TL;DR

• PILON allows immediate termination by paying the employee instead of requiring them to serve their notice.
• PILON is fully taxable in the UK and must be processed through payroll under HMRC’s PENP rules.
• Having a PILON clause in the contract is key to avoiding breach of contract or disputes.
• PILON usually covers basic salary and may include holiday pay or benefits if stated in the contract.
• It differs from garden leave, where the employee remains on payroll and benefits continue.

• Direct Payroll Services UK can help ensure your PILON is legally correct and fully compliant.

Navigating the termination process involves understanding the rights and obligations set out in the employment contract. One key aspect is the notice period, which ensures both parties have time to prepare for the end of employment. Sometimes, however, employers may opt for immediate termination rather than having employees work through their notice. In these cases, payment in lieu of notice provides a solution. Grasping the rules and implications of PILON is essential for employers and employees seeking a fair and compliant exit.

What Is Payment In Lieu Of Notice (PILON)?

Payment in lieu of notice (PILON) refers to a termination payment given to an employee, compensating them for the notice period not worked. Legally, this sum replaces the required notice period stipulated in an employment contract. This lump sum is often calculated based on the employee’s salary and may include considerations for holiday entitlement and other benefits. PILON can mitigate potential legal disputes related to unfair dismissal, ensuring compliance with employment law and preserving the integrity of the employment relationship.

What Are The PILON Rules In The UK?

Understanding the rules around Payment in Lieu of Notice (PILON) is essential for employers to remain compliant with UK payroll laws and avoid potential disputes. These rules cover a range of areas from how notice periods are defined to when PILON can be applied, what it should include, and the importance of clear written communication. Below, we break down the key aspects of PILON that every UK employer should be aware of:

1. What Is The Difference Between Statutory And Contractual Notice?

Statutory notice is the minimum notice period UK law requires employers to provide based on an employee’s length of service. An employee with over a month but less than two years of service is entitled to one week’s notice. This increases by one week for each additional full year worked, up to a maximum of 12 weeks. However, many employment contracts offer enhanced (contractual) notice, which must not be shorter than statutory requirements.

2. When Can Employers Use PILON?

There are specific circumstances where Payment in Lieu of Notice can be lawfully and strategically applied. The following scenarios highlight when UK employers may choose to implement PILON to streamline the termination process and safeguard business interests:

• If contractually agreed: Employers may enforce PILON if it’s written into the employment contract.
• By mutual agreement: Even without a clause, PILON can be agreed upon between both parties.
• To protect the business: Employers often use PILON to prevent disruption, safeguard confidential data, or avoid risks from disengaged employees.

3. When Is PILON Not Allowed?

PILON is a valuable tool, but only when applied correctly. Below are common situations where using PILON may be restricted or inadvisable, and where employers must proceed with caution to avoid breaching employment law:

• No PILON clause in contract: Employer may risk breach of contract if they enforce PILON unilaterally.
• Gross misconduct: PILON is rarely offered in summary dismissals for serious disciplinary issues.
• Voluntary resignation: Employees can request PILON, but employers are not obligated to agree unless contractually required.

If PILON is not contractually valid, any restrictive post-employment clauses (like confidentiality obligations) may not be enforceable. This could leave the employer vulnerable.

Employers in UK must align with statutory requirements, respect contractual terms, and follow HMRC guidelines to stay legally compliant and avoid costly claims. For end-to-end support with payroll transitions and legal compliance, partner with Direct Payroll Services, your trusted experts in pay in lieu of notice scenarios.

4. What Payments Are Included In PILON?

Typically, PILON covers basic salary and, if contractually agreed, overtime and accrued holiday. Bonuses, commissions, pension contributions, and non-cash benefits are usually excluded unless explicitly stated in the employment contract. Clear terms help avoid disputes and ensure compliance. Unless specified otherwise in the contract, PILON typically includes:

5. Why Is Written Communication Required For PILON?

Proper documentation is essential when issuing Payment in Lieu of Notice to ensure HMRC compliance and avoid misunderstandings. Employers must follow clear communication protocols, as outlined below, to formalise the termination and meet statutory obligations:

• Provide written confirmation of termination.
• Detail the amount paid and the period it covers
• Apply correct tax and National Insurance deductions per UK laws

What Are The Key Distinctions Between Garden Leave, PILON, And Notice Period?

When considering your options at the end of employment, it’s important to know how working notice and PILON differ. When employees work their notice, they continue their usual duties, remain employed, and accrue benefits until the period ends. With a garden leave, the employment relationship remains active, allowing the employee to draw their regular income and retain access to company benefits. In contrast, PILON ends the employment contract immediately, with a lump sum payment replacing ongoing wages.

This distinction affects benefits, pension accrual, and your ability to start new employment. The table below summarizes the key differences:

For many, understanding these differences is crucial in planning their next steps after a termination notice.

Why Choose Payment In Lieu Of Notice?

PILON is more than just a contractual option, it’s a strategic decision used in various employment scenarios.

The Office for National Statistics UK estimates that payrolled employees in the UK fell by 135,000 (0.4%) between May 2024 and May 2025, highlighting the ongoing workforce adjustments where PILON can help employers manage swift, lawful exits (Source)

From protecting company interests to maintaining professionalism during exits, the following points explain why employers and employees may choose payment in lieu of notice and how it benefits both parties:

• Quick Termination: Enables immediate departure when it’s in the best interest of the business or employee.
• Flexibility For Employers: Avoids the risks of a disengaged employee remaining on-site during the notice period.
• Mutual Agreement: Used when both parties agree to an immediate separation, such as redundancy or settlement agreements.
• Historical Solution: Emerged as a practical tool to manage workforce flexibility and facilitate smoother transitions.
• Fairness In Employment: Offers a fair exit process, ensuring both employer and employee are treated equitably.

What Are The Scenarios For Offering A Payment In Lieu Of Notice?

PILON isn’t a one-size-fits-all solution. Employers typically turn to it in circumstances where keeping the employee during the notice period may be impractical or risky. The following examples highlight when payment in lieu of notice can serve as a logical alternative to worked notice:

• When there is a risk that the employee’s continued presence could harm the business or affect morale.
• If the employee has access to confidential information or key systems that the employer wants to protect.
• In cases of redundancy, where a quick transition is beneficial for workforce planning.
• When both parties agree to a lump sum as a settlement agreement, it is often to suit mutual interests.

However, PILON is generally not used when termination is due to gross misconduct, unless specified in the employment contract. The employer’s choice reflects the unique circumstances of each termination notice.

How To Calculate Pay In Lieu Of Notice?

Calculating PILON requires accuracy and attention to the terms of the employment contract. The amount of pay typically reflects the employee’s base salary for the notice period, but may also include regular contractual benefits and allowances.

Employers should ensure the payment mirrors what the employee would have received had they worked the notice period in full. The next sections cover the factors affecting PILON amounts and how different contract types are handled. Let’s take a look at this example:

Sarah’s PILON Breakdown

• Salary: £3,000/month
• Notice period: 3 months
• PILON clause: Included
• Payment made on termination day

Calculation:

£3,000 × (90 ÷ 30) = £9,000 PILON (fully taxable under HMRC PAYE)

Sarah’s contract did not include commissions or benefits in PILON, so only her basic salary is paid.

How Does PILON Differ For Various Employment Contracts?

Different contract types require tailored approaches to PILON. For permanent staff, the payment should match the notice period outlined in the employment contract, including any minimum notice period and relevant benefits. Fixed-term contracts may specify the amount and timing of PILON, while casual workers might only be entitled if the contract explicitly allows it. It’s also essential to consider holiday entitlement, pension contributions, and any other additional benefits that would have accrued during the notice.

Clear documentation and communication are vital. Employers should spell out these terms in the employment contract, review benefits eligibility, and ensure the payment matches what the employee would have received if working their notice.

Is Pay In Lieu Of Notice Taxable In The UK?

Payment in lieu of notice (PILON) is fully taxable in the UK, even if it’s not mentioned in the employment contract. Since 6 April 2018, HMRC treats most PILON payments as Post-Employment Notice Pay (PENP), which means they’re treated as earnings and taxed like normal salary.

This means:

• Income tax and Class 1 National Insurance must be deducted
• The payment must be processed through the company’s PAYE payroll system
• Employers and employees should not assume any part of the PILON is tax-free unless it qualifies as a separate termination payment outside of PENP

Example: How PILON Tax Works

Anna earns £,5000/month and has a 2-month notice period. Her employer opts for PILON and pays her £10,000 on termination.

Tax Treatment:

• The full £10,000 is treated as taxable income
• Income tax and National Insurance contributions are deducted at the standard rate
• She receives the net amount in her final payslip, just as she would if she had worked the notice

If you’re including a termination bonus, ex gratia settlement, or compensation beyond PILON, parts of it could be tax-free up to £30,000, if it qualifies under HMRC rules. To get it right, contact Direct Payroll Services UK. We’ll ensure your payroll is fully compliant and your exit payments are processed accurately. Speak with our experts today.

Conclusion

Understanding Payment in Lieu of Notice (PILON) is essential for both employers and employees navigating the complexities of employment termination. Recognising its legal implications, potential scenarios for use, and the calculation process can make a significant difference in ensuring compliance and clarity in these situations. By being informed about the advantages and disadvantages of PILON, both parties can make more strategic decisions that align with their interests. This knowledge not only helps in managing expectations but also fosters a smoother transition during times of change.

Frequently Asked Questions

What is payment in lieu of notice?

Payment in lieu of notice (PILON) is a lump sum paid to an employee when their contract is terminated without requiring them to work the notice period. It compensates for lost earnings, and the amount is typically equivalent to what the employee would have earned during that time.

What is salary in lieu of notice and how does it work?

Salary in lieu of notice refers to the employee’s regular pay, like basic salary and allowances, provided upfront instead of having them serve their notice. It’s part of the broader concept of PILON and should reflect contractual entitlements.

What is wages in lieu of notice in UK employment?

Wages in lieu of notice are the earnings an employee would have received if they had worked through the notice period. In UK employment law, this is a form of PILON and is often used when immediate termination is necessary.

When should pay in lieu of notice be paid?

Pay in lieu of notice should be paid either on the termination date or as soon as reasonably practicable afterward. Timely payment ensures compliance with employment law and helps prevent disputes with employees.

Is pay in lieu of notice taxable in the UK?

Yes, pay in lieu of notice is taxable in the UK. It is treated as earnings and subject to income tax and National Insurance contributions, unless specified otherwise in a valid tax exemption.

Is pay in lieu of notice pensionable?

Usually, pay in lieu of notice is not pensionable. Since employment ends immediately upon PILON, employers typically stop making pension contributions after the termination date.

What does payment in lieu of notice redundancy mean?

Payment in lieu of notice redundancy means the employer pays out the notice period instead of having the redundant employee work it. This helps streamline the redundancy process while complying with legal obligations.

How to calculate pay in lieu of notice correctly?

To calculate pay in lieu of notice, include the employee’s base salary, bonuses, benefits, and any accrued holiday pay for the notice period. It must reflect what the employee would have earned if they had worked the notice.

Can employer refuse pay in lieu of notice?

An employer can refuse pay in lieu of notice if there is no PILON clause in the contract. In such cases, the employee may be required to work their full notice unless both parties mutually agree otherwise.

What is the legal status of pay in lieu of notice UK?

Pay in lieu of notice UK is legally valid if stated in the employment contract. Without a PILON clause, offering such a payment can be seen as a breach of contract unless mutually agreed upon in writing.

What is annual leave in lieu of notice?

Annual leave in lieu of notice refers to offsetting the notice period with unused holiday days. Alternatively, if the employee doesn’t take the leave, the employer must pay for it along with PILON.

I have an employee who’s asking for payment in lieu of notice, what should I do?

If your employee requests payment in lieu of notice, check the employment contract for a PILON clause. If allowed, calculate the appropriate amount and document the agreement to stay compliant.

When can employers use PILON?

Employers can use PILON when they need a quick and smooth exit, such as in cases of redundancy, workplace disruption, or to protect sensitive information. It is also useful when mutual separation is agreed.

When can an employer opt for payment in lieu of notice?

An employer may opt for payment in lieu of notice when keeping the employee during the notice period poses a risk or is not practical. It ensures immediate termination without breaching contract terms.

What are the pros and cons of PILON for employers?

PILON offers fast employee exits, risk mitigation, and administrative ease. However, it can increase upfront costs and lead to confusion or disputes if not clearly outlined in the employment contract.

What is pay in lieu of notice and why is it important?

Pay in lieu of notice allows employers to terminate employment instantly while ensuring employees are financially compensated. It’s important for business continuity, legal compliance, and fair treatment.