONs can be complex and has changed over the years. Historically, if there was no contractual PILON clause, the payment might have been treated as damages for breach of contract and could have benefited from the £30,000 tax-free exemption that applies to certain termination payments.

However, current HMRC rules, specifically since April 2018, have largely harmonised the tax treatment of PILONs. Regardless of whether there's a contractual PILON clause or it's a non-contractual payment in lieu, the full amount of a PILON is generally subject to income tax and National Insurance contributions (NICs). This means it is taxed in the same way as regular earnings.

The Problem with "Next Payroll Run" Promises

Employers often tell employees that their PILON will be processed "in the next payroll run." While this might seem convenient for the employer, it is legally incorrect and problematic for the employee.

A PILON is compensation for an immediate termination of employment. It's not a regular salary payment for work performed. By delaying the payment until the next payroll run, the employer is effectively:

Breaching the spirit of the PILON: The purpose is an immediate clean break with immediate financial compensation. Delaying it means the employee is without the funds they are due for a period they were supposed to be paid for.
Creating potential cash flow issues for the employee: The employee may be relying on this payment for immediate expenses, especially if they are not moving straight into a new role.
Potentially complicating tax matters: While the tax treatment is generally consistent, a delay can sometimes muddy the waters regarding the exact tax period the payment falls into, although this is less of an issue since the 2018 tax changes.

Legally, when a PILON is agreed or invoked, the employee's employment terminates, and the payment should be made at that point or very shortly thereafter, usually within days, not weeks until the next payroll cycle. An expert employment solicitor would always advise that the PILON should be paid on or around the date of termination, as part of the final payment package, to ensure legal compliance and fairness to the departing employee.

I founded Settlement Agreement Expert with the purpose and objective of providing employees with quick, simple and no-cost independent legal review and advisory services. For advice on your situation, including any settlement agreements get in touch today, call 0330 043 8845, email clive@solicitor.help, or request a call back.