Payment in lieu of notice (PILON) clauses
From 6 April 2018 payments made in respect of a notice period, whether a contractual payment or not, will be subject to tax and NICs as general earnings with a new concept of 'post-employment notice pay' being introduced in the legislation.
Non-contractual payment in lieu of notice
Currently there is a tax advantage to not having a PILON clause in the employment contract. When the contract is terminated and there is no PILON clause, an employer can make a payment in lieu of notice and as this is in breach of the contract (the employer had no contractual right to pay in lieu), generally it can be paid tax and NICs free. This can benefit the employer and the employee as less tax and NICs are payable and so termination packages can be increased to reflect the tax advantageous position. Employees are more likely to accept the inflated offer.
It is worth noting that many employers would not choose this route as making a payment in lieu of notice without a contractual right to do so will breach the contract and any restrictive covenants would fall away – PILON clauses do serve a purpose. However, employers can overcome this issue by reaffirming the restrictive covenants through a settlement agreement.
Payments made pursuant to a contractual PILON clause will continue to be taxable and subject to employer and employee NICs.
What if the termination date is before 6 April 2018 but payment is made after 6 April 2018?
The new rules only apply to terminations on or after 6 April 2018. If termination takes place before this date the old rules apply.
Will the £30,000 exemption be reformed?
Under the Income Tax (Earnings and Pensions) Act 2003 ("ITEPA") payments made to an employee which are not earnings may be paid tax free up to a £30,000 exemption and with no obligation to pay NICs at all.
Although there was some discussion the Government has confirmed that the £30,000 exemption will remain. However, from 6 April 2019 employer NICs will be payable on termination payments above £30,000.