What is PILON? A Guide to Payment in Lieu of Notice

In most employment contracts, there is a notice period – the time an employee or employer must give before ending the employment relationship. This allows for a smooth transition, handover of responsibilities, and time for both parties to adjust.

However, there are situations where an employer may prefer not to keep an employee working through their notice. Instead, they can bring the contract to an end immediately and provide a compensatory payment. This is known as PILON, or Payment in Lieu of Notice.

PILON is a common feature in UK employment law and can appear in both standard contracts and negotiated settlement agreements. It’s important for both employers and employees to understand how it works, because it affects contractual rights, final pay calculations, and even tax treatment.

In this post, we will cover:

• What PILON means and how it differs from working a notice period.
• The circumstances in which employers might use PILON.
• The legal and tax implications of making or receiving a PILON.
• How employers can structure PILON properly to avoid disputes.
• What employees should look out for when offered PILON.

By the end, you’ll understand the essentials of Payment in Lieu of Notice and how it can impact both sides of the employment relationship.

Tip: PILON can only be paid lawfully if the employment contract includes a PILON clause, or if it is agreed as part of a settlement. Otherwise, the payment may be treated as damages for breach of contract – which can carry different tax implications.

Useful resource: ACAS – Notice periods

What is PILON?

PILON stands for Payment in Lieu of Notice. It is a mechanism that allows an employer to bring an employee’s contract to an immediate end, rather than requiring the employee to work through their notice period. Instead of working, the employee receives a payment equal to what they would have earned during that period.

How It Works

• If an employee’s contract specifies a one-month notice period, they would normally continue working for that month after resigning or being dismissed.
• With PILON, the employer ends the contract immediately but pays the employee one month’s salary (plus any benefits owed under the contract) in place of that notice period.

Example

• An employee’s contract states a 1-month notice period.
• On 1 July, the employer terminates the contract and makes a PILON payment of one month’s salary.
• The contract ends immediately, and the employee is not required to work in July, but they receive pay as if they had.

Key Points

• PILON is not the same as garden leave. On garden leave, the employee remains employed and continues to receive pay and benefits while not working, until the end of their notice. With PILON, employment ends straight away.
• PILON can only be paid lawfully if the contract includes a PILON clause or if both parties agree (such as in a settlement agreement). If not, the payment may be treated as compensation for breach of contract.

Useful link: UK Government – Ending employment: notice periods

When is PILON Used?

Employers typically use Payment in Lieu of Notice (PILON) when it is not practical, desirable, or safe for an employee to continue working through their notice period. Instead, the contract is ended immediately, with the employee receiving payment for the period they would otherwise have worked.

Common Situations Where PILON is Used

Sensitive Roles or Confidential Information

For employees with access to sensitive data, intellectual property, or client relationships, employers may prefer to end the contract immediately to protect the business.

Example: A senior sales manager leaving to join a competitor may be paid PILON rather than serving their notice while still accessing client databases.

Redundancy or Business Restructure

When roles are being made redundant, businesses often want a clean break. PILON avoids the awkwardness of keeping employees at work when their role is ending.

Avoiding Workplace Disruption

If the employment relationship has broken down, keeping the employee in the workplace during their notice could cause tension or risk to morale. Paying PILON allows for an immediate and smoother exit.

Efficiency and Certainty

Employers may wish to finalise matters quickly and allow both parties to move on without the delay of a full notice period.

Key Considerations for Employers

• The contract should contain a PILON clause to avoid the risk of breach of contract claims.
• PILON must include not just basic salary, but also any benefits and contractual entitlements that would have accrued during the notice period (such as pension contributions, car allowance, or bonuses, if applicable).

Tip: If a contract does not have a PILON clause, paying PILON may be treated as damages for breach of contract, which can affect whether tax and National Insurance apply.

Useful resource: ACAS – Notice periods and termination

Is PILON the Same as Severance Pay?

No. Payment in Lieu of Notice (PILON) is not the same as redundancy pay or severance pay. While all three involve payments made when employment ends, they serve very different purposes.

Key Differences

• PILON: Compensation for the employee’s contractual notice period. It ensures the employee receives the pay they would have earned if they had worked their notice.
• Redundancy Pay or Severance Pay: A separate entitlement or negotiated sum, usually based on length of service, age, and the reason for termination. Redundancy pay is a statutory right in certain cases, while severance pay may be an additional, discretionary payment.

Example

• An employee with five years of service has a one-month notice period.
• If dismissed, the employer could make a PILON payment of one month’s salary.
• If the dismissal is due to redundancy, the employee may also be entitled to statutory redundancy pay (or enhanced redundancy under their contract). This is in addition to the PILON.

Why the Distinction Matters

• Employers must not assume that PILON covers redundancy or severance obligations – they are separate entitlements.
• Employees should understand what they are being offered to avoid missing out on payments they are legally due.

Useful resource: UK Government – Redundancy pay and rights

How is PILON Taxed?

The tax treatment of Payment in Lieu of Notice (PILON) is a key area where confusion often arises. Unlike some termination payments, PILON is generally treated as ordinary earnings.

Tax Treatment of PILON

• Income Tax: PILON is subject to Income Tax at the employee’s usual rate (20%, 40% or 45%, depending on their tax band).
• National Insurance Contributions (NICs): Both employer and employee NICs are due, just as if the salary had been paid through normal employment.
• PAYE: Employers must process PILON through their payroll system and deduct tax and NICs at source before making payment to the employee.

How This Differs From Redundancy Payments

• PILON is always taxable in full, as it represents salary that would otherwise have been earned.
• Statutory redundancy pay (and certain approved termination payments) can benefit from a £30,000 tax-free allowance, with tax only applied to amounts above that threshold.

Example

An employee earning £3,000 a month is dismissed with a one-month notice period.

• If the employer pays PILON of £3,000, it will be subject to PAYE tax and NICs, reducing the net payment to the employee.
• If the same employee also qualifies for statutory redundancy pay of £5,000, that redundancy payment is tax-free (because it falls within the £30,000 allowance).

Tip: Employers should make sure PILON is clearly itemised on the final payslip. This avoids confusion with redundancy or severance payments, which may have different tax treatment.

Useful resource: HMRC – Tax on redundancy payments