Settlement Agreements & Payments in Lieu of Notice
A settlement agreement payment in lieu of notice means that your employer pays your salary, and perhaps also benefits, for your notice period. You do not have to work during that time. For example, if an employee has a three month notice period, the employer might decide that today will be the last day of employment but that they will be paying your wages for three months even though you are not physically coming in to work any more.
This is slightly different from being put on ‘garden leave’ which means that you are told not to work, but also not to take another job with a competitor. (So you can literally do your gardening if you wish – hence the phrase.) With garden leave you would normally be paid at the end of each month as usual, and you still remain employed, so theoretically your employer could call on you to do more work. When you are paid in lieu of wages, you do not remain employed.
What is PILON?
Pay in lieu of notice is also known as PILON for short. It may also be referred to as wages in lieu of notice. It is very common to find PILON in settlement agreements. This is because settlement agreements tend to occur after either a dispute or a redundancy and there is some reason why your employer prefers not to continue to interact with you on a day to day basis. Therefore they often do not want you to be in the office once the relationship has broken down. To find out whether or not you are getting a good deal overall, try our Settlement Agreement Calculator and our article about how much money you should get.
Top 3 TIPS
- ‘In lieu’ means ‘instead of’ in French, so you receive notice pay but don’t actually work your notice period;
- Pay in lieu of notice is very common when an employee leaves after redundancy or a dispute; and
- Sometimes it can be paid tax free, but employers do tend to tax it.
How can I get pay in lieu of notice?
It is a great thing if you can get it, because you get paid for time when you don’t have to work. This is especially valuable if you have a long notice period. (Remember that if you have been employed for over 4 years, then your notice goes up by a week per year up to 12 weeks maximum (after 12 years employment) regardless of what your contract says. So even if your contract still says 4 weeks, you would legally be entitled to 12 weeks.)
Pay in lieu of notice is available from many companies if there has been some kind of dispute or disagreement at work, because in such circumstances employers actually prefer that you are no longer in the office. Thus it is often just a case of asking your employer to pay you in lieu of notice – you may not need to negotiate with them at all to get it as it can benefit all parties. Of course if your employer offers you pay in lieu of notice then try to keep a poker face and just act as though you expected this as standard; then continue to negotiate the ‘ex gratia’ element of the deal.
Is payment in lieu of notice taxable?
In practice, whether your payment in lieu of notice is paid to you tax free or not will depend on your employer and their accountants. Most employers will insist on taxing the payment in lieu just to be on the safe side, despite the fact that legally you could be entitled to receive it tax free.
According to the letter of the law, whether the payment in lieu of notice is taxable or not will depend on the provisions of your contract of employment. If your contract of employment has no PILON clause, then it is easier to argue that it is not taxable. This is because your employer can effectively breach your employment contact by not giving you the requisite notice pay, and therefore the payment could be deemed to be a compensation amount for this breach. The amount can then be classed as a non-taxable ‘ex gratia’ payment.
If your contract has a discretionary PILON clause (which provides that the employer may at their discretion pay you an amount of money in lieu of notice) then it is harder to argue that it is not taxable. This is because your employer can effectively use their discretion not to pay you in lieu of notice and also not require you to work out your notice, and therefore any payment made to you would legally be deemed to be a benefit arising from your employment, and therefore taxable.
Other employment law websites seem to suggest that the situation is a lot more black and white than it actually is.
How to get your pay in lieu of notice paid tax free…
In the situations outlined above, in order for you to get the best financial outcome, what your settlement agreement would need to do is to define the payment as an ex gratia payment rather than a payment in lieu of notice. It should also make the sum of money not equal to the notice pay, but different enough to be clearly a separate amount. By using these tactics in the settlement agreement document, a similar sum of money to your notice pay can be defined as a tax free amount rather than a taxable contractual benefit.
The problem you may well have is that your employer will still probably refuse to take a risk by paying your PILON tax-free. We may be able to put forward the relevant case law on your behalf to make them change their minds. For example, we have dealt with settlement agreements against some of the biggest companies in the UK, and some of these companies do make their payments in lieu of notice tax free. This kind of knowledge can give employers the confidence they need to pay you tax free.
As you might expect, the guidance on the HMRC website is quite ambiguous and tricky to navigate. We found this page the most useful and it states as follows:
“EIM13924 – Termination payments and benefits: example: compromise agreements
Sections 62 and 401ITEPA 2003
A compromise agreement (see EIM12855) states that it settles all claims in respect of the employment or its termination for £35,000. No contractual claims are specified in the agreement. The contract of employment provides for a terminal bonus of £5,000 to be paid. This bonus has not been dealt with elsewhere. By its wording, the agreement satisfies that entitlement. £5,000 of the £35,000 is earnings from the employment within Section 62 ITEPA 2003 (see EIM00515).
An employment contract says that the employer is to give either 6 months’ notice or a payment in lieu of notice. The employee is dismissed without notice and negotiations commence. These result in a compromise agreement (see EIM12855) which states that it settles all claims in respect of the employment or its termination for £35,000. No contractual claims are specified in the agreement itself.
An employment contract says that the employer can terminate by giving 6 months’ notice or, at its discretion, by making a payment in lieu of notice. The employee is dismissed without notice and the employer immediately makes it clear that its discretion to make a payment under the contract is not being exercised. Negotiations take place because the employer (a) prefers to settle the matter by making a payment of damages for breach of contract rather than face the expense and uncertainty of legal proceedings by the employee and (b) believes that the employee has found another job and so the payment can be less than would be due under the contract (see EIM13070). The negotiations result in an agreement for a payment equal to the gross salary and benefits that would have been paid in the notice period, less a deduction to reflect the fact that the employee had found an equivalent job starting in 2 months. The character of the payment is damages for breach of contract and so falls within Section 401 ITEPA 2003 (see EIM12978 and EIM13070).”
To summarise what this is saying, essentially if the payment made to the employee is agreed after termination and is substantially less than the amount which would be payable in lieu of notice, then it can be classed as damages and not taxed. We would argue therefore that if the payment is substantially more than pay in lieu of notice, then this would also mean that it is not taxable because it is obviously damages rather than a contractual benefit.