You may have heard references to PILON or ‘pay in lieu of notice’, but wonder what it actually means, when to use it and what the legal implications are. On this page, we will answer all these questions and provide practical examples and best-practice tips. That way, UK&I employers know exactly how this process works in case they want to implement it.
What Is Pay In Lieu Of Notice (PILON)?
PILON is a payment made by an employer to an employee when the employer decides to end the employment immediately, rather than have the employee work their notice period. Instead of remaining employed, the employer terminates the employee’s contract of employment immediately. They pay the employee the amount they would have earned if they had stayed on and served out their notice period.
Employers used PILON when:
- There is a business risk to an employee remaining in the company after they have handed in their notice. Risks can include confidentiality concerns, workplace disruption, or customer loss.
- The employer wants the employee to make a clean, quick exit for reasons other than personnel conflicts.
There are legal reasons why employers must handle PILON very carefully. Ideally, a clause on PILON will be included in the contract, allowing the employer to terminate it immediately and pay in lieu of notice.
PILON is different to other termination-of-contract payments, such as:
- Payment for Unused Holiday: this compensates the employee for any holiday entitlement that they have accrued but not yet taken. Unused holiday must be compensated at the termination of a contract, regardless of whether PILON is involved.
- Redundancy pay: an employee who is being made redundant may receive a payment related to the loss of their job. Employers may pay redundancy pay at the same time as PILON, but this does not affect the notice period.
Legal Requirements of PILON
PILON is not a statutory right. Legally, employers can make a PILON payment if the contract of employment includes a PILON clause or if there is a mutual agreement or settlement with the employee to pay PILON. Employers must meet minimum statutory notice obligations under the Employment Rights Act 1996, which ensure that an employee is paid correctly for the period they are working out notice.
If there is no clause in the contract and no agreement with the employee, terminating employment and making a payment is technically a breach of contract.
Statutory vs. Contractual PILON
PILON is not a statutory right, but continuing to earn money during the notice period that you are working is legally protected, depending on how long you have been working. The law ensures that employers will pay employees correctly for the period they work after the termination of their contract of employment.
Contractual PILON is a clause in the contract of employment that allows the employer to terminate employment immediately and make a payment, rather than allowing the employee to serve their notice. The clause should define the different elements of pay included in a PILON payment. A well-drafted PILON clause protects confidentiality and ensures restrictions are in place to protect a company after an employee leaves.
PILON & Garden Leave: What’s The Difference?
Whereas a PILON payment ends employment immediately, an employee on garden leave remains employed by the company until the end of their notice period. An employee on garden leave will usually still receive benefits and accrue holiday, depending on the contract.
PILON at a Glance
If you are in a rush,
| What is PILON? | A salary payment is made immediately upon termination of a contract, rather than expecting an employee to serve their notice. |
| When is PILON used? | Companies make PILON payments when they do not want their employees to remain employed after contract termination. There is usually a significant business risk involved in the employee continuing to be employed. |
| What is the legal requirement for PILON? | A PILON payment must accurately reflect the salary that would have been paid to the employee if they had remained employed. To avoid a breach of contract claim, the contract of employment should cover PILON payments, or there should be a mutual agreement in place. |
| Is PILON a statutory right? | There is no statutory right to PILON. However, legally, employers must honour statutory notice periods. |
| What is the contractual definition of PILON? | The contractual definition of PILON is the clause in the contract that defines when and how a company will terminate employment immediately and pay out the notice period. |
| What are the tax rules for PILON? | PILON payments constitute normal earnings and are taxed accordingly (PAYE and national insurance). |
| Do PILON payments include holiday and benefits? | The specifics included in a PILON payment will depend on the details outlined in the contract clause. |
| How does PILON link to restrictive covenants? | PILON payments can support the enforcement of restrictive covenants if handled correctly. |
| What are the risks with PILON payments? | Mishandling a PILON payment can lead to a risk of breach of contract, reputational damage and loss of enforceable restrictions. |
When Should Employers Use PILON
Employers should only ever use PILON when their contracts of employment contain a PILON clause or when they have reached a mutual agreement with the employee. Companies should consider using PILON in the following situations:
- There is a risk to confidential information, commercial relationships or business continuity.
- There is a need to reduce the disruption or emotional strain associated with the termination of the contract of employment.
- The organisation is undergoing significant change and requires a rapid transition of personnel.
- The company or the employee must terminate the working relationship with immediate effect for any other reason.
As outlined earlier, there is no legal requirement for employers to use PILON. If they choose to do so, it must be paid correctly and taxed appropriately, and both parties must mutually agree to it.
How to Calculate PILON
When calculating the amount required for a PILON payment, the key is that the employee must end up in the same financial position as they would if they had worked their notice period. As a result, the PILON payment must include any benefits or allowances as part of the salary.
It is also essential to comply with the requirements set out in the PILON clause in the contract of employment. Where there is an explicit PILON clause, employers usually pay the salary plus any contractual elements. Where there is an explicit clause, employees may be entitled to the full value of what they would have earned, including discretionary payments, because ending the contract early is technically a breach of contract.
Follow these steps to calculate a PILON payment accurately:
- Identify the correct length of notice: the notice period will be outlined in the contract or based on the statutory requirement of 1 week for 1 month to 2 years service, or 1 week for each year of service up to 12 weeks.
- Calculate what the employee would have earned: this includes base salary, regular allowances and benefits that can be quantified (e.g., health insurance), and any guaranteed bonuses or commission payments for that period. Usually, this calculation does not include any overtime payments (unless guaranteed), non-contractual commission payments or discretionary bonuses.
- Add any contractual extras: for example, if your employee has accrued holiday but not taken it, or there is an agreement to provide cash instead of specific benefits.
- Calculate the tax and national insurance: for tax purposes, PILON is considered normal pay, so you need to calculate tax and national insurance as usual.
PILON Calculation Example
Here’s an example of how to calculate PILON.
An employee has a monthly salary of £3,000, a car allowance of £300 per month, private healthcare provision in cash equivalent of £50 per month and no guaranteed commission or bonus due. Their notice period is 3 months, and accrued holiday is not included in the PILON payment.
Salary: £3,000 x 3 = £9,000
Car allowance: £300 x 3 = £900
Cash value of benefits: £50 x 3 = £150
Total PILON before tax = £10,500
PILON Best Practices for Employers
When it comes to PILON payment planning, paying attention to detail is the foundation for best practice. Here are X tips if you are working with PILON payments:
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Check the Contract
Checking the contract should be the first thing you do, so you can be sure whether or not you can terminate a contract immediately without risking a breach of contract. Ensuring that all contracts, especially senior-level ones, have a clearly drafted PILON clause is essential.
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Calculate the PILON Payment Accurately
Use a checklist to ensure that you are consistent and include the correct elements in your calculation. Ask someone else to check your calculation. Remember that HMRC treat PILON payments as normal earnings, not compensation.
Managing holiday pay properly ensures that employees are accurately compensated for any holidays they have accrued but not taken. Often, it’s easiest to keep the payment for accrued holiday pay separate from the PILON payment. If so, provide a clear breakdown of the total payment so the employee understands the different elements.
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Communicate Clearly
Take time to explain to the employee, respectfully and carefully, that the company is invoking the PILON clause in their contract, how the payment is calculated and taxed, and when they will receive it. Doing so avoids any misunderstanding which may lead to reputational damage. Immediately after the meeting, provide written confirmation of the termination date, amount payable and when, and the impact on benefits.
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Be Strategic
Avoid treating PILON as a shortcut for when you need someone out of the business quickly. PILON should be part of an overall strategy for managing the termination of employment within the organisation. On one level, a well-drafted PILON clause will prevent the outgoing employee from accessing sensitive systems and enforce any post-termination restrictions, such as a non-compete clause. On the other hand, it can ensure that PILON is used consistently across similar roles and circumstances to avoid any unfair dismissal claims.
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Keep Everything On Track
Avoiding delays such as late payment is essential to minimise reputational damage and legal claims. Other common pitfalls are forgetting benefits or holiday pay and failing to explain the tax implications. Using a checklist can ensure you don’t miss any essential details or deadlines.
Alternatives to PILON
There are several alternative approaches to PILON. Which one is best for your business depends on the employee’s role, the nature of the departure, legal and contractual constraints, how the company wants to manage the employee’s exit, and any potential business disruption.
Alternatives to PILON include:
- Working the notice period: allows knowledge transfer, maintains goodwill and relationships, and avoids any additional payroll costs linked to PILON.
- Garden leave: when an employee remains employed but does not attend work, it provides an operational break while maintaining contractual obligations and restrictive covenants.
- Mutually agreed early termination: can reduce the tension and administrative burden of a formal process like PILON or garden leave; must be confirmed in writing and be contractually compliant.
- Phased or reduced notice period: for example, remote working or handover of key duties earlier allows knowledge transfer and maintains goodwill between employer and employee; ag, this must be confirmed in writing and be contractually compliant.
- Settlement agreement: these can provide certainty for both parties when the circumstances are complex or sensitive, but can be costly in terms of legal advice.
Offboarding with Factorial
A business management system like Factorial supports the offboarding process, specifically the implementation of PILON, in several ways. Having a centralised system that stores employee records, contracts, and communications in one place makes it easy for managers to check whether a contract includes a PILON clause and to work out all the details related to the payment, including holiday pay and benefits. The system also stores policies and provides a checklist to help avoid forgetting anything.
Pay in Lieu of Notice (PILON) FAQs
- Should Employers Have A PILON Clause In Employment Contracts?
Yes, employers should have a clearly drafted PILON clause in their employment contract, as this allows them to feel confident using PILON when needed without risking a breach of contract.
- What If Employers Don’t Have A Clause?
If employers don’t have a PILON clause in their contract, it is still possible to use PILON through a mutual agreement with the employee.
- How Is PILON Generally Calculated?
Companies generally calculate PILON by using the salary that the employee would have expected to earn during the notice period.
- What Is An Effective Date Of Termination (EDT) And Why Is This Important?
An effective date of termination (EDT) is the formal legal date when employment ends. It is essential because it is used in UK employment law to determine rights such as redundancy, notice entitlement, unfair dismissal eligibility, and statutory timelines for making claims.
- Is PILON subject to tax?
Yes, since 2018, PILON payments have been subject to UK tax and national insurance contributions.
- What are the risks of not paying PILON correctly?
If companies do not pay PILON correctly, they risk both a claim for breach of contract and reputational damage.
- Can PILON be applied during garden leave?
Yes, if an employer has a PILON clause in their contract, they place an outgoing employee on garden leave, and then decide to terminate the contract earlier and instigate PILON instead. If there is no PILON clause in the contract and an employee has agreed to go on garden leave, the employer needs to be careful to apply PILON, as this could be considered a breach of contract.
