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Introduction to this document

Letter confirming payment in lieu of notice

Where you’ve stated an employee isn’t required to work out their notice period and instead will be paid in lieu of notice, use our letter to confirm the PILON payment. You need to work out whether it’s a contractual payment or not and be aware of the tax implications.

Contractual payment or damages?

Where there’s an express clause in the employee’s contract of employment permitting you to make a payment in lieu of notice (a PILON clause), then any PILON you make will be regarded as wages payable under the contract. Conversely, in the absence of such an express clause, pay in lieu of notice will be regarded as a payment of compensation in connection with termination of employment, i.e. damages for your breach of contract. So what’s the difference? Firstly, with a PILON clause, you can limit the amount payable to the employee to a sum based on basic salary only (see our Pay in Lieu of Notice Clause). However, where you have to pay damages for breach of contract, the damages must put the employee in the position they would have been had the contract been properly performed, i.e. had the employee been permitted to work their notice period. This means you will have to compensate them for the loss of any bonuses, commission, annual leave and other benefits in kind during what would have been their notice period. Secondly, since without a PILON clause you are committing a breach of contract if you pay in lieu, there is a risk that a tribunal or court will hold that you cannot then enforce the other provisions of the employee’s contract. If the contract contained post-termination restrictive covenants, this could cause you a major issue. Thirdly, the employee could issue a claim against you for wrongful dismissal if you have paid in lieu with no PILON clause, although if you have adequately compensated them for their loss, their claim shouldn’t get very far. Fourthly, if you do not have a PILON clause and you terminate employment without notice, other than in cases of gross misconduct, arguably the contract still continues unless the employee actually accepts your repudiatory breach of contract or until the end of the contractual notice period – which means the employee could demand its continued performance until then.

The tax position

The major downside to having a PILON clause is that the payment is then fully taxable as it’s a payment of wages made under their contract. Without a PILON clause, you can make the payment tax-free (subject to the tax-free £30,000 limit) as compensation for loss of employment, although there’s still a risk HMRC could say it’s a contractual payment if, by custom and practice, you always tend to pay employees in lieu of notice on termination of employment. Also, even if you can pay the sum tax-free, you don’t have to pay the employee based on gross salary if you don’t want to - you could still pay them based on net salary and make the tax saving yourself.

PILON letter

Our Letter Confirming Payment in Lieu of Notice refers to the original dismissal letter in which you would have stated that a payment in lieu of notice would be made. It then goes on to confirm the amount of the PILON payment and we’ve included two options for the payment to be based on either gross or net salary. What we’ve not provided for is it to include a sum in respect of other benefit-in-kind losses (where the payment is damages for breach of contract), so you’ll either need to add this in where applicable or you could take the risk that the employee won’t raise the issue. Where the PILON payment is made in exercise of a contractual PILON clause, we’ve included optional wording to make this clear. Finally, we’ve included two options relating to whether you’re enclosing a cheque for the PILON or whether you’re going to pay it into their nominated bank account.