Following part 1 of our in-depth guide for payroll teams on termination payments, this time we are looking at Payment In Lieu of Notice payments (PILON). PILON is a method of immediately exiting an employee from the organisation by paying their notice without requiring them to work. It is often used in sensitive dismissals, for senior exits or for employees working in confidential areas. As with any termination payment, a payment in lieu of notice is subject to strict rules from HMRC regarding tax, application and calculation. This guide is designed to help payroll teams navigate PILON and avoid the risk of non-compliance or employment tribunals.
MSP Payroll can support your payroll processes, whether it’s a termination or a redundancy. We can provide any level of help, from advice and consultancy through to full Payroll outsourcing.
Speak to us here to find out more.
What is a payment in lieu of notice?
PILON is a payment provision that an employer can make to an employee instead of requiring them to work their notice period as defined in their employment contract. They receive a lump sum which represents the amount they would have earned if they had worked their full notice period. Once PILON has been agreed, the employee immediately finishes their employment and stops accruing holiday pay entitlement and pension contributions beyond their finishing date.
PILON is subject to tax and NIC contributions as the final payment of the employee’s salary rather than an additional payment (such as Ex Gratia). For tax-free payments, see part 1 of our series on termination payments.
Payment in lieu of notice can only be used where a notice period is still applicable, i.e. if gross misconduct has been established by HR and the business wishes to terminate without a notice period, then PILON cannot be applied.
If your team is handling termination payments, and you would like support, MSP Payroll can help. Speak to us today.
When is PILON applied?
PILON can be applied by companies in four situations:
- The contract contains a PILON clause, allowing the business to end employment immediately on payment.
- The employee is made redundant and is to leave the business immediately – note this means the PILON should be considered alongside any Ex Gratia payments made.
- The employee is dismissed in a way that still allows for a notice period to be worked, but the employer wishes them to leave immediately.
- A settlement agreement or compromise is reached, which includes notice payment as part of the package.
Note that PILON is not a replacement for gardening leave, where an employee is considered to be completing their notice period, but is not working during that time.
Post Employment Notice Pay
Post Employment Notice Pay (PENP) was established in 2018 to clarify and calculate the NIC and Tax implications for a PILON payment. Before PENP, only contractual PILON agreements were subject to NIC and tax; they would be included in the £30,000 tax threshold (as mentioned in part 1 of this series). Now ALL payments in lieu of notice are subject to tax and NIC deductions.
How is PENP calculated?
Identifying the correct notice period
An employee will contractually have one of two types of notice period. Either a statutory notice period, which is the legal minimum based on the length of time worked at the organisation, or a contractual notice period, which is a longer notice period written in the employee’s signed contract.
It’s important to identify which notice period is applicable, as the time period will define the rest of the PENP calculation. An organisation can only give an employee more notice, not less.
Check the reason for termination
The payroll team should check and receive in writing the reason for termination of employment from HR or legal counsel. This should then define whether a notice period is applicable. If an employee is dismissed for gross misconduct or has resigned with immediate effect because of constructive unfair dismissal, then a notice period is not applicable, and a PILON will not be paid. PILON is also not applicable if the employee resigns; in this instance, they should work their notice, or agree with the organisation on a shorter time period, with the employee agreeing not to receive payment for the remainder.
Calculate the payment period
The PENP covers the payment period, not the date from which the employee was paid. For instance, in this example from HMRC, if the employee is paid on the 15th of each month for the period 1st to 31st, then the pay period is the 1st to 31st, not the 16th to 15th of the month.
The last pay period would then cover the whole months specified by the contractual or statutory notice period, as long as this exceeds the minimum notice period, or the number of working days covered by the notice period, where whole months are not applicable.
Identify basic pay
Basic pay is the “total employment income the employee receives”, disregarding any amount received as an “allowance”. The allowance might include commission, bonuses, company car allowances or benefits in kind; however, this is an area that can become complicated quickly, so payroll teams should confirm with HR or legal counsel what, contractually, might be included in basic salary and which can be reasonably assumed to be an allowance.
Payroll teams should also be wary of salary sacrifice agreements. Basic pay is calculated based on the original salary level, before the salary sacrifice deduction, not after it. Often, this is overlooked and creates issues of compliance and potential tribunals if not addressed correctly.
MSP Payroll can help calculate PENP for leaving employees. Speak to our team to find out how.
Run the PENP formula
The calculation for PENP is as follows:
((BP x D) / P) – T
- BP is Basic Pay, as mentioned above
- D is the number of calendar days in the notice period post-employment
- P is the number of calendar days in the employee’s last pay period, and
- T is any payment in connection with the employee termination that is subject to income tax
We provide an example below – but for a full explanation of each element, visit the HMRC employment income manual.
PENP formula example
An employee is paid £5,000 gross basic pay (BP) per month (P), and they have a contractual notice period of three months, or 90 days (D). They are only receiving their notice period payment, and so do not have any other payments subject to income tax (T).
Therefore, the PENP formula is as follows:
((£5,000 x 90) / 30) – 0 = £15,000 PENP
This is then treated as earnings and processed through payroll with income tax and Class 1 National Insurance deducted as per normal. If the formula ever produces a negative figure, then PENP is counted as zero.
If you would like guidance for termination payments, MSP Payroll can help. Contact our team here.
PILON reported on payslips
PILON must be processed through payroll and reported in an RTI submission in the pay period it is paid. PILON must also appear on the employee’s payslip, and we recommend you communicate beforehand what PILON is and why it will have a separate line on the payslip. This will avoid any questions or anxiety from the employee once they receive their payslip.
Payment in lieu of notice must not be treated as a separate cash settlement outside of the normal payroll process. It must have a PAYE deduction, and if there are multiple elements to the termination payment, each component must be clear to the employee.
Understanding and processing PILON
PILON and PENP are relatively straightforward processes once they have become familiar or routine. The consequences of incorrect calculations sit with the employer, and HMRC will recover any errors alongside payments from the organisation, not the employee.
MSP Payroll works with businesses to provide support, review calculations, or run PILON payments on behalf of payroll teams. We can empower your team or take the pressure off them to ensure compliance and execution are always accurate.
Our next article, part 3 in the termination payments series, will look at Ex Gratia payments.
How can MSP Payroll help?
Our experts can provide comprehensive support for payroll teams processing termination payments. This could include:
- Facilitating BACs payments for your organisation to employees
- Calculating or reviewing termination payments before they are completed
- Consultancy support on termination payments with guidance on PILON or PENP
- We are specialists for all payroll regulations and provisions, including SSP, SMP, pensions seasonal payments, PAYE and National Insurance Contributions.
Contact us here if you would like to discuss implementing payroll support.
Calculating Payment In Lieu of Notice: Frequently Asked Questions
Is PILON the same as garden leave?
No, PILON and Gardening Leave are separate. With PILON, the employee’s contract of employment terminates immediately, and any entitlements or accruals that would have occurred during the notice period are accounted for in the final payment. Any benefits are also terminated, such as company cars, etc.
An employee on Gardening Leave is still classed as an employee of the organisation until the leave ends (which might be a notice period, or longer as agreed with the employee). The employee still receives a salary each pay period and is entitled to accrue holiday and benefits.
What notice period is used in the PENP calculation?
The PENP calculation uses the longer notice period, whether that’s contractual or statutory. For instance, an employee might have a contractual notice period of two weeks, but is entitled to a statutory notice period of 6 weeks, because of their length of service. The PENP calculation would use the 6 weeks’ entitlement rather than the two-week contractual one.
How should PILON appear on the employee’s payslip?
PILON should be clearly itemised on the final payslip, showing clearly that it is a payment in lieu of notice. It should also show any HMRC deductions as per a normal salary period. Itemising the payslip makes it easier for employees to understand exactly what they are being paid, reduces follow-up questions or complaints and ensures easier compliance should HMRC raise a query.