Key Takeaways

  • Wages in lieu of notice (PILON) allow employers to end employment immediately by paying employees what they would have earned during the notice period.
  • PILON may include more than base salary, such as bonuses, commissions, and benefits, depending on the employment contract.
  • Tax treatment depends on whether the payment is contractual or discretionary; most wages in lieu of notice are subject to income tax and deductions.
  • Employers should clearly outline payment in lieu provisions in employment contracts to avoid breach of contract claims.
  • Global and jurisdictional differences exist—notice requirements and entitlements vary by country or state.
  • Employees should carefully review settlement terms, especially regarding benefits, accrued leave, or stock options.

Pay in lieu of contractual notice is when a payment is made to an employee upon termination without notice. This payment ends their employment at that point.

Overview of Payment in Lieu of Notice

When payment is made to compensate an employee for money they would have earned had they worked during their contractual notice period, it is called a payment in lieu of notice. The contractual notice period must be given as a term for a contract of employment whether expressed or implied. If it is expressed, it can be written or spoken.

Other terms may be agreed to, as well. The notice must be given in writing, or the employer can make a payment in lieu of notice when shortening the notification timeframe. A payment in lieu of notice is different from a garden leave where the employee remains employed but is not required to attend work. The employee is still under contract and cannot take another job during the notice period.

A payment in lieu of notice is applied when an employer wants to terminate an employee's services immediately. An example of when an employer would not use payment in lieu of contractual notice is when an employee is terminated for gross misconduct.

Legal Purpose of Wages in Lieu of Notice

The main legal purpose of wages in lieu of notice is to give both employers and employees flexibility when ending the employment relationship. Instead of requiring the employee to work during the notice period, the employer may choose to pay out the notice period to:

  • Maintain operational efficiency when it is not practical or desirable for the employee to remain.
  • Protect business interests, such as safeguarding confidential information or preventing disruption in the workplace.
  • Reduce legal risks by compensating the employee fairly, which helps avoid wrongful dismissal or breach of contract claims.

This option, however, must be balanced against contractual rights. If the contract does not contain a payment in lieu clause, the employer risks claims of wrongful termination unless full entitlements are covered.

Employment Contracts and Payment in Lieu of Notice

A payment in lieu of notice provision in a contract lays the groundwork for the immediate termination of an employee. With the provision in place, an employer would not be in violation of breaching the employment contract if the provision clearly states the terms of the payment in lieu of notice. This would include the amount to be paid for this type of termination.

A normal practice for employers when drafting a payment in lieu of notice stipulation is including the provision that employment is subject to termination at any time if a payment in lieu of notice is paid for the employee's basic salary accruing during the notice period.

If an employer has not included a payment in lieu of notice provision in the contract, it can be tricky. While technically any termination of employment with a payment in lieu of notice is likely to breach an employment contract, this can be avoided with the inclusion of pay and benefits a worker would be entitled to during the notice period.

Making a payment for annual leave that would have accrued and an additional payment by way of a full and final settlement can help avoid any disagreements between the employer and employee. The situation can become more complex if the following situations apply:

  • Share options are in play.
  • The employee loses additional pay or benefits during the notice period because the employer is not covering them under the payment in lieu of notice.
  • The employee is in the process of receiving medical treatment covered by the company's health insurance.
  • The dismissal process was not handled properly.

In these situations, an employment lawyer can be consulted to make sure contractual obligations are not breached.

What Wages in Lieu of Notice Include

Although the phrase often refers to an employee’s base salary during the notice period, wages in lieu of notice may extend to other forms of compensation depending on the employment agreement and local laws:

  • Base salary or hourly wages covering the notice duration.
  • Accrued benefits, such as vacation pay, sick leave, or health coverage.
  • Bonuses or commissions that the employee would reasonably have earned.
  • Retirement contributions that would have been made during the notice period.

Employers who exclude these elements may face disputes, especially if the employee suffers measurable financial loss. For this reason, detailed wording in the employment contract is crucial.

Calculating Payment in Lieu of Notice

When payment in lieu of notice is in progress, it should be made immediately upon termination of employment. Three options are available for making a payment in lieu of notice:

  • Per the terms of employment stating the employee is entitled to the payment.
  • At the employer's discretion per the terms of employment.
  • Regardless of contractual rights or any provisions made.

Taxes on payments in lieu of notice vary based on how they are handled and paid. Taxes are usually paid when the payment is made at the employer's discretion and when it is stated in the terms of employment.

When payment is made, there is no contractual right or provision. This is usually due to a breach of contract. This means the payment in lieu of notice can be considered an advance payment for damages to the employee for losses and as a way to avoid a potential legal claim.

New rules affecting the payment in lieu of notice went into effect on April 6, 2018. Moving forward, employers should consider including payments in lieu of notice in employment contracts. Such a clause allows payment without breaching the contract.

Tax and Compliance Considerations

The tax treatment of wages in lieu of notice depends on whether the payment is contractual or discretionary:

  • Contractual PILON: When included in the employment contract, payments are treated like normal wages and subject to payroll taxes, income tax, and required deductions.
  • Non-contractual PILON: If the employer makes the payment without a contractual obligation, it may sometimes be treated as damages for breach of contract. However, in most jurisdictions—including the U.S. and U.K.—these payments are still taxable as ordinary income.

Employers should also comply with statutory notice obligations in their jurisdiction. For example, U.S. states may have minimum notice or wage requirements, while other countries (like Canada or the U.K.) impose statutory redundancy rules. Failing to comply can lead to penalties or employee claims.

Global and Jurisdictional Differences

Notice periods and payment in lieu rules vary significantly worldwide:

  • United States: Generally governed by employment contracts and state laws; “at-will” employment may limit entitlements, though severance policies often include PILON.
  • United Kingdom: PILON is recognized under statute and contract; tax rules after April 2018 treat most payments as taxable income.
  • Canada: Provinces impose statutory minimum notice or pay in lieu, often supplemented by “common law reasonable notice” which may extend entitlement.
  • Other jurisdictions: Some countries mandate both severance and wages in lieu, with amounts determined by tenure and labor codes.

Employers with international workforces must align their policies with local labor laws to ensure compliance.

Frequently Asked Questions

  1. What is the difference between wages in lieu of notice and severance pay?
    Wages in lieu of notice cover the notice period that an employee would have worked, while severance pay is typically an additional benefit or obligation tied to redundancy or long service.
  2. Are wages in lieu of notice taxable?
    Yes. In most jurisdictions, they are treated as regular income and subject to income tax, Social Security, and other payroll deductions.
  3. Can an employer choose not to offer wages in lieu of notice?
    If the employment contract or law requires notice, the employer must either allow the employee to work the period or pay in lieu. Exceptions may apply for terminations due to gross misconduct.
  4. Do wages in lieu of notice include bonuses or commissions?
    They may, depending on the terms of the contract and the timing of when bonuses or commissions would have been earned.
  5. What should an employee do if they are not offered wages in lieu of notice?
    Employees should review their contract and local labor laws. If required payments are withheld, they may have grounds to bring a claim.

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