Pay in lieu of Notice – When does tax apply?

Making a payment in lieu of notice (PILON) is a way of ending an employment contract with immediate effect meaning that the employee will not work a notice period. An employer will make a payment of the amount that an employee would normally have been paid if they had worked the notice period.

Whether tax is payable on the PILON all depends on the contractual agreement between the employer and the employee and whether it is usual

practice for the employer to make this type of payment.

If under the terms of the contract, the employer has the right to make a payment in lieu of notice then the payment is made as part of the contract and taxable.  The same would apply if it was customary for the employer to make payments in lieu of notice when terminating an employee’s employment regardless of which party chose to give notice to end the contract.

If however, PILON is not covered in the employee’s contract of employment nor customary practice for the employer to make this type of payment, then PILON would be treated as damages for a breach of contract on the part of the employer and so would not be taxable.

Other payments made at the time of leaving such as holiday pay will be taxable as they are a contractual payment.

For more information on PILON please see: http://www.acas.org.uk/index.aspx?articleid=4540