Pay in lieu of notice is now taxable
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Pay in lieu of notice (PILON) is a payment made to an employee when employment is terminated without notice, instead of the employee working through a notice period and receiving pay in the normal way. It is different from ‘garden leave’, in which the employee is still in employment during the notice period and is paid during that period, even though he or she is not present at work.
Under the previous rules (which still apply where the termination date was before 6 April 2018, even if the payment is made after that date), whether or not a payment in lieu of notice was taxable depended on the terms of the employee’s contract.
If the contract of employment contained an express clause allowing the employer to pay the employee in lieu of notice, the payment represents wages and would, therefore, be subject to tax and national insurance contributions.
If the contract of employment didn’t contain an express payment in lieu of notice clause, but the employer’s custom and practice was always to pay in lieu, such a term may have been implied into the contract of employment and any resulting payment in lieu may have been taxable.
However, if there was no payment in lieu of notice contract clause, and there was no risk of there being one implied, the payment could be regarded as compensation for a breach of contract (the failure to give the employee his or her contractual notice) and the first £30,000 will be tax-free.
But, as of the 6th April 2018 the rules have changed, so all PILON made in respect of employment that terminated on or after that date is subject to tax and national insurance, regardless of whether the employment contract provides for PILON or not.
Employers must now calculate what the employee’s basic pay would have been had he or she worked the notice period, using a formula set out in the legislation. Where a termination payment is greater than this amount, the £30,000 exemption can apply to the remainder.
If you need help or advice on the matter of payments in lieu of notice call us on 01386 751740.