Settlement agreements and payments in lieu of notice

Receiving a payment in lieu of notice in your settlement agreement means that your employer pays your salary, and perhaps also benefits, for your notice period, but you do not have to work during that time. ‘In lieu’ means ‘instead of’ in French . For example, if an employee has a three month notice period, the employer might suddenly announce that today is the last day of employment, but that they will be paying three months wages even though you are not coming in to work any more. You might be put on ‘garden leave’ which means that you are told not to work, but not to take another job with a competitor – so you can do your gardening if you like (hence the phrase).

Payment in lieu of notice, or PILON, is often offered in settlement agreements, and is a good thing if you can get it. To find out whether or not you are getting a good deal overall, try our Settlement Agreements Calculator.

Is payment in lieu of notice taxable?

In practice, whether your payment in lieu of notice is paid to you tax free or not will depend on your employer and their accountants. Most employers will insist on taxing the payment in lieu, just to be on the safe side, despite the fact that legally you are normally entitled to receive it tax free,

According to the letter of the law, whether the payment in lieu of notice is taxable or not will depend on the provisions of your contract of employment.

If your contract has a ‘discretionary PILON clause’, then it is not taxable. (A discretionary PILON clause is one which says something like ‘we may in our discretion decide to make a payment in lieu of notice instead of requiring you to work your notice period.) This is because your employer can effectively decide to not pay you in lieu of notice (according to their discretion) and not require you to work out your notice, and therefore any payment made to you would legally be deemed to be an ‘ex gratia’ payment, thus tax free up to £30,000.

Similarly, if your contract of employment has no PILON clause at all, then it is not taxable. This is because your employer is seen to be breaching your employment contact by not giving you the requisite notice pay, and therefore the payment is deemed to be an ex gratia payment.

In the above 2 situations, what your settlement agreement would need to do is simply to describe the payment as an ex gratia payment, rather than a payment in lieu of notice. By using this label in the settlement agreement document, the same sum of money can be defined as a tax free amount rather than a taxable contractual benefit.

Many employers do not understand this technical are – you can refer them to the HMRC at http://www.hmrc.gov.uk/manuals/eimanual/eim13924.html.However in practice it is normally their accountants who will block this practical move.

The only scenario when a payment in lieu of notice would have to be taxed would be if your contract contains an obligatory payment in lieu of notice or PILON clause. This is because it is a contractual benefit, rather than an ex gratia payment, and thus it is a part of your overall employment package. It is highly unusual, however, to see a contract of employment with an obligatory PILON clause in it – most employers prefer to keep the option of insisting that their employees do work out their notice period.

The problem you may well have is that your employer will still probably refuse to take a risk by paying your PILON tax-free. That’s where we come in – we may be able to put forward the relevant case law on your behalf to make them change their minds. For example, we have dealt with settlement agreements against some of the biggest companies in the UK, and some of these companies do make their payments in lieu of notice tax free. This kind of knowledge can give employers the confidence they need to pay you tax free.

If you are receiving a payment in lieu of notice in your settlement agreement, as well as an ex gratia payment and other benefits, we will always seek to ensure that you receive the compensation in the most tax efficient way. Have a look at the testimonials to see how we helped others in your situation.

If you want to negotiate a tax-free payment in lieu of notice or if you have any other settlement agreement query, email us on [email protected], call us 0800 533 5134 or 020 7717 5259 or click here to arrange a call at a convenient time.