Significant changes are planned to come into effect on 6 April 2018 which will impact the taxation of some payments in lieu of notice (PILONs). The practice of being able to make certain non-contractual PILONs on a tax-free basis is to be abolished. Although the legislation has not yet been finalised, employers should be aware of the proposals now, as there may be benefits to making termination payments before 6 April 2018.


PILONs made in exercise of a contractual right to make a PILON are taxed and subject to NICs as earnings, in the same way as salary. The same is true for so-called auto-PILONs, a term coined by HMRC to describe the automatic practice of making PILONs.

Where there is no contractual PILON or auto-PILON, but an employer terminates employment without allowing the employee to serve out their notice period, any payment in respect of the monies that an employee would have earned in their notice period constitutes damages for breach of contract. It can therefore be paid (together with other ex gratia payments and redundancy pay) tax free up to £30,000, and completely free of employer and employee NICs.

New proposals for taxing PENP payments from 6 April 2018

Under the draft Finance (No. 2) Bill 2017, there will be a change to the taxation of termination payments made on or after 6 April 2018 which are not already taxable as a PILON or auto-PILON. In those circumstances, where a termination payment is made, the legislation will deem some or all of it to be referable to the basic pay that the employee would have earned in his/her notice period, if it had been served out. That "slice" of the payment will be fully taxable and will no longer fall within the £30,000 tax-free allowance. The Bill proposes that:

  • Basic pay for what would have been the notice period, if it had been worked, should be taxable as a 'PENP' payment (post-employment notice period payment).
  • The principle applies only to basic pay: compensation for loss of benefits can still fall into the £30,000 allowance
  • Though the legislation is not entirely clear, the principle appears to only apply to payments which are not already fully taxable (so it should not affect contractual PILONs or auto-PILONs since those are already fully taxable)
  • The principle applies to the amount which is deemed to be basic pay referable to the unexpired notice period according to a statutory formula
  • The amount which is actually paid for the notice period is not relevant. Nor does it matter that a PENP payment is included as part of a larger ex gratia figure and not described as notice pay. The statutory formula applies to the part of any termination payment which is deemed to be a PENP payment
  • The statutory formula is straightforward for monthly-paid employees whose unworked notice is in complete months:


  • An employer makes a termination payment to a departing executive on 1 May 2018. The notice period is 6 months. The executive does not work any of their notice. There is no PILON clause or auto-PILON. They were paid monthly.
  • Under the statutory formula, the PENP payment is 6 months' basic salary.
  • The amount representing 6 months basic salary is effectively carved out of the lump sum termination payment and subject to tax and NICs as a PENP payment. The rest would ordinarily be paid tax free up to £30,000, provided that it is a genuinely ex gratia payment.
  • The statutory formula is more complicated if the employee is not paid monthly or if their unworked notice period is not in complete months (for example because it is in weeks or because they worked a few days of their notice). In these circumstances, the PENP payment is calculated in calendar days, using a daily rate calculated (rather artificially) using the last pay period:


The executive in the example above is given notice on 1 May and works 3 days of their 6 month notice period. This means they have 181 days of the notice period remaining (as the six months May to October consist of 184 days). The PENP payment is now calculated according to the more complicated version of the statutory formula. The practical effect is that the PENP payment is 181 days of the executive's daily basic salary, where the daily basic salary is 1/30th of the executive's basic salary in April (April was the last complete pay period before notice was given and there are 30 days in April).

  • Under the more complicated version of the formula the PENP payment will therefore vary depending on the number of calendar days in both the unworked notice period and the last pay period. This approach to calculating the PENP payment may not correspond to an employer's own systems for calculating daily rates or for pro-rating notice pay.

New proposals for NICs on termination payments from 6 April 2019

In a separate development, the government plans to introduce legislation to make ex -gratia payments above the first £30,000 subject to employer (but not employee) NICs. This was originally due to come into effect at the same time as the proposals described above but has now been delayed for a year.


Employers should be aware that this legislation is in draft form only, and may change before it is finally introduced. It is also possible that as yet unpublished HMRC guidance on it may change the way in which it impacts termination payments. However, employers who are currently forecasting job losses after 6 April 2018, or before 6 April 2018 but where termination payments may be made after 6 April 2018, should factor the new proposals into any discussions with staff about termination payments.

As April 2018 approaches, employers should also:

  • consider if the termination payment should be made before 6 April 2018, as there may be a tax benefit to the employee in doing so
  • be ready to specify the date when payments will be made - the PENP payment rules will apply to payments received on or after 6 April 2018
  • be particularly cautious about staged payments where one or more payment falls on or after 6 April 2018 as the new rules will have an impact

These new rules are undoubtedly complex, and we expect there to be widespread confusion while they bed in. If you wish to hear more about their application in practice, with worked examples, please click the following link to register for our upcoming webinar on the topic.