An employee is leaving. You don’t want them in the business for another few weeks, but you also don’t want a legal or payroll mess landing on your desk later. That’s where Payment in Lieu of Notice, usually shortened to PILON, comes in.
For a small business, PILON often sounds simple. End employment now, pay the notice period, move on. In practice, the mistakes usually happen in the details. The contract wording might not support it. Payroll may tax it incorrectly. Holiday pay gets missed. Commission or benefits are forgotten. Then what looked like a clean exit turns into a dispute.
That matters more in a tighter labour market. ONS data showed a decrease of 32,000 payrolled employees in the UK between October and November 2024, which is one reason PILON keeps coming up in redundancy and termination conversations (Avensure on PILON and recent UK payroll trends). If you handle employee exits, you need a process that is both quick and compliant.
If you’ve searched what is pilon payment, the short answer is this. It’s a payment that lets you end employment immediately instead of asking the employee to work their notice. The more useful answer is how to use it properly without creating contract, tax, or holiday pay problems. That’s the part many guides skim over, and it’s the part that matters most when you’re the one signing off the exit.
Table of Contents
- Introduction Navigating Employee Exits with PILON
- What Is A PILON Payment Core Concepts Explained
- The Legal and Contractual Foundation of PILON
- Navigating Tax and National Insurance on PILON Payments
- How to Calculate a PILON Payment Accurately
- Common PILON Pitfalls for Small Businesses
- Frequently Asked Questions About PILON
Introduction Navigating Employee Exits with PILON
A typical PILON situation looks like this. A manager tells you the relationship has broken down, or a redundancy decision has been made, or someone in a sensitive role shouldn’t stay in the business for the rest of their notice. You want a clean break that protects the team, the systems, and the business.
PILON can do that. It lets you end employment immediately while still meeting your notice obligation financially. That can be the right call when access to client data needs to stop at once, when morale is already fragile, or when keeping someone in post serves no practical purpose.
The problem is that many small businesses treat PILON as an admin shortcut. It isn’t. It’s a legal and payroll decision wrapped into one. If the contract doesn’t support it, you can create a breach of contract issue. If the calculation is wrong, you can underpay or overpay. If payroll treats it badly, the tax consequences can follow long after the employee has left.
A clean exit only stays clean if the contract, payroll treatment, and final pay calculation all line up.
The safest approach is to think about PILON before you need it. That means checking contracts, knowing what counts in the payment, and making sure whoever runs payroll understands the tax position. Small businesses often have one person wearing HR, finance, and operations hats. That makes a repeatable process even more important.
What Is A PILON Payment Core Concepts Explained
A practical definition that makes sense in real life
PILON means Payment in Lieu of Notice. In plain English, you end the employment straight away and pay the employee for the notice period they would otherwise have worked.
Think of it as a contract buyout. Instead of keeping the contract alive for the notice period, you buy out that period with a payment. The employee leaves immediately. The business gets a clear end date. Payroll processes the money due.
For UK employers, statutory notice is at least one week per year of service up to 12 weeks, although many contracts provide more generous notice terms. PILON has to reflect the notice the employee is entitled to, and the payment can include more than basic salary depending on the contract and the circumstances.
A straightforward example helps. If someone earns £2,500 a month and has a 2-month notice period, the PILON would be £5,000 gross before deductions, processed through payroll. That payment is separate from any redundancy payment or other termination sums.
PILON versus working notice and garden leave
These three options often get mixed together, but they do different jobs.
- Working notice means the employee stays employed and keeps doing the role until the notice period ends.
- Garden leave means the employee stays employed but doesn’t attend work or perform normal duties.
- PILON means employment ends immediately and you pay the value of notice instead.
Working notice is usually best when you still need a handover, customer continuity, or someone to finish a project. Garden leave works better when you need to keep the person away from systems or clients but still want the employment relationship, and its restrictions, to continue for a period. PILON suits situations where a fast, final break is the safest or most practical option.
If you need immediate separation, PILON is often the cleanest route. If you need control for a bit longer, garden leave may be the better fit.
The key point is that what is pilon payment isn’t just a definition question. It’s a decision about how you want the exit to work operationally. Small businesses usually need speed, certainty, and a record of exactly what was paid and why.
The Legal and Contractual Foundation of PILON
Why the clause matters
If there’s one essential point with PILON, it’s this. You need a proper PILON clause in the employment contract if you want to rely on it safely.
Without that clause, using PILON is a breach of contract. That exposes the business to damages claims, and precise drafting avoids that breach entirely. Tellent puts it clearly in its explanation of PILON clauses and immediate dismissal wording (Tellent on PILON clauses and breach risk).
For a small business, trouble often starts at this point. Owners often assume that paying notice solves everything. It doesn’t. If the contract says the employee should work notice and gives you no express right to pay instead, the payment may not cure the contractual problem. You’ve still ended the contract in a way the contract didn’t allow.
That’s why contract housekeeping matters as much as the exit itself. If your contracts and handbook are dated, it’s worth reviewing your wider documentation alongside your termination clauses. Benely’s guidance on modern workplace policies is a useful reminder that handbooks and contracts need regular updates if you want your procedures to hold up in practice.
What a sound PILON clause should cover
A workable PILON clause shouldn’t be vague. It needs to tell both sides what happens if the employer chooses immediate termination.
At a minimum, the clause should cover:
- Immediate effect: It should say clearly that employment can end immediately on payment.
- Payment components: It should define whether the payment includes only basic salary or also commission, bonuses, benefits, and holiday-related sums.
- Timing: It should state when the payment will be made.
- Benefits treatment: It should deal with loss of benefits, such as a company vehicle, if those form part of the package.
- Written confirmation: It should allow the employer to confirm the exercise of PILON in writing.
A vague clause causes arguments. A specific clause reduces them because payroll, HR, and the employee can all see the same basis for calculation.
Practical rule: Don’t wait until a difficult exit to discover your contract is silent on PILON.
If you’re reviewing your documents, keep your compliance process joined up. A practical starting point is this employment law compliance guide for UK employers, especially if your current contracts have grown piecemeal over time.
Navigating Tax and National Insurance on PILON Payments
How HMRC treats PILON now
The tax treatment of PILON changed in a way that removed a lot of old assumptions. Since April 2018, PILON is treated as earnings for tax purposes under the Post-Employment Notice Pay (PENP) rules. That means the notice pay element is subject to income tax and National Insurance through payroll.
A common mistake employers still make is assuming a payment connected to termination can be bundled into a tax-free termination amount. That isn’t how PILON works. Genuine termination payments may have different treatment, and tax-free treatment can apply up to £30,000 in some cases, but that does not turn PILON itself into a tax-free sum.
Where small businesses get caught out
The difficult part isn’t usually knowing that PILON is taxable. The difficult part is getting the notice pay element right. HMRC scrutiny has not gone away, and mistakes still happen when businesses confuse notice pay, holiday pay, and other termination amounts.
HMRC data indicates a 15% rise in employment termination payment disputes between 2024 and 2025, often tied to miscalculating PENP, and those disputes can expose a small firm to over £5,000 in legal fees (DavidsonMorris on PILON, PENP, and dispute risk).
Common tax handling problems include:
- Misclassifying notice pay: Putting it into a broader termination payment without payroll deductions.
- Blurring payment types: Mixing redundancy, holiday pay, and PILON into one figure with no clear breakdown.
- Ignoring contractual detail: Missing the parts of pay that should sit inside the taxable notice element.
- Weak payroll coordination: HR decides the exit terms, but payroll doesn’t receive the detail in time.
For finance teams that want a refresher on how PAYE treatment works in practice, this guide to PAYE for UK contractors is a useful companion piece because the core payroll discipline is the same. Identify what counts as earnings, process it correctly, and keep the audit trail.
If your systems are fragmented, it also helps to review how your payroll setup handles final payments and deductions. This overview of payroll software for small business is useful when you’re assessing whether your current process can cope with more complex exits.
How to Calculate a PILON Payment Accurately
Start with the notice period
A PILON calculation starts with a simple question. What notice is the employee entitled to? That might be the statutory minimum, the contractual notice period, or the more favourable of the two depending on the contract.
Once you know the notice period, calculate the employee’s base pay for that period. Variable items and benefits only come in after that. At this stage, small businesses often move too quickly and assume “one month’s pay” is enough.
Add the elements employers often miss
PILON can include more than basic salary. The exact components depend on the contract and what the employee would have received during notice. That can include holiday accrual, commission, and the cash value of lost benefits where appropriate. Variable pay is typically approached using a 12-week average where that basis applies.
A useful worked example comes from GoCardless. For a 5-year employee with 1 month’s notice and a £40,000 annual salary, the PILON includes £3,333 basic pay, £1,064 for 8 untaken holiday days, and £200 for benefits loss, for a total of around £4,600 pre-tax (GoCardless on PILON calculations and worked example).
That example shows why underpayments happen. The business thinks in terms of salary only. The employee thinks in terms of the full package they would have received if they had remained employed through the notice period.
Sample PILON Calculation Breakdown
| Payment Component | Calculation | Amount |
|---|---|---|
| Basic salary | 1 month notice at monthly basic pay | £3,333 |
| Accrued holiday | 8 untaken days at daily rate | £1,064 |
| Benefits loss | Contractual benefit value | £200 |
| Total pre-tax | Around £4,600 |
A practical checklist helps before you approve final figures:
Confirm notice first
Check the contract and length of service. Don’t calculate pay until the legal notice position is clear.Read the pay clauses carefully
Commission, allowances, bonuses, and benefits shouldn’t be added or excluded by guesswork.Separate PILON from other sums
Holiday pay, redundancy, and ex gratia payments should be identified clearly, even if paid at the same time.Send payroll a written breakdown
A one-line instruction causes mistakes. A component-by-component breakdown prevents them.
Good PILON calculations come from contract reading, not rough estimation.
If you want a practical reference for the notice-period side of the calculation, this UK guide to calculating notice periods is worth keeping to hand. For comparison, even though it covers a different jurisdiction, the UL Lawyers severance calculator is a useful reminder of how much easier exit calculations become when each payment component is broken out clearly instead of lumped together.
Common PILON Pitfalls for Small Businesses
The errors that create most disputes
The most common PILON mistakes aren’t dramatic. They’re admin errors that look small until someone challenges them.
Holiday pay sits high on that list. ACAS data from 2025 shows that 40% of small firm redundancies involving PILON have holiday pay disputes, with manual tracking errors leading to average overpayments or underpayments of £2,500 (Personio on PILON and holiday pay disputes). If your holiday records live across email approvals, spreadsheets, and manager memory, you’re exposed.
Other frequent errors include:
- No contractual PILON right: The business assumes payment alone fixes the exit.
- Variable pay omitted: Commission or similar earnings are ignored without checking the contract.
- Benefits forgotten: Car allowance, health-related benefits, or other contractual items are left out.
- Poor documentation: Payroll receives a total figure but no rationale behind it.
What works better than spreadsheets
What works is surprisingly unglamorous. One source of truth for leave records. A contract review before termination letters go out. A written payment breakdown that HR and payroll both use. Those habits prevent most avoidable disputes.
What doesn’t work is a manual chain of assumptions. One manager estimates unused holiday. Another person copies the figure into payroll. Nobody checks whether the contract includes commission in notice pay. The employee queries the result after leaving, and now the business is reconstructing records under pressure.
Use this quick sense-check before processing PILON:
- Leave records current: Approved leave, carry-over, and accrual are up to date.
- Contract reviewed: Notice, variable pay, and benefits clauses have been checked.
- Payments separated: PILON, holiday pay, and any other termination payments are listed individually.
- Decision recorded: The file shows why PILON was used and when employment ended.
Small businesses don’t need a complicated process. They need a dependable one.
Frequently Asked Questions About PILON
Can an employee ask for PILON
Yes, they can ask. You don’t have to agree unless the contract or a negotiated exit arrangement requires it. In practice, employers usually decide whether PILON suits the business better than working notice or garden leave.
Is PILON the same as redundancy pay
No. PILON is notice pay for an immediate exit. Redundancy pay is a separate entitlement. If someone leaves because of redundancy, they may receive both, but they should be treated as different elements in the final package.
What about restrictive covenants
This depends heavily on the contract wording and the way the exit is handled. If you use PILON without a contractual right, you risk turning the termination into a breach of contract issue, which can weaken your position on post-termination restrictions. This is one reason contract drafting matters before problems arise.
Is PILON due in gross misconduct cases
Usually, no. Gross misconduct can justify dismissal without notice, which means no PILON for the notice period. But that doesn’t remove other final pay obligations. If the employee has accrued but untaken holiday that must be paid, you still need to deal with that correctly.
A few final practical points often help:
- Put it in writing: The termination letter should confirm the effective date and set out what is being paid.
- Don’t merge everything into one figure: A breakdown reduces confusion and gives payroll a clear instruction.
- Check timing: Final pay should be processed promptly and consistently with the contract.
- Get advice when the contract is messy: The cost of checking the wording is usually lower than the cost of defending a dispute.
When an exit feels rushed, slow down just long enough to verify the contract and the calculation.
