To pay in lieu or not to pay in lieu?

There are pros and cons, and the law is changing.

As a broad rule we recommend employers pay an employee their notice pay when parting company, unless of course they are dismissing for the employee’s breach of contract, i.e. Gross Misconduct. This is known as pay-in-lieu of notice or PILON and can provide an employee with, in effect, an enhanced termination payment.

However, the law will be changing in 2017 and all PILON payments will be subject to tax and NI.

In the meantime there are several reasons for a PILON:

  1. It draws a line. If the parting is difficult, say for a redundancy, it can be uncomfortable for the employee and employer to continue to encounter each other.
  2. Making payments without deduction of tax and NI “sweetens the pill” and supports the employee for a longer period of time than would otherwise be the case.
  3. Potentially, PILON can be treated as a termination payment and therefore as we said above, paid to the employee without deduction of tax or national insurance. But there are traps here for the unwary!
  • If the employee has a contractual right to a PILON then the pay is subject to normal PAYE rules.
  • If the employee is off on long term sick at the point of dismissal (often a reason for pay in lieu) notice pay should be treated as earnings and is subject to PAYE.
  • HMRC helplines can lack clarity, so a disclaimer is worth including in any termination agreement – namely to make the employee liable for any tax or NI liability arising.
  • There is a limit, in any event, of £30,000 on termination payments if they are to be free of tax.

PILON may avoid future liability. So accrual of holiday pay, pension payments, or service related benefits cease on dismissal, which of course is earlier if no notice is given. However failure to pay may also be challenged if the dismissal breaches contractual rights to these payments.

It may be possible to avoid, or at least reduce, the payment of certain bonuses.

A contractual PILON clause may be restricted to salary only, avoiding claims for holiday pay, bonus etc.

But there are also some reasons for not using PILON

  • If there is no contractual right to PILON, then paying in lieu is breach of that contract, for which damages are due. The pay-in-lieu compensates for those damages. But it may be argued that it does not wholly compensate, so there could still be a claim for missed holiday pay, reduced pension, etc.
  • The breach of contract (if there is no contractual right to PILON) may be used to release the employee from any obligations they may otherwise have under covenants made in the contract, such as confidentiality of information.
  • Service related benefits, such as death in service benefits, may give right to challenge; if the PILON is seen as an attempt to deprive an employee of those benefits.
  • By placing an employee on “Garden leave” you can prevent him or her working for a competitor during the period of leave.
  • It may be possible that the employee can do some valuable work for you during a period of leave; which is one reason for having notice periods in the first place!

The guidance here is general and may not apply in particular situations.

Please contact Employer Solutions for help in this complex area.

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