Payment in lieu of notice (PILON) is compensation paid to an employee upon termination, which allows the terminated employee to receive pay in place of working through their notice period.
The payment allows the employer to terminate the employee immediately and compensates the employee for what they would have earned in wages if they worked during their contractual notice period.
A notice period is the amount of time an employee is required to work after their employer dismisses them or they resign. In most countries, employees are entitled to a notice period—although circumstances and the length of the notice period differ depending on the country’s local employment regulations.
However, an employer may wish to terminate an employee without requiring them to work their notice period and opt for payment in lieu of notice.
When is payment in lieu of notice used?
Payment in lieu of notice often occurs when an employer wants to avoid any disruptions caused by a terminated employee continuing to work during their notice period.
Below are a few examples of when an employer may use payment in lieu:
- The employer may not want a terminated employee to continue having access to business systems and information.
- The employee has requested to leave without working their notice.
- The employer is concerned the employee may disrupt the rest of the workplace.
- The employer is worried the employee will not carry out their job properly.
How does payment in lieu of notice work?
Where applicable, domestic or international employment contracts must include a clause for payment in lieu of notice. With a payment in lieu provision in place that states the terms of the payment in lieu of notice, an employer is not in violation of breaching the employment contract.
Upon an employee's dismissal or departure, the employer can terminate the agreement immediately by paying the exiting employee the equivalent wages they would have earned during their notice period. The employee does not complete or work their notice period.
How is pay in lieu of notice calculated?
Payment in lieu of notice is calculated based on the employee’s salary and the notice period outlined in their contract. Notice periods range from several days to several months, depending on the country and local employment regulations.
To calculate the pay in lieu amount, multiply the employee’s salary by the number of days, weeks, or months of the notice period.
For example, if the employee’s annual salary is $70,000 and their notice period is two weeks, the payment in lieu of notice is calculated as:
($70,000 / 52 weeks in a year) x 2 weeks = $2,692
This calculation is the baseline payment in lieu based on the employee’s wages; employers must also consider all forms of compensation, including employee benefits, when calculating pay in lieu of notice payments.
Is pay in lieu the same thing as severance?
Pay in lieu and severance pay are not the same. Payment in lieu covers wages and benefits the employee is entitled to if they had worked their notice period, whereas severance is additional compensation provided to departed employees based on their length of employment.
For example, local employment law may require an employer to provide one week of severance pay to dismissed employees for every year they worked with a company. Requirements for severance pay vary by country.
While severance pay is not required in every country, many employers provide severance to attract and retain talent and uphold morale and business reputation.
Is PILON subject to income tax?
Payment in lieu of notice is considered taxable and subject to the same income tax rates and deductions as regular income. Payment in lieu is treated as earnings for the tax year in which it is paid, and the employer must deduct and pay the employee’s income tax on the pay-in-lieu payment the same as with regular payroll payments to ensure payroll compliance.
How does pay in lieu of notice differ from garden leave?
With pay in lieu of notice, the employee’s employment ends immediately, and they receive the compensation they would have earned for working their notice period. The relationship between the employer and employee ends, and the employment contract is no longer legally binding.
However, with garden leave, the employee remains employed for the duration of the leave period until the contract legally ends but is instructed to stay away from the workplace during that time. The employee can choose to work remotely or not work at all but continues to receive pay and benefits during the garden leave period. The departing employee is still under contract and cannot take another job during the notice period.
Disclaimer: This information does not, and is not intended to, constitute legal or tax advice and is for general informational purposes only. You should contact your attorney or tax advisor to obtain legal and/or tax advice with respect to your particular situation. Only your individual attorney or tax advisor can provide assurances that this information—and your interpretation of it—is applicable or appropriate to your specific situation. All liability with respect to actions taken or not taken based on this information is hereby expressly disclaimed. All content is provided "as is" and Velocity Global makes no representations or warranties concerning this information.