Payment in Lieu of Notice (PILON) in the UK: What Employers Need to Know

If you run a small business, there will probably come a time when an employee needs to leave quickly - whether that’s due to performance, misconduct concerns, redundancy, or simply a breakdown in the relationship.

That’s where payment in lieu of notice (often called PILON) comes up. In simple terms, PILON lets you end employment straight away, while paying what the employee would have earned during their notice period.

Handled properly, PILON can be a practical tool to protect your business, reduce disruption, and keep things professional. Handled poorly, it can trigger claims for breach of contract, disputes over pay, and unnecessary stress.

Below, we break down what PILON is, when you can use it, how to calculate it, the tax position at a high level, and the paperwork you should have in place to stay compliant.

What Is PILON (And Why Do Employers Use It)?

PILON stands for payment in lieu of notice. It’s a payment you make to an employee instead of requiring them to work their notice period.

In practice, PILON usually means:

• you terminate employment immediately (or on a very short timeframe), and
• you pay the employee what they would have received if they had worked their notice.

Employers tend to use PILON when keeping the employee in the workplace during notice would create business risk or practical issues, for example:

• Confidential information risk (client lists, pricing, internal strategies)
• Customer and staff disruption (tension, low morale, conflict)
• System access concerns (IT security, data download risk)
• A clean operational handover (you’d rather reassign immediately)
• Time pressure (you need a swift decision during restructure)

For small businesses especially, PILON can be a sensible way to “draw a line” quickly while still paying what’s owed.

PILON vs Garden Leave

PILON is often confused with garden leave, but they’re not the same:

• Garden leave = the employee remains employed during notice, is usually told not to attend work, and continues receiving normal salary/benefits until their notice ends.
• PILON = employment ends immediately and you pay an equivalent amount instead of letting the notice run.

Which option is better depends on your employment contract wording and what you’re trying to achieve (for example, whether you need post-termination restrictions to kick in as soon as possible).

When Can You Use PILON In The UK?

This is the key point: whether you can use PILON lawfully depends on the employee’s contract and the circumstances of termination.

1) Contractual PILON (The Cleanest Option)

The safest approach is where the employee’s contract includes a clear PILON clause. If you have that clause, you can usually terminate immediately and pay in lieu without it being a breach of contract (so long as you follow what the clause says).

That’s why it’s worth getting your Employment Contract right from day one - it’s much harder to fix these issues once a relationship has deteriorated.

A well-drafted PILON clause will often cover:

• what payments are included (salary only, or also benefits/bonus/commission)
• whether holiday accrues up to the termination date
• timing of payment
• how deductions (tax/NI) will apply

2) Non-Contractual PILON (Higher Risk)

If there is no PILON clause, you may still decide to end employment immediately and make a payment equivalent to notice. But if the contract doesn’t allow it, doing so can be treated as a breach of contract.

Why does that matter? Because breach of contract can create real downstream problems, such as:

• the employee claiming wrongful dismissal (a contractual claim)
• arguments about whether post-termination restrictions (restrictive covenants) can still be enforced in the usual way
• disputes about what should be included in the payment (bonus, benefits, etc.)

Sometimes, employers assume “we paid them anyway, so what’s the issue?” The issue is that employment contracts aren’t just about money - they’re about rights and obligations on both sides.

If you’re unsure, it’s worth getting advice before you act, especially if the employee is senior or has access to sensitive information.

3) PILON Where You’re Dismissing For Misconduct Or Performance

There’s also a practical point: PILON is often used even when dismissal is for capability or conduct reasons, because it removes the immediate workplace risk and ends employment cleanly.

But remember:

• Gross misconduct dismissals are typically summary dismissals (no notice), but you must be confident it genuinely meets the threshold and your process is fair. A sloppy process can create claims.
• Poor performance terminations often need warnings and a fair process. You might still pay notice (or use PILON), but process matters.

If you’re dealing with serious conduct issues, it’s worth using a clear disciplinary approach and a proper Gross Misconduct checklist mindset - document decisions, follow your policy, and avoid rushed conclusions.

4) PILON In Redundancy Situations

PILON can also come up during redundancy, particularly where you don’t need (or can’t accommodate) the employee working through their notice period.

Just keep in mind that redundancy has its own requirements - consultation, fair selection, and correct notice. If you’re managing exits during a restructure, having clarity on Redundancy Notice obligations can stop small mistakes becoming expensive ones.

How Do You Calculate PILON? (A Practical Checklist)

Calculating PILON sounds simple - “pay the notice period” - but the details are where disputes happen.

A good starting point is to ask: what would the employee have received if they worked their notice? Then replicate that as closely as your contract requires.

Step 1: Confirm The Notice Period

Check:

• the employee’s contractual notice period
• their statutory minimum notice (under the Employment Rights Act 1996)

In most cases you follow the contract if it provides more than the statutory minimum, but you need to confirm the wording and any probation clauses.

Step 2: Decide What’s Included In PILON

This is heavily contract-dependent. PILON may cover some or all of:

• basic salary
• regular overtime (if it’s contractual/normal)
• commission (sometimes contentious - depends how it accrues)
• cash allowance (e.g. car allowance)
• benefits (private medical, phone, etc.) or the cash equivalent
• pension contributions (again depends on the scheme/contract)

If your contract has a PILON clause, follow it closely. If it doesn’t, you need to take extra care to avoid paying too little (which can lead to claims) or paying amounts you didn’t need to (which can be costly for a small business).

Step 3: Add Untaken Holiday Pay

Holiday entitlement doesn’t disappear just because employment is ending. You’ll normally need to pay for:

• accrued but untaken statutory holiday up to the termination date, and
• any additional contractual holiday, depending on your policy/contract wording.

This is a separate calculation from PILON, but it’s commonly dealt with at the same time in the final payslip.

Step 4: Confirm Deductions And Timing

Make sure payroll knows:

• the termination date
• how PILON should be described in payslips
• what deductions apply (PAYE/NI)
• when payment will be made (often the next payroll run, but check your contract and usual pay practices)

Delays in final payment are a common trigger for disputes - even where the underlying dismissal was otherwise handled reasonably.

Is PILON Taxable In The UK?

In most cases, yes - PILON will be subject to tax and National Insurance in some form.

From an employer perspective, it helps to think about PILON in two buckets:

• Contractual PILON: commonly treated as earnings and processed through payroll with PAYE and National Insurance.
• Non-contractual PILON: the rules are more technical, and HMRC’s post-employment notice pay (PENP) rules often mean some (or all) of the notice element is taxed as earnings even where there isn’t an express PILON clause.

In plain terms, HMRC will usually expect tax/NI to be deducted from money paid instead of notice, because it’s replacing salary that would have been taxed anyway.

Because the tax treatment can be nuanced (especially if there are settlement payments, bonus arrangements, or complicated benefit packages), it’s sensible to align your legal approach with your accountant and payroll provider, and check HMRC guidance where needed. (This section is general information only and isn’t tax advice.)

If you’re negotiating an exit package, you should also be careful about how you describe different parts of the payment (for example, distinguishing notice pay from any ex-gratia amount) - but always take advice to avoid mischaracterising payments.

What Are The Legal Risks If You Get PILON Wrong?

PILON is common - but it still creates legal risk if you don’t handle it carefully.

Here are some of the most common issues we see for small businesses.

Breach Of Contract / Wrongful Dismissal Claims

If the contract doesn’t allow PILON, or you underpay what’s owed, the employee may claim wrongful dismissal (which is a contractual claim, not the same as unfair dismissal).

Even if your business had a valid reason to end employment, paying incorrectly can still create liability.

Unfair Dismissal Risk (Process Still Matters)

PILON doesn’t “solve” unfair dismissal risk.

If the employee has the qualifying service to bring an unfair dismissal claim (or if the claim relates to an automatically unfair reason), you still need:

• a fair reason, and
• a fair process.

For example, if you’re terminating due to long-term sickness or capability, make sure you’ve followed a sensible process and taken advice on an Ill Health Capability Dismissal approach before rushing to end employment.

Disputes About Benefits, Commission, And Bonus

Employees often challenge PILON calculations where their pay isn’t just a basic salary.

Commission and bonus disputes are particularly common. Ask yourself:

• Is commission contractual and already “earned” during the notice period?
• Is there a bonus scheme that requires the employee to be employed on a payment date?
• Does the contract allow you to exclude discretionary bonuses from PILON?

These are contract interpretation issues - so the wording matters.

Paperwork Gaps And Inconsistent Messaging

If you say one thing in a meeting, another thing in a termination letter, and payroll processes something different again, it creates confusion and mistrust.

A clear termination letter helps you keep the message consistent and reduces the chance of later disputes. Many employers use a structured Termination Letter format that confirms:

• the termination date
• whether PILON applies
• what will be paid (and when)
• how company property must be returned
• any ongoing obligations (confidentiality, restrictive covenants, etc.)

How Can You Protect Your Business When Using PILON?

The best way to reduce PILON headaches is to set your process and documents up properly before you need them - because terminations tend to happen under pressure.

1) Make Sure Your Employment Contracts Cover PILON

If you don’t already have one, adding a clear PILON clause into your standard employment contract can be a huge risk-reducer. It gives you flexibility while keeping the exit legally “clean”.

For many small businesses, having consistent contracts across the team also helps you avoid accidental inconsistencies (for example, different notice periods for similar roles without a good reason).

2) Keep A Consistent Offboarding Checklist

Even a simple internal checklist can help you stay organised. Consider including:

• termination date confirmed in writing
• final pay items confirmed (PILON, holiday pay, expenses)
• return of property (laptop, keys, phone, uniform)
• IT access removal timing (email, CRM, cloud storage)
• confidentiality reminder
• handover plan (if any)

3) Be Careful With “Immediate Termination” Language

There’s a difference between:

• ending employment immediately with PILON, and
• summary dismissal for gross misconduct (no notice / no PILON).

If you label a termination as “gross misconduct” without a proper basis and investigation, you can escalate risk fast. In many cases, paying PILON can be a more pragmatic, lower-conflict approach - but it still needs to align with the contract and your process.

4) Get Advice If The Exit Is Complex

If the employee is senior, has access to sensitive information, or there’s already conflict, it’s worth getting advice early. The cost of a quick check is often much less than the cost of defending a claim later.

And if you’re dealing with a wider restructure, redundancies, or multiple exits, you may need a more coordinated plan to keep communications and documents consistent.

Key Takeaways

• PILON (payment in lieu of notice) lets you end employment immediately while paying what the employee would have earned during notice.
• The safest approach is contractual PILON - a clear PILON clause in the employment contract that sets out what will be paid.
• If there’s no PILON clause, paying in lieu may still be possible, but it can create breach of contract risk and potential complications when you’re relying on post-termination restrictions (restrictive covenants).
• When calculating PILON, check the notice period, confirm what counts as “pay” (salary, allowance, benefits, commission), and don’t forget holiday pay.
• PILON is typically subject to tax and (in many cases) National Insurance, so make sure payroll processing aligns with your legal documentation and take accountant/payroll advice where needed.
• Even with PILON, you still need a fair reason and process to reduce unfair dismissal risk (especially for performance, capability, and redundancy scenarios).

If you’d like help reviewing your employment contracts, adding a PILON clause, or managing a termination smoothly, you can reach us at 08081347754 or team@sprintlaw.co.uk.