04 March 2003

KEEBLE HAWSON

www.keeblehawson.co.uk

E-MAIL UPDATE

Employment - Payments in Lieu of Notice

The Inland Revenue has recently produced new guidance regarding the way in which payments in lieu of notice (PILONs) are treated for tax purposes.

The main point is in respect of the situation where a contract of employment gives the employer the right to make a PILON at its discretion, rather than as an obligation.

If the employer decides to exercise that right and make a PILON, any payment to the employee is treated as an emolument from employment and will be fully taxable.

If the employer decides not to exercise the right and merely terminates the contract without notice, this will constitute a breach of contract and so any payment to the employee will be regarded by the Inland Revenue as damages for breach of contract. Therefore:

Depending on the value of the payment, this will fall within the £30,000 tax exempt category.
Class 1 National Insurance Contributions will not be payable (this benefits both the employer and employee)
If the employee finds alternative employment in what would have been the notice period, the employee must give credit against the payment for any earnings received in that period (the employee is also under a positive duty to mitigate their loss and will therefore be obliged to take action to secure such alternative employment)

It is therefore more cost efficient for an employer to terminate the employment in breach of contract and pay compensation to the employee, than it is to rely on a PILON clause.

However, employers should be aware that if they decide to take this course of action rather than exercising their discretion to make a PILON, the breach of contract means that the employer will not be able to enforce any restrictive covenants within the contract.

Where a compensation payment is being made to avoid the tax consequences of a PILON, it should be noted that the Inland Revenue's guidance makes it clear that:

If a purported compensation payment is substantially the same value as any payment that would have been made under the PILON clause, that payment is likely to be viewed as being made under the PILON clause and will therefore be fully taxable.
If there is no identifiable breach of contract, the Revenue will assume that the payment has been made under the terms of the contract even where it is not precisely the same amount and is paid in a different form to that provided for in the contract.
The Revenue will accept that a payment is compensation rather than PILON where the payment has characteristics of a compensation payment (ie if a reduction has been made to reflect the fact that the employee has found alternative employment or to reflect tax and NI contributions which would have been paid)
The Revenue will also accept written evidence that the payment was not made under a PILON clause.
Incomplete documentation regarding the termination of the employment contract is usually the trigger for the Revenue to assume that the payments are taxable.

Therefore, where a compensation payment is intended (rather than a PILON) it is advisable for the employer to have contemporaneous documentation showing that the payment is being made as compensation for breach of contract rather than pursuant to any PILON clause.

For more information contact:-

Paul Grindley
0113 399 3424
paulgrindley@keeblehawson.co.uk

Sarah Hall
0114 290 6329
sarahhall@keeblehawson.co.uk
www.keeblehawson.co.uk

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