Information Leaflets



From April 2018 new rules mean that when you pay an employee in lieu of notice you’ll have to apply PAYE, instead of treating the payment as exempt. However, part of it can still paid tax free. What’s liable to tax and NI, and what’s not?

PILON The Problems

The tax treatment of payments in lieu of notice (PILONs) has been a bone of contention for HMRC for years. It often disputes whether the circumstances of a PILON allow it to be covered by the exemption (up to £30,000) which applies to payments made in respect of the termination of an employment. However, new rules aim to remove the uncertainty from 6 April 2018. But contrary to what HMRC would have you believe, the changes do not always simplify the tax treatment. In fact, they can make it extremely fiddly.

Plain and Simple Cases

Despite the potential complexity, the new rules will produce an easy-to-arrive-at result in straightforward situations. You must first work out the employee’s basic pay figure ignoring overtime, commission and bonuses for the twelve months up to the last day of their employment, i.e. the date you terminated it. Next, establish the number of days in the notice period which the employee would have been required to work, had you not terminated their employment, divide that by 365 and multiply it by the first figure.

Example. Ben was employed by Acom for three years when it makes his job redundant on 1 May 2018. Acom asks Ben to leave immediately. His contract stipulates four weeks’ notice. Acom pays Ben £3,000 compensation. His basic pay over the previous twelve months was £18,600. The taxable PILON is £1,427, i.e. £18,600 / 365 x 28.

Note. This taxable amount is treated as general earnings so PAYE tax and NI must be deducted and Acom must pay employers’ NI. The balance of the £3,000 is taxable as a termination payment. In our example this means the £1,573 (£3,000 - £1,427) can be paid to Ben tax and NI free as it’s within the £30,000 exemption.


The trouble is that not all termination payments are as neat as our example. An employee’s contract may include, say, a guaranteed PILON, a very long notice period or none at all, the employee may have been employed for less than a year, or been included in a salary sacrifice arrangement. There is a vast number of permutations which tend to come into play with more senior employees and directors, which is why the new rules include a formula to cover all situations.

 Tip. Although the tricky formula applies to simple cases as well as complex ones, you can short cut it, as we did in our example.


Negotiations over compensation payments can drag on for a long time. It’s therefore important that you understand the effects of the new rules because even if you start negotiations now, by the time you make a payment they might apply.

Tip. Where the new rules will mean an (ex)employee has to pay more tax and NI on their termination payment, you might be able to use this as a bargaining chip over the next few months to speed up negotiations or even agree on a lower settlement if it’s paid before 6 April.

Payments in lieu of notice (PILONs) will count as general earnings from 6 April 2018. A special formula is used to work out the amount liable to tax and NI where the PILON is part of a compensation payment. You might be able to use the effect of the new rules as a bargaining chip to settle negotiations before 6 April 2018.



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