Payment in Lieu of Notice (PILON): When You Can and Cannot Use It

Short answer: If an employee’s contract contains a PILON clause, you can end employment immediately by paying the notice pay. If it does not, paying in lieu is a breach of contract, and the employee can claim damages. Payments in lieu are taxable in full, and since the post-employment notice pay rules apply, the tax treatment is more complicated than many employers expect.

“Just pay them and let them go” is the most common instruction we hear when an employer wants an employee out quickly. It is sometimes the right answer. It is often done without the contract clause that makes it lawful.

Notice basics

An employee is entitled to the longer of their contractual notice and the statutory minimum. The statutory minimum is one week after one month’s service, then one week for each complete year up to a maximum of 12 weeks. Many contracts set longer periods, particularly for managers.

The employer can end the contract lawfully by giving notice, by paying in lieu where the contract allows it, or without notice only where the employee has committed a repudiatory breach, such as gross misconduct.

With a PILON clause

A contractual PILON clause allows the employer to end employment immediately by paying a sum in place of notice. Where the clause is properly drafted and operated, the dismissal is lawful and the payment is a contractual one. The key points are:

• the clause should say what the payment includes. Basic pay only, or also benefits such as pension contributions, a car allowance and private medical cover.
• it should say whether the employer may choose to use it, and whether it can be paid in instalments.
• it should say what happens to accrued holiday pay, which is paid separately.
• it should say whether the employee can be asked to keep to confidentiality and restrictive covenants after payment, which they normally will.
• Restrictive covenants. An employer’s repudiatory breach can release the employee from post-termination restrictions such as non-competes and non-solicitation clauses. A covenant that would have protected your client base may no longer be enforceable.
• Agreement can fix it. If the employee agrees to leave and take the money, record that in a settlement agreement or a signed agreement.
• Reputation. An employee who feels pushed out may be more willing to raise other claims.

A discretionary clause, where the employer may choose to pay in lieu, is normally enforceable according to its terms. Drafting matters. Cerberus Software v Rowley [2001] shows that whether pay in lieu is a right or a discretion can affect the damages the employee can claim and whether they must give credit for earnings elsewhere, so check the exact wording before relying on it.

Without a PILON clause

If the contract has no PILON clause and you pay instead of allowing notice, the employer is in breach. The employee can claim damages for wrongful dismissal, which is normally the pay and benefits they would have received during the notice period, less what they earn or could reasonably earn elsewhere. A wrongful dismissal claim is often modest in amount, which is why many employers take the risk. But there are other consequences:

Where it matters that the covenants survive, either follow the contractual notice route, use garden leave if the contract allows, or reach a negotiated exit.

Tax and National Insurance - PILON

All payments in lieu of notice are subject to income tax and National Insurance in full. This applies whether the payment is contractual or not.

The post-employment notice pay rules (PENP) are designed to stop employers avoiding tax by paying a termination sum in place of notice and then claiming the £30,000 exemption. In broad terms, PENP is the basic pay the employee would have received during any unworked notice period, minus any contractual PILON. It is taxed as earnings, with employer and employee National Insurance. Only the balance of a termination award above that, and statutory redundancy pay, can benefit from the £30,000 exemption. Where the employee is paid in equal monthly instalments, the PENP figure is often zero if the contractual PILON matches basic pay, but you should calculate it each time.

HMRC’s internal guidance confirms that PENP is subject to section 38A of the Income Tax (Earnings and Pensions) Act 2003 from 6 April 2026, so employers should check their payroll process for terminations. Ask your payroll provider to confirm how they calculate it.

Effective date of termination

Where an employer terminates with a PILON, the contract usually ends on the day it is communicated. That date matters for qualifying service for an unfair dismissal claim, for time limits and for the start of the redundancy and notice calculations. Statutory minimum notice can be added to service in some cases, so check the dates carefully, especially around the six month qualifying period that applies from 1 January 2027.

A simple decision process

1. Read the contract. Is there a PILON clause, and is it contractual or discretionary?

2. Decide whether the covenants matter. If yes, think carefully before breaching.

3. Compare the options: work the notice, garden leave, PILON, or an agreed exit.

4. Calculate what is owed: notice pay, benefits, accrued holiday and any PENP.

5. Confirm it in writing, with the termination date, the payment, how it is made and the continuing obligations.

6. Speak to payroll before you promise a figure.

Is your termination clause fit for purpose? We review and redraft termination provisions for a fixed fee. [Get your termination clauses reviewed]

Frequently asked questions on PILON

Can I pay in lieu of notice without a clause in the contract? You can, but it is a breach of contract unless the employee agrees. The employee can claim damages for wrongful dismissal, and a breach may release them from restrictive covenants. A signed agreement or settlement agreement avoids this.

Is PILON taxable? Yes. Payments in lieu of notice are subject to income tax and National Insurance in full. Post-employment notice pay rules also apply to unworked notice, so the £30,000 exemption may be reduced.

What is the difference between PILON and garden leave? On garden leave the employee remains employed and is paid during notice but does not work. With PILON, employment ends immediately and the employee receives a payment. Garden leave keeps covenants and duties alive during notice.

Do I pay holiday pay on top of PILON? Yes. Accrued but untaken holiday is paid on termination in addition to the notice payment, unless the employee has taken the holiday during the notice period.

Can I use PILON for gross misconduct? No notice or payment is normally due where the employee has committed gross misconduct, and you can dismiss without notice, provided you follow a fair process. Do not use PILON as a shortcut that avoids the process.

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Reviewed 8 October 2026. This article is general guidance and not legal advice.