Payment In Lieu Of Notice - Approach with caution
A typical payment in lieu of notice (PILON) clause:
The Company may, in its sole and absolute discretion, terminate the Appointment at any time and terminate the Employee’s employment without notice and may make a payment of basic salary in lieu of notice.
Express Clause = Taxable
In this situation the employer reserves the right to either ask the employee to work out their notice or to leave immediately and make a payment in lieu instead. If a payment is made automatically i.e. because a PILON clause is included in the contract, the PILON is usually taxable as salary in the normal way. This is because, where the employer and employee have mutually agreed that employment can be terminated early, there is no breach of the employment contract and so the severance payment is regarded as income and not damages.
Damages = Not subject to tax (up to £30,000)
At Ortolan, we advise that rather than include an express PILON clause, it is better to simply include a garden leave clause setting out the right to require the employee to remain at home in the “garden” during any notice period. Then, at a later date the parties can agree to a payment equivalent to the gross amount due for the remaining notice period in return for the employee’s employment to terminate immediately. As this was not included in the original contract, the payment can be made tax free as damages.
The reasoning is logical, albeit slightly academic. If there is no PILON clause in the contract then the employer is likely to be in breach of contract if it terminates the employee’s employment without proper notice. As a result, the payment made to the employee is not a payment under the terms of the contract of employment (which would be taxable). Instead, it is an advance payment of damages, aimed at compensating the employee for the employer’s alleged breach of contract and avoiding a potential legal claim. The payment, in this instance will usually be able to be paid tax free up to £30,000.
Posted on 04/02/2015 by Ortolan
