What is Payment in Lieu of Notice (PILON) Tax Treatment?

Full Definition

A payment in lieu of notice (PILON) is a lump sum an employer pays an outgoing employee instead of requiring them to work out their notice period. Before April 2018, the tax treatment of PILON depended on whether the employment contract contained an express PILON clause: contractual PILONs were taxed fully as earnings, while non-contractual (or "ex gratia") PILONs could sometimes be paid as part of a termination payment and benefit from the £30,000 tax-free exemption that applies to genuine redundancy and compensation payments. From 6 April 2018, this distinction was removed. All PILON payments -- contractual or not -- must now be identified using a statutory formula known as Post-Employment Notice Pay (PENP), and the PENP amount is always taxed as general earnings, subject to both Income Tax and Class 1 National Insurance (including employer NI), regardless of what the employment contract says. The PENP calculation broadly represents the basic pay the employee would have received had they worked their full notice period, calculated using a formula based on the employee's last full month or week of basic pay before termination, minus any contractual notice pay already taxed as earnings. Any part of a termination payment that exceeds the PENP amount -- for example, a genuine ex gratia redundancy element on top of notice pay -- can still qualify for the £30,000 Income Tax exemption and unlimited employer NI exemption (though employer NI applies to amounts above £30,000 from 6 April 2020). Employers must therefore split a termination payment into its PENP (taxed as earnings) and non-PENP (potentially tax-free up to £30,000) components on the employee's final payslip and P45, and getting this split wrong is a common source of disputes and HMRC compliance checks.

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