PILONS – should you have them?

The government and HMRC are considering changing the rules surrounding termination payments made to employees.  The proposals follow a review by the Office of Tax Simplification which concluded that the current system is ‘fraught with confusion and uncertainty.’  The intention is to simplify the rules whilst increasing certainty for employees regarding the payment they will receive if they lose their job. For employers these changes are likely to lead to increased costs.

The proposals include:

-          Removing the distinction between contractual and non-contractual pay in lieu of notice clauses (‘PILONs’);

-          Aligning the income tax and NIC treatment of termination payments; and

-          Moving the £30k tax free cap (probably downwards).

We do not yet have final details, but the government are considering applying a tax exemption only to payments made to employees with two or more years’ service.  The amount of the exemption is also undecided, but the government suggests that it should be reduced from the current level of £30,000 and set in bands reflecting the length of service of the employee concerned.  The final part of the proposals is that the tax exemption should only be available where the termination is wholly or mainly due to redundancy.
We may not yet have all the answers, but this review reminds employers that it is important to consider whether or not to include a PILON in employment contracts.

Currently, when a PILON clause is included, the termination payment will be subject to tax and NICs.  When there is no such clause, the payment will be tax and NIC free (up to the current tax free cap).  If employers based their contractual terms on tax treatment alone it would therefore make sense not to include a PILON in a contract of employment.  However, there are other factors to consider.  Most notably, without a PILON clause, any attempt to terminate employment without giving notice could result in a breach of contract claim and will invalidate any continuing obligations under the contract such as restrictive covenants and confidentiality provisions.   It is also possible to limit an employer’s liability on termination in the PILON to basic salary only in respect of the notice period, avoiding potentially costly payments such as bonus, car allowances, insurance benefits and commission during the notice period.
As with most things in life, the PILON comes with pros and cons.  Employers may wish to revisit their contracts when the government introduces the new rules on termination payments.

Rhona Darbyshire