Tax Piles on to PILONs
by Alex Brooks
When an employment contract is terminated, the employee is sometimes paid out for some or all of their notice period, rather than having to work the whole of it. This is known as a “payment in lieu of notice” or “PILON”.
Where a contract of employment provides for a PILON to be made, this is known as a “contractual PILON”. When a contractual PILON is made, it is subject to the usual deductions for income tax and National Insurance Contributions (“NICs”), in precisely the same way as salary, since it is treated as “earnings” for this purpose.
By contrast, if the employment contract does include reference to any PILON, but one is paid, it will be a “non-contractual PILON”. Non-contractual PILONs were not treated as earnings, but as payments of damages for breach of contract, such that the first £30,000 of any non-contractual PILON could be paid without any deductions, and amounts above that threshold were subject to income tax but not NICs.
With effect from 6 April 2018, much of that advantage was removed. A non-contractual PILON must now be split into:
(1) the amount of basic pay (but excluding benefits, bonuses, commission, etc.) that the employee would have received if they had worked their notice period – this is subject to income tax and NICs; and
(2) any additional amount – this is likely to be considered true compensation for loss of employment and may benefit from same tax treatment as previously applied to non-contractual PILONs.
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