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HMRC internal manual

Employment Income Manual

Termination payments and benefits: payments in lieu of notice (PILONs): payments made “automatically”, habitually or by practice or custom

With effect from 6 April 2018, an element of all payments received in connection with the termination of a person’s employment are chargeable to income tax as general earnings (see EIM13874).

As EIM00640 explains, in some circumstances a payment made without legal obligation can be chargeable as earnings under section 62 ITEPA 2003 if it is customary to make it. This is to be considered when there is no written reference in employment terms to PILONs (see EIM12976). Cases such as Corbett v Duff (23TC763) and Laidler v Perry (42TC351) demonstrate the general proposition that voluntary or non-contractual payments may be within section 62 ITEPA 2003 (see EIM01040 and EIM00645).

For example, an employer may always make a payment for any notice period that is not worked, even though nothing is written down. This may be described as a custom, habit, practice or expectation, but the terminology used is less important than identifying the character of the payment. If the payment is made as an automatic response, it is in some cases arguable that it is earnings within section 62 ITEPA 2003 provided that its character is not that of a damages payment (see EIM12978 and EIM13070). Care is needed here because simply making a payment “automatically” or habitually does not of itself make it earnings – an employer may pay damages in that way.

If the payment is not one of damages then the fact that an individual employee does not know about the practice is not crucial; what is more important is whether it is part of the employment relationship where the individual works, namely whether it is perceived as a normal part of the employer-employee relationship rather than as a specific response to not receiving due notice at that time. In the latter scenario, the employer may be responding specifically to the possibility of being sued for damages for breach of contract and so makes a payment to cover that possibility.

It is less important how long the practice has been in place than whether it is an automatic part of the employment. So where it is clear that an employer intends to follow a particular path in the future, a practice can come into being very quickly.

Such a practice should not be argued to exist where there is a procedure for making a genuine “critical assessment” in the making of payments, so that they are not made automatically. For example, an employer makes PILONs instead of giving notice, but each payment is looked at under an internal written procedure that assesses what payment is to be made. The result is that some employees may be forced to sue for compensation, or some may receive less than the equivalent of gross salary (because, for example, they already have another job to go to). A “critical assessment” will essentially seek to identify adjustments typical of a damages payment (see EIM13070). Such PILONs are dealt with as damages because an individual employee cannot be certain that a payment equal to salary due in the notice period will automatically be made and so is not part of the working relationship between employer and employee (see EIM12978).

However, as EIM13070 explains, such adjustments are not mandatory and an employer may have valid commercial reasons not to make them. For example, in a large scale programme where employees predominantly have short notice periods the gain from making them may be outweighed by the cost of doing so and the potential bad feeling generated in the workforce may also be a factor. Any such reasons must be taken into account when deciding whether the character of the payment is that of damages.

Do not suggest that such a payment is contractual. Since you will be dealing with unwritten provisions, such a payment will in general only be contractual if it can be “implied” into the contract. This is a complex non-tax law concept, but broadly a PILON cannot usually be implied because it would conflict with the contractual and statutory right to receive a period of notice. Such payments can still fall within section 62 ITEPA 2003 even if they are not contractual, as explained above, but good evidence must be established from documents and if necessary interviews before asserting that section 62 ITEPA 2003 applies in such a situation and the payment must be analysed as not being one of damages.