Can I receive my payment in lieu of notice tax free in a settlement agreement?
A settlement agreement will often bring an employee’s employment to an end without the need to work the notice period. Instead, the employee receives a payment based on what they would have earned during their notice period. This is known as a payment in lieu of notice or a PILON for short. Many people presume that if the PILON is paid under a settlement agreement it can be paid free of tax. However, this is not necessarily the case.
Is the PILON contractual or not?
As a general rule, payments that are made under an employment contract are taxable. This obviously includes salary, commission, bonuses, and holiday pay. Meanwhile, payments that are made by way of compensation are tax free (up to £30,000). For example, damages for unfair dismissal or discrimination would come within this category. And so an important question is whether the PILON is contractual or not. Does your employment contract contain a clause that allows your employer to make a PILON? If it does, then the PILON should be taxed. Since, it is being made in accordance with the employment contract.
If however the employment contract does not give the employer the right to make a PILON, the same payment can usually be made tax free. It can be described as compensation for not working your notice period. The issue can become more complicated because terms of an employment contract are not necessarily contained in a single document. For example, there may be something in a staff handbook that has contractual effect. Similarly, if it is the usual custom and practice of the employer to pay PILONs, then HMRC may argue that it is effectively a contractual term even though it is not written down. This is known as an implied term.
Ensuring that the settlement agreement is drafted to minimise the tax liability
Often, an employer will include in the settlement agreement a provision that the PILON will be paid subject to tax. This may or may not be necessary. You should ask your solicitor to check your employment contract to see whether there is scope for the PILON to be paid tax free. If there is, it may be necessary to amend the wording of the settlement agreement to allow for this.
Do you need advice on your settlement agreement?
If you need legal advice on whether the PILON in your settlement agreement can be paid free to tax, it is wise to speak to a professional employment law firm. Only the lawyers know the best route for you to take and this is certainly the best way to move forward and get the result you want. For more information you could read this free guide to settlement agreements.
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