NIM02530 | Class 1 NICs: Earnings of employees and office holders: Payments made on termination of employment: Payments in lieu of notice (PILONs): Contractual PILONs

In addition to specifying the period of notice, a contract of employment may provide expressly for a sum to be paid instead of that notice being given.

Such wording in a contract means that the contract actually provides that in the event of the employment being terminated prematurely a PILON will be made.

The intention behind this payment is exactly the same as in any PILON situation. The employer wishes to satisfy the employee’s entitlement to damages in the event of the required notice not being given. The payment is therefore included in the contract as an alternative to the period of notice to forestall any possibility of legal action for damages. In the event that the due notice is not given there will be no breach of contract as long as the alternative payment is made – there can therefore be no action for damages in respect of a breach of contract.

The PILON is contractual because the payment is provided for in the contract of employment. Where a PILON is paid in such circumstances the payment is earnings for the purposes of Class 1 NICs because it is something to which the employee becomes entitled as part of the terms on which they agreed to provide their services. It is therefore part of the employee’s rewards for their labour – and satisfies the definition of “earnings” in section 3(1) of the Social Security Contributions and Benefits Act 1992 because it is “remuneration…derived from an employment”. See NIM02010.

‘Discretionary’ PILONs

In some cases, the contractual arrangements may give the employer a choice or discretion of either giving the required notice or making a PILON. In such a case an employer may decide not to give proper notice and also not to make a PILON under the contract. If he takes this line, the terms of the contract will be breached, and any payment made in respect of that breach will be a compensatory payment made in consideration of the individual’s entitlement to damages as a result of the breach.

You should examine the evidence carefully in these cases to confirm that the employer actually chose to breach the contract. The tax case of Richardson v Delaney (to be reported) is an example of a case where the High Court rejected the employer’s claim that such a breach had occurred.

However, note that from 6 April 2018, this type of PILON became taxable as general earnings, and also now treated as earnings for Class 1 NICs purposes. See NIM02555 for further information.

See examples 2 and 3 in EIM13924.