Daniel Stevens highlights an important consideration for employers in respect of employment contracts for their employees.
Where employment contracts contain a specific payment in lieu of notice (PILON) clause, any payment made in respect of that clause is treated as earnings for tax and National Insurance contributions (NIC) purposes. For that reason, contracts are often left silent, as this can be beneficial from a tax perspective for both the employee and the employer – but there are non-tax considerations which are important.
What is a PILON?
A PILON is a payment made to an employee which reimburses them for loss of their job – for example through redundancy – in an amount equivalent to their notice period. If the payment is provided for in the contract (or if it is common practice for a PILON to be made), the payment is taxable and subject to both primary and secondary NICs.
In the absence of a clause, it is often arguable that the payment (if made) is compensation for loss of office. This is not earnings, and so is not subject to NIC at all. In addition, the payment can qualify for partial tax exemption (i.e. up to £30,000). It might appear at first glance that this should be the default option; however, you could be leaving yourself open to further claims via an employment tribunal if you do not include a clause.
‘Silent’ contracts
Making a PILON when the contract is silent is technically a breach in the terms of the contract. If an outgoing employee was sufficiently disgruntled, you should be aware that you could be required to make further payments if the PILON doesn’t adequately reflect the true position the employee would have been in if they had remained in employment. Whilst this could indeed be simply restricted to salary, that won’t always be the case. Bonus payment considerations in particular might be a headache in the case of largely commission based staff such as sales representatives.
Possibly more financially damaging for your business, however, is the possibility of a tribunal refusing to enforce other contract terms you may have inserted. A particular concern would be realised if any restrictive covenant clauses were unenforceable.
Example: No PILON clause
Freida works as an accounts manager for A Ltd. She has charge of some 150 valuable accounts, many of whom she has won directly through networking. Her contract does not contain a PILON clause. However, it does contain a clause that would restrict her from approaching any of A Ltd’s clients for a period of two years in the event she left the company.
Freida is dismissed in May 2016, and given a PILON of £25,000. A Ltd inform her that this has been structured in such a way that she will not need to pay tax or NIC on it.
Freida is incensed at the termination package, and the way that the dismissal came about. She takes the company to a tribunal as she feels her termination package does not reflect bonuses she would almost certainly have received later in the year for work she had already done. The tribunal finds that the company has breached the contract terms, and awards Freida a further payment. It also dismisses the enforceability of the restrictive covenant.
Following the tribunal’s decision, Frieda approaches a number of clients, and within six months, has converted 20 clients, worth over £300,000 per year, to her new employer.
Practical Tip:
When drawing up employment contracts, do not be short-sighted and only consider the tax implications of including (or excluding) a PILON contract. Remember also that you can include a PILON clause on a flexible basis – i.e. that one ‘may’ be paid - leaving things open. You can, for example, still require the employee to work that notice period.
