Garden Leave Pay: How It Is Taxed, PENP and PILON Rules 2026/27

What Is Garden Leave?

Garden leave (sometimes spelled 'gardening leave') refers to an arrangement where an employee who is serving out their notice period is required to stay away from the workplace. The employee remains employed and continues to receive their full salary and benefits, but is effectively barred from performing any duties or accessing company systems.

Employers typically use garden leave to:

• Protect confidential information and client relationships during a departure
• Prevent the employee from immediately joining a competitor
• Allow time for knowledge transfer and project handovers before the employee leaves
• Enforce non-compete obligations (in conjunction with restrictive covenants)

Garden leave clauses must be expressly included in the employment contract to be enforceable. An employer cannot unilaterally place an employee on garden leave without a contractual right to do so -- attempting to do so without consent could constitute a breach of contract.

Tax Treatment of Garden Leave Pay

From a tax perspective, garden leave is straightforward: the employee remains employed throughout the notice period, and pay received during that period is employment income. It is subject to:

• Income tax through PAYE at the employee's marginal rate (20%, 40%, or 45% depending on total earnings)
• Employee National Insurance at 8% on earnings between GBP12,570 and GBP50,270, and 2% above GBP50,270
• Employer National Insurance at 13.8% on earnings above the secondary threshold of GBP5,000 per year

There is no tax advantage to garden leave over working the notice period. The employee receives the same gross pay, and the same deductions apply. The only difference is that the employee is not required to attend work or perform their duties.

Benefits During Garden Leave

Benefits provided during the garden leave period are treated in exactly the same way as during normal employment. If the employee has a company car, it remains a benefit in kind throughout the garden leave period. The P11D value is unaffected by the fact that the employee is not attending the office.

This is different from PILON (see below), where the employee's employment typically terminates on the date of the PILON payment and benefits cease at that point.

Pension Contributions During Garden Leave

Pension contributions (both employee and employer) normally continue during garden leave unless the scheme rules or the employment contract state otherwise. From a tax perspective, contributions remain deductible in the normal way and do not trigger any special rules.

What Is PILON?

Payment in lieu of notice (PILON) is a payment made by an employer to an employee instead of requiring them to work out (or otherwise be paid for) their notice period. Rather than serving a three-month notice period on garden leave, the employer might pay a lump sum equivalent to three months' salary and end the employment immediately.

The key distinction from garden leave is that PILON terminates employment on the date of payment. The employee is no longer employed after receiving PILON; they are free immediately to start new employment, subject to any restrictive covenants.

PILON Is Always Taxable

A common misconception is that PILON is only taxable as earnings if there is a PILON clause in the employment contract. Before 2018, this distinction had some relevance -- a contractual PILON was clearly taxable, while a non-contractual PILON had a more complex position.

Since April 2018, PILON is always taxable as earnings, regardless of whether the employment contract includes a PILON clause. The post-employment notice pay (PENP) rules, introduced by Finance Act 2017, removed the distinction entirely.

The PENP Formula Explained

The PENP rules require employers to identify the post-employment notice pay component of any termination payment and treat it as earnings for tax and NI purposes. The formula applies whenever an employee's employment ends with some or all of the notice period unserved.

The basic PENP formula is:

PENP = (BP x D) / P

Where:

• BP = the employee's 'basic pay' in the last pay period before the trigger date (usually the date notice was given, or the date the employer decided to end employment early)
• D = the number of days in the unserved notice period (days of notice the employee was entitled to but did not work or receive as garden leave)
• P = the number of days in the relevant pay period (for a monthly-paid employee, typically 30 or 31; for a weekly-paid employee, 7)

The PENP is then compared to the total termination payment. The lower of the total payment or the PENP is treated as taxable earnings. Only the amount exceeding the PENP can potentially benefit from the GBP30,000 termination payment exemption.

PENP Example

Emma is paid a monthly salary of GBP5,000 (basic pay). Her notice period is three months. Her employer terminates her employment immediately and pays her a total termination package of GBP40,000. She was not placed on garden leave.

Her unserved notice period is 3 months = approximately 92 days (using 30 days per month x 3 = 90 days, or actual calendar days).

PENP = (GBP5,000 x 92) / 30 = GBP15,333.

The first GBP15,333 of her GBP40,000 payment is taxable as earnings (PILON equivalent). The remaining GBP24,667 is a non-PENP termination payment. The first GBP24,667 falls below GBP30,000, so it qualifies for the GBP30,000 exemption in full. Emma pays no income tax on the non-PENP element.

However, if Emma had served one month on garden leave and only the final two months were unserved:

PENP = (GBP5,000 x 61) / 30 = GBP10,167.

The GBP5,000 received as garden leave pay is already taxed as earnings. The PENP element of her termination payment reduces to GBP10,167. More of her package can then benefit from the GBP30,000 exemption.

Garden Leave Reduces PENP

This is an important planning point: serving garden leave reduces the PENP calculation because it reduces the number of unserved notice days (D in the formula). Where an employer wants to give the employee a generous termination package while minimising tax on that package, placing the employee on garden leave for part of the notice period before the termination date can increase the amount available for the tax-exempt GBP30,000 bucket.

Interaction With the GBP30,000 Termination Payment Exemption

The GBP30,000 exemption at section 403 ITEPA 2003 applies to genuine termination payments that are not otherwise taxable as earnings. Garden leave pay is taxable earnings -- it does not benefit from the exemption. PENP-equivalent PILON is taxable earnings -- it does not benefit from the exemption either.

Only the element of a termination payment that:

• Is not PENP, and
• Is not otherwise earnings under the employment contract, and
• Is genuinely compensatory (rather than contractual)

can benefit from the GBP30,000 exemption. This typically includes:

• Enhanced redundancy payments above the statutory minimum
• Ex gratia payments made as a genuine gesture of goodwill
• Compensation for loss of employment (non-contractual)

Amounts above GBP30,000 that qualify for the exemption are taxable as employment income at the employee's marginal rate, with employer NI at 13.8% (but not employee NI).

Restrictive Covenants and Payments

Sometimes employers pay separate amounts in consideration for the employee agreeing to post-termination restrictive covenants (for example, agreeing not to work for a competitor for 12 months). These payments are treated as employment income and are fully taxable as earnings. They do not benefit from the GBP30,000 exemption and are not treated as capital.

HMRC is alert to attempts to artificially structure termination payments to disguise earnings as restrictive covenant consideration. Genuine restrictive covenant payments are permissible, but the valuation must reflect the commercial reality of the restriction.

Benefits Ceasing on Termination

Where an employee's employment terminates immediately (via PILON rather than garden leave), their entitlement to benefits ceases on the termination date. Company car benefits, private medical insurance, and other benefits in kind end at that point.

If an employee on garden leave has their employment terminated early during the garden leave period, any benefit in kind ceases from the termination date. The P11D value for the tax year is calculated up to that date only.

Practical Guidance for Employees Receiving Termination Packages

Ask your employer for a written breakdown of the termination package. This should show:

• Garden leave pay (dates and amounts)
• PENP calculation and the amount treated as PILON
• Any enhanced redundancy pay
• Any ex gratia payment
• Any restrictive covenant consideration

Check that PAYE has been operated correctly. All earnings elements (garden leave, PILON/PENP) should have PAYE and NI deducted. The non-PENP termination payment up to GBP30,000 should have no PAYE or employee NI deducted (though employer NI at 13.8% will be due on amounts above GBP30,000).

Check your tax code is adjusted. If your tax code has been amended following a P11D filing or a change to your benefits during the year, make sure the adjustment reflects your actual position on termination.

Seek specialist advice for packages above GBP30,000. At this level, the interaction between PENP, the exemption, and your marginal rate can significantly affect the net amount you receive.

Summary

Garden leave pay is taxable employment income throughout the notice period, with PAYE and NI applying in the normal way. PILON is also always fully taxable under the PENP rules introduced from April 2018, regardless of whether the contract includes a PILON clause. The PENP formula (BP x D / P) determines the earnings element of a termination package. Serving garden leave reduces the PENP calculation and can increase the amount available for the GBP30,000 termination payment exemption. Benefits continue during garden leave and cease on the date employment actually terminates.