What is payment in lieu of notice and how does it work for UK employees and employers?

Payment in lieu of notice (PILON) is one of the most tax-sensitive termination payments UK employers handle, and in the 2026/27 tax year HMRC continues to apply the post-employment notice pay (PENP) rules introduced in 2018. In short, PILON is a payment that ends employment immediately and compensates the employee for their unworked notice period. Treating it as a general ex-gratia lump sum, instead of applying the PENP calculation, creates immediate risk of HMRC penalties for under-reporting.

When and why do employers use payment in lieu of notice (PILON)?

Employers use PILON when they want to accelerate an individual's departure rather than requiring them to remain on-site during their active notice timeframe. This approach is standard during the redundancy process, structural reorganisations, or sensitive mutual termination cases where keeping an employee active presents operational, security, or cultural risks.

Where the contract includes a contractual PILON clause, the employer can trigger PILON without breaching the employment terms, effectively buying out the notice period. Even where no such clause exists, the employer may still elect to make PILON as part of the employment termination process, but must still respect the employee’s contractual and statutory notice period minimums.

• PILON replaces the requirement to work the notice period.

• A contractual PILON clause gives the employer the right to pay PILON instead of requiring the employee to work the notice period.

• Discretionary PILON (no contract clause) can still be offered as part of the employment termination process, subject to contractual and statutory obligations.

• PILON allows an employer to end employment immediately, with the remaining notice period paid instead of worked.

👉 To note: where no PILON clause exists, the employer can still make PILON, but it is treated identically for tax purposes under HMRC’s post‑2018 rules.

What is the difference between PILON and garden leave?

The primary difference between PILON and garden leave relates to the worker's active employment status during the notice period. A PILON arrangement confirms that the employment ends on a contractually or mutually agreed termination date.

Conversely, an individual placed on gardening leave remains legally employed by the business until the notice period expires, continuing to receive their regular salary and accumulating standard benefits.

When does PILON arise in a redundancy situation?

PILON arises in a redundancy situation when an employer decides to conclude an individual's physical presence immediately after completing the statutory consultation phases. Instead of asking the redundant worker to remain active for several weeks or months, the business compensates them financially for that unserved time.

When structuring these termination packages, payroll administrators must isolate notice calculations from standard statutory redundancy figures. Blending these distinct lines into a single, non-taxable lump sum breaks HMRC rules, as notice buyouts are classified as fully taxable earnings.

Is payment in lieu of notice taxable in the UK?

PILON is generally subject to Income Tax and Class 1 NICs via the PAYE system, and must be processed with deductions applied cleanly through payroll. All notice buyouts are managed directly through employer PAYE procedures and are subject to the statutory PENP calculation as set in HMRC's Employment Income Manual (EIM13874). The £30,000 tax‑free threshold does not cover standard notice buyouts, which are handled through structural rules under ITEPA 2003.

⚠️ Warning: Treating PILON as a non‑taxable payment or trying to offset it against the £30,000 threshold creates HMRC under‑payment risk and potential penalties, consistent with HMRC’s treatment of PENP and termination payments.

How is PILON separated from the £30,000 redundancy exemption?

PILON is carved out of the £30,000 tax‑free redundancy allowance by the PENP calculation, which HMRC uses to determine how much of a termination payment relates to the notice period. The PENP calculation allocates the PILON amount to the post‑employment notice element, ensuring this sum is taxed in full under ITEPA 2003. Any remaining termination payment that is genuinely redundancy‑related, such as the statutory redundancy fund, may then potentially qualify for the £30,000 threshold.

• PENP is the post‑employment notice pay calculation applied to PILON.

• In practice, any amount identified as post-employment notice pay (PENP) is taxed as earnings through PAYE and Class 1 NICs. 

• The remaining termination payment is eligible for the £30,000 exemption if it qualifies as redundancy.

• Incorrect allocation of PILON can expose the employer to HMRC under‑reporting and penalties.

Is payment in lieu of notice pensionable under UK rules?

Whether pension contributions apply depends on the rules of the specific pension scheme, the employment contract, and how the payment is classified under those rules. Employers should check the scheme documentation before assuming PILON is pensionable.

If an employment contract states that PILON is calculated using basic salary alone, pension contributions are typically excluded. However, calculations can alter if a contractual clause dictates otherwise, or if the payment passes through standard pre-tax deductions before distribution.

How is payment in lieu of notice calculated?

Payment in lieu of notice (PILON) is calculated by multiplying an employee's basic gross pay by the remaining days or months left unserved in their contractual notice allocation. Although there is no official HMRC payment in lieu of notice calculator, employers generally calculate PILON using the employee's pay and notice entitlement before applying PAYE and NIC deductions.

The final gross value must be thoroughly reconciled alongside all other termination elements, including accrued holiday and statutory redundancy awards. Each payment line must be allocated to the right tax treatment before the FPS is submitted.

📌 Example: an employee on £36,000 basic salary with 3 months’ notice has a gross PILON of £9,000 before tax.

What pay elements must be included in a PILON calculation?

The specific pay elements included in a PILON calculation depend on the phrasing used within the employment contract. Standard contractual clauses often state that PILON is restricted to basic salary alone, allowing the business to exclude bonuses, commission structures, and regular cash allowances.

If the contract lacks an explicit PILON clause and the employer is paying damages to prevent a wrongful dismissal claim, the calculation must reflect the employee's full remuneration package. This means processing teams may need to factor in average commission trends, historical overtime, and the cash value of healthcare or car allowances.

💡 Good to know: Any accrued, untaken holiday pay must be calculated and displayed on a separate line from PILON. Holiday balances are treated as standard earnings and are not fed into the PENP calculation workflow.

How do you apply the PENP formula to calculate taxable PILON?

PILON is allocated to PENP (post‑employment notice pay), which measures the notice‑related taxable portion of the termination payment under HMRC rules. 

A common way to express the core formula is: 

• (BP x D) ÷ P = PENP

• Where BP is basic pay in the last pay period

• D is the days in the notice period 

• P is the days in the last pay period.

This PENP amount is fully taxed as Income Tax and Class 1 NICs; any remaining termination payment may potentially qualify for the £30,000 redundancy threshold if it meets HMRC conditions. In practice, HMRC's full PENP rules also include adjustments for contractual PILON and variable pay, so this is a simplified version for payroll teams, not the complete formula. The full mechanism is set out in HMRC's Employment Income Manual (EIM13874).

📌Example: an employee with basic pay of £3,000/month (P = 30 days, BP = £3,000) and a 3-month contractual notice period (D = 90 days) gives PENP = (£3,000 × 90) ÷ 30 = £9,000. This £9,000 is fully taxable through PAYE and Class 1 NICs, even if the wider termination payment is structured as redundancy.

How is PILON processed through payroll and reported to HMRC?

PILON appears in the payroll run for the period in which it is paid, not when the decision is made. At that point, full PAYE and Class 1 NICs are deducted from the gross PILON as earnings under RTI, and an FPS (Full Payment Submission) must be sent to HMRC on or before the payment date, even if it falls outside the normal payroll cycle. Good record‑keeping supports the PAYE and NIC treatment and any later PENP or redundancy calculations.

• Include PILON in the payroll run for the period it is paid.

• Retain payslip details and supporting records for audit.

👉 To note: If PILON is paid outside the normal payroll cycle, an additional FPS must still be submitted on or before the payment date; the rules for RTI submissions and for payroll reports help clarify how these off‑cycle payments should be reported and documented, as a delayed FPS risks a late filing penalty.

💡Good to know: Under Schedule 55, Finance Act 2009, HMRC issues automatic late-filing penalties of £100 to £400 per month depending on employer headcount (£100 for 1–9 employees, £400 for 250+).

How do you submit an FPS for a PILON payment outside the normal payroll?

When PILON is paid off‑cycle, it triggers a separate off‑cycle FPS under the normal RTI rules. The FPS must be submitted on or before the payment date of the PILON, or a late submission penalty may apply. This FPS is created and sent through the employer’s payroll software as a single payment line for the PILON.

• Off‑cycle FPS is triggered whenever PILON is paid outside the normal payroll.

• FPS must be sent on or before the payment date.

• A late FPS can attract a late filing penalty.

• The FPS is submitted through the usual payroll software route.

How do you apply payroll deductions to net PILON correctly?

Net PILON is calculated using the standard gross‑to‑net logic: the gross PILON is taxed under the employee’s current PAYE code for that period, with Class 1 NICs applied on the full gross amount. If the employee is repaying a student loan, the relevant deduction is taken using the same plan that applies to their normal earnings. The payslip must show the gross PILON, tax, NICs, other deductions, and the net amount.

• Apply the employee’s current PAYE code to the gross PILON unless the payment is made after the P45 has been issued, in which case HMRC’s post-P45 PAYE rules apply.

• Deduct Class 1 NICs on the full gross PILON.

• Deduct student loan repayments if applicable.

• Display gross and net PILON on the payslip.

These calculations are processed in alignment with standard UK pre-tax deductions frameworks.

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