Your Settlement Agreement Solicitor

The Settlement Agreement Solicitor

Episode 10: Tax on Payments in Lieu of Notice

Hello and welcome back to The Settlement Agreement Solicitor Podcast, where I, Geoffrey Caesar, help you navigate the ins and outs of settlement agreements with confidence. As a solicitor of England and Wales with over 20 years of experience, I’ve seen first-hand how changes in the law can impact your financial outcome in a settlement. This episode focuses on one such significant change.

We are going to talk about Payments in Lieu of Notice (PILON) and the crucial tax changes that took effect in April 2018. We’ll cover what PILON is, what changed with the law, and what it means for you if you’re signing a settlement agreement today. I will bring in some insights from case law, explanatory notes from the legislation itself, and parliamentary debates to really get to the heart of the issue.

So, let’s dive in!

What is PILON?

Let’s start with the basics. Payments in Lieu of Notice, or PILON for short, are payments made by an employer to an employee instead of requiring them to work out their notice period. Essentially, it’s compensation for your notice period, but instead of serving your time, you get the cash.

In many settlement agreements, you might find that a PILON is offered, especially if the employer wants a clean break and doesn’t want the employee hanging around for several months. Now, that might sound simple enough, but here’s where the tax implications come into play.

The Pre-2018 Landscape: More Favourable Treatment

Prior to April 2018, there was some favourable tax treatment available for PILON payments. If your employment contract didn’t specifically include a PILON clause, any payment your employer made to you instead of your notice period could sometimes be treated as a non-contractual payment. And, if it was non-contractual, this meant it might be considered a termination payment—eligible for the £30,000 tax-free allowance.

In effect, if your contract didn’t explicitly require a PILON, you could argue that this was compensation for loss of employment rather than salary. As a result, you could potentially receive the payment without it being taxed in full, provided it stayed within the £30,000 limit. This created a loophole of sorts, where employees whose contracts lacked a PILON clause could sometimes walk away with more in their pockets.

The 2018 Legislative Change: Closing the Loophole

However, in April 2018, the tax treatment of PILON changed significantly with the introduction of the Finance Act 2017, which amended the Income Tax (Earnings and Pensions) Act 2003 (ITEPA 2003).

To quote directly from the Explanatory Note to the Finance Act 2017:

“The new measure provides clarity and certainty, so that all employees will pay income tax and National Insurance contributions (NICs) on the basic pay they would have received had they worked their notice in full, regardless of whether there is a contractual PILON clause or not.”

This means that from 6 April 2018, all PILON payments—whether they are explicitly included in the contract or not—are treated as taxable earnings. The distinction between contractual and non-contractual PILON has effectively been erased. As a result, any payment you receive in lieu of notice is now subject to income tax and National Insurance contributions as if it were salary. There’s no longer any opportunity to apply the £30,000 tax-free allowance to PILON, no matter the circumstances.

This new provision is referred to as Post-Employment Notice Pay (PENP). Essentially, PENP ensures that any compensation for the notice period is taxed as if the employee had continued working during that time.

The Legislative Background: HMRC’s Reasoning

The UK government introduced this change as part of an effort to simplify the tax system and ensure fairness. In fact, in parliamentary debates around the Finance Act, HMRC highlighted that this loophole created inconsistencies where some employees benefited from favourable tax treatment simply because their contracts didn’t have a PILON clause. Employers could structure agreements to take advantage of this, resulting in unequal tax outcomes for employees in similar situations.

The new rule was designed to ensure a level playing field. Now, any payment you receive in lieu of notice—whether explicitly in your contract or not—is taxed as income.

Relevant Case Law

While the 2018 legislation is relatively recent, there has been case law predating the Finance Act 2017 that illustrated the confusion around PILON payments. One such case is HMRC v. White (2014), where the court dealt with a situation involving the tax treatment of termination payments. Although this case came before the 2018 change, it highlighted the kind of uncertainty the new law sought to clarify.

In White, the issue was whether certain payments made to an employee could be treated as non-taxable termination payments or whether they should be taxed as earnings. The case underscored the need for clearer legislation around what should and shouldn’t be taxable, which is exactly what the Finance Act 2017 aimed to address.

What Does This Mean for Your Settlement Agreement?

So, where does this leave you if you’re signing a settlement agreement today?

PILON payments are now always taxable, whether or not they are included in your contract. You’ll pay income tax and National Insurance on these payments, just as you would with your regular salary.

If you’re offered a compensation payment for the loss of your job, such as an ex-gratia payment or a redundancy payment, that’s where you could still benefit from the £30,000 tax-free exemption. But PILON doesn’t fall into this category any longer.

Understanding your rights and obligations under the current law is critical to ensuring you walk away with as much of your settlement as possible. The changes in the law, while closing a loophole, do make it harder to benefit from tax-free payments when it comes to your notice period.

Why Expert Legal Advice Matters

This is where having a solicitor who specialises in settlement agreements is crucial. The difference between getting solid advice and signing on the dotted line without fully understanding the tax implications could cost you thousands of pounds. I work with clients every day to review their agreements, ensure compliance with the law, and, most importantly, minimise their tax liability.

If you’re in the position of negotiating a settlement agreement, don’t go it alone. Let me, Geoffrey Caesar, help you get the best possible outcome. You can reach me at settlementsolicitor.uk. My services never cost you a penny because I work within the legal fees cap provided by your employer.

Thank you for tuning in to The Settlement Agreement Solicitor Podcast! I hope this episode has clarified PILON and tax.

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As always, if you have a settlement agreement on your desk, I’m here to help you make sense of it and secure the best possible deal.