A settlement agreement payment in lieu of notice means that your employer pays your salary, and perhaps also benefits, for your notice period, but you do not have to work during that time. (‘In lieu’ means ‘instead of’ in French.) 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 three months’ wages 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 not to take another job with a competitor – so you can do your gardening if you like (hence the phrase). With garden leave you would normally be paid at the end of each month of garden leave as usual, and you still remain employed, so theoretically your employer could call on you to do more work.
Pay in lieu of notice, also known as PILON, is very common to find in settlement agreements (formerly known as compromise agreements). This is because settlement agreements tend to occur after either a dispute or a redundancy, whereby there is some reason that your employer prefers not to continue to interact with you on a day to say 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 continue employment;
- Pay in lieu of notice is very common whereby an employee leaves after redundancy or a dispute; and
- Sometimes it can be paid tax free, but employers tend to tax it.
How can I get pay in lieu of notice
Pay in lieu of notice is a great thing if you can get it, because you get paid for time when you don’t even have to work. This is especially great if you have a decently long notice period. (Remember if you have been employer 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 years).
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 to see the back of you rather than have you carrying on and bringing your colleagues down. Thus it is often just a case of asking your employer to pay you in lieu of notice – you may not need to negotiate this at all. Of course if your employer offers you pay in lieu of notice then try to keep a poker face and not to smile too much, and just make out 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 an amount of compensation for breach of contract, which can be classsed 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 decide to not pay you in lieu of notice (according to their discretion) and 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 cut and dried than it actually is.
In the above 2 situations, 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, and make the sum of money not equal to the notice pay, but different enough to be clearly a different amount. By using this thinking 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
- Example 1
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).
- Example 2
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.
The circumstances show that the employer is dismissing the employee and the compromise agreement represents a negotiation of the terms of that dismissal.
If the employee had been dismissed without the agreement, there would have been a contractual entitlement to a payment in lieu of notice, if notice was not given. The employer does not have any discretion about paying the PILON under these contractual terms. Those terms require that if notice is not given then the employer has to make a PILON instead.
So part of the £35,000 satisfies that contractual entitlement and is earnings from the employment as described in EIM12976.
- Example 3
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. Of course this is partly what we do, so we would argue that it should be more!
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If you want help negotiating a tax-free payment in lieu of notice or if you have any other settlement agreement query, get in touch on 020 7717 5259, 0800 533 5134, or email [email protected], or fill in your details in the form below. If you are receiving a payment in lieu of notice in your settlement agreement, as well as an ex gratia payment and other benefits, we will always seek to ensure that you receive the compensation in the most tax efficient way. Have a look at the testimonials to see how we helped others in your situation.