Guide
Payment in lieu of notice (PILON): how it works and how it is taxed
Updated
PILON swaps the notice period for money: employment ends now, and the employer pays what the notice period would have earned.
What PILON is
Payment in lieu of notice ends the employment immediately; instead of working (or sitting out) the notice period, the employee receives a payment covering the salary they would have earned in it. Many contracts contain an express PILON clause letting the employer choose this route. Without a clause, paying in lieu is technically a breach of contract, usually a harmless one if the full value is paid, but it can release the employee from restrictive covenants, which is why employers with post-termination restrictions want the clause in writing.
How PILON is taxed
Since April 2018, notice pay cannot be dressed up as tax-free compensation. HMRC's post-employment notice pay (PENP) rules tax the basic-pay value of any unworked notice as ordinary earnings, with income tax and National Insurance due, whether or not the contract has a PILON clause (gov.uk: tax on termination payments). The £30,000 termination exemption only ever applies to genuine compensation beyond notice, such as statutory redundancy pay or an ex gratia sum.
What a PILON typically covers
- Basic salary
- Always: the pay the notice period would have produced. Check whether the clause pays basic pay only or salary plus benefits.
- Benefits and pension
- Only if the contract says so. A basic-pay-only clause lawfully drops car allowances, pension contributions and insurance for the notice period.
- Holiday
- Accrual stops at the termination date, because employment ends immediately. Accrued untaken holiday to that date must still be paid.
- Bonus
- Depends entirely on the scheme rules and the clause; this is the line most often disputed. Take advice before signing anything away.
PILON or garden leave?
With PILON, employment ends now: no accrual, restrictions depend on the drafting, and the ex-employee can start elsewhere (subject to covenants). Garden leave keeps the contract alive to the end of notice. The comparison matters enough that we cover it separately: notice period vs garden leave.
Tax treatment summarised at this page's updated date. Nothing here is tax or legal advice; a settlement agreement should always be reviewed by a solicitor, which is also a legal requirement for it to bind.