Payment in Lieu of Notice (PILON): Ending Employment Cleanly, Fairly, and Legally

Ending an employment relationship is rarely just a technical exercise. Even when a decision is commercially justified, the way it is handled can have lasting consequences — legally, reputationally and emotionally.

For employers, one of the most common tools used to bring an employment relationship to a swift and controlled conclusion is Payment in Lieu of Notice, more commonly referred to as PILON.

At its simplest, PILON allows an employer to terminate employment immediately while paying the employee what they would have earned during their notice period. In practice, however, it raises important contractual, tax, and risk-management considerations — particularly for owner-managed businesses.

This article explains what PILON really means under UK employment law, when it can be used safely, and how to avoid turning a clean exit into an unnecessary dispute.

What Is a Payment in Lieu of Notice?

A Payment in Lieu of Notice is exactly what it sounds like. Instead of requiring an employee to work their contractual or statutory notice period, the employer ends employment immediately and makes a lump-sum payment equivalent to what the employee would have received had they worked that notice.

From a business perspective, PILON is often used where:

• The employment relationship has irretrievably broken down
• There are concerns around confidentiality or sensitive information
• The employer wants a clean and immediate separation

Once a PILON is made, the individual is no longer an employee. That distinction is critical and separates PILON from arrangements such as garden leave, where employment continues even though the employee is not working.

Why Employers Use PILON

For many businesses, particularly SMEs, PILON is about control and certainty.

Allowing an employee to remain in the business during their notice period can carry risk. They may still have access to confidential data, client relationships, or staff. They may also disengage, damage morale, or simply fail to contribute meaningfully.

PILON provides a way to:

• End the relationship decisively
• Protect the business
• Give the employee clarity and financial certainty

Handled correctly, it can be a pragmatic and professional solution for both sides.

Handled poorly, it can expose the employer to breach of contract claims, tax complications, or unfair dismissal risk.

The Importance of a PILON Clause

Whether a PILON is lawful often comes down to what the employment contract says.

If the contract includes an express PILON clause, the employer has the right to terminate employment immediately and make a payment instead of notice. This avoids a breach of contract and provides a clear legal basis for the payment.

Where no PILON clause exists, the position is more complex. Terminating without notice may technically amount to a breach of contract, even if the employer pays the equivalent amount.

In those circumstances, PILON may still be used — but it is often:

• Negotiated as part of a settlement agreement
• Framed carefully to manage risk
• Accompanied by waivers of claims

This is where early legal advice becomes particularly important.

PILON and Settlement Agreements

In practice, PILON frequently forms part of a wider exit package documented in a settlement agreement.

This is common where:

• The termination is sensitive
• There is potential exposure to claims
• The parties want certainty and finality

A settlement agreement allows the employer to:

• Make a PILON payment
• Set out exactly what is being paid and why
• Secure a waiver of employment claims

From the employee’s perspective, it provides clarity, legal advice, and a clean break.

For business owners, settlement agreements are often the safest way to deploy PILON where contractual rights are unclear or where the risk profile is higher.

What Does a PILON Payment Cover?

A properly structured PILON usually reflects what the employee would have received had they worked their notice period.

This typically includes:

• Basic salary
• Contractual benefits
• Pension contributions

Bonuses and commission are more nuanced. Whether they are included depends on the wording of the contract and any bonus scheme rules.

Disputes often arise where employers assume that a PILON only covers salary. In reality, failing to include contractual benefits can lead to claims — particularly where senior or long-serving employees are involved.

Tax Treatment: A Common Pitfall

The tax treatment of PILON is frequently misunderstood.

Where a PILON is contractual, it is treated as earnings and subject to:

• Income tax
• National Insurance contributions

This applies even if the payment is made as a lump sum.

By contrast, genuine compensation for loss of employment (above contractual entitlements) may benefit from the £30,000 tax-free exemption — but PILON itself does not.

Mischaracterising PILON payments for tax purposes can create problems for both employer and employee, and so careful drafting is essential.

PILON vs Garden Leave

PILON is often confused with garden leave, but the two operate very differently.

With garden leave, the employee remains employed during the notice period but is instructed not to attend work or perform duties. They continue to receive salary and benefits as normal.

With PILON, employment ends immediately.

The distinction matters because:

• Restrictive covenants often operate differently
• Share schemes may be affected
• Benefits and protections cease immediately

Choosing between PILON and garden leave is not simply a stylistic decision — it is a strategic one with legal consequences.

PILON in Redundancy Situations

PILON is commonly used in redundancy scenarios, particularly where employers want to:

• Accelerate organisational change
• Reduce uncertainty
• Allow employees to move on quickly

While redundancy payments themselves may qualify for favourable tax treatment, PILON does not. It remains taxable as earnings.

Redundancy processes also carry specific procedural requirements. PILON cannot be used to bypass consultation obligations or fair process.

Risk Areas for Employers

From a legal perspective, PILON creates risk where:

• There is no contractual right to make the payment
• The payment is miscalculated
• Benefits or bonuses are overlooked
• Tax treatment is incorrect
• The termination process is unfair
• Termination of share related ownership and its valuation is tied in with employment termination

In SME environments, where contracts may be historic or inconsistent, these issues arise more often than many employers expect.

The cost of getting PILON wrong often exceeds the cost of taking advice upfront.

PILON and Unfair Dismissal

PILON does not remove the need for a fair dismissal process.

An employee may still bring an unfair dismissal claim if:

• The reason for dismissal is not fair
• A fair procedure was not followed

PILON deals with notice entitlement, not fairness.

This is a crucial distinction. Employers sometimes assume that paying notice in full insulates them from claims. It does not.

A Personal Approach to Employment Law

At 3volution, we regularly advise business owners who want to do the right thing — for their business and for their people.

We understand that employment termination decisions are rarely black and white. They involve commercial pressures, personal relationships, and reputational considerations.

Our role is to:

• Help clients understand their legal position clearly
• Structure exits that are fair, lawful, and proportionate
• Reduce the risk of disputes and claims

PILON, when used properly, is a valuable tool. When used casually, it can become an expensive mistake.

Summary of Payment in Lieu of Notice

Payment in Lieu of Notice is not just a payroll decision. It is a legal mechanism with real consequences.

For employers, the key is not simply whether you can use PILON, but whether you are using it correctly, contractually, and strategically.

If you are considering terminating an employee’s contract — particularly at a senior level — taking advice early can mean the difference between a clean exit and a lingering problem.

Corporate law may be technical. But when it comes to people, it is always personal.

FAQs about PILON

What is a Payment in Lieu of Notice (PILON)?
A PILON is a lump-sum payment made to an employee when their employment is terminated immediately, instead of requiring them to work their notice period.

Is PILON taxable in the UK?
Yes. Contractual PILON payments are subject to income tax and National Insurance.

Can I use PILON if there is no PILON clause?
Possibly, but it may amount to breach of contract unless handled carefully or documented through a settlement agreement.

Does PILON prevent unfair dismissal claims?
No. PILON deals with notice pay, not the fairness of the dismissal process.