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All change: new rules on how Payments In Lieu Of Notice (PILONs) are taxed

06 April

All change: new rules on how Payments In Lieu Of Notice (PILONs) are taxed

The tax position in respect of payments in lieu of notice changed on 6th April 2018. Whether you’re an employer or employee it’s important to understand how the new rules affect you.   

By way of a reminder, Payments In Lieu Of Notice [PILONs] is a payment made to an employee for a notice period that they have been told by their employer that they don’t have to work. PILONs can form part of a contract of employment… but not always… and how payments are treated for tax and NI purposes differs depending on if there is a PILON clause in the contract.   

The purposes of the change in law is to simplify the tax rules for all concerned, and to eliminate the ‘tax or no tax’ uncertainty from termination discussions. In short, the government has removed any distinction between contractual and non-contractual severance payments.   

Until the recent change, it used to be the case that when negotiating settlement agreements to terminate contracts of employment, the severance payment could be treated as a tax-free sum up to £30K.  Severance payments normally include a damages element that compensated the employee for them not being able to work their notice period.   

The only exception to this was when there was a PILON in the employment contract. This meant that the notice pay had to be subject to the normal deductions of PAYE and NI.   

Now, regardless of whether there is a contractual PILON clause or not, the employee will be deemed to be being paid their notice pay and this will be taxed in the normal way. In effect the loop hole that gave some scope to get additional severance pay tax free has now been closed.   

In practical terms, what does this mean?   

Whilst the government may have simplified the rules, the change benefits neither the employer or employee as additional payments now have to paid by both. Historically, severance payments have been attractive to employees because they receive a tax-free lump sum. With the PILON payment now being taxable there is less incentive for an employee to “take a package” and therefore this change has the potential to increase employment litigation. And as for employers….well not for the first time they will bear the financial brunt of the change.

If you need employment law advice, please contact Emma Digby: