When employees are dismissed it is not uncommon for the employer to pay them lump sums "in lieu of notice" rather than require them to work out their statutory or contractual notice periods . However there is no general implied contractual term which always entitles an employer to provide pay in lieu of notice - see Morrish v. NTL Group Ltd CS 2007 , Scottish Court of Session on 3rd July 2007).

If a lump sum is paid it will normally be calculated by reference to the remuneration the employee would have earned if he had worked out the notice to which he was entitled.

Two different types of payment are often lumped together under the generic name "pay in lieu of notice" or "PILON", namely (i) payments specifically provided for in the employee's contract of employment - as a general rule these are fully taxable, but see below - and (ii) payments not provided for in the contract to compensate the employee for not allowing him to work out the notice period to which he is entitled - as a general rule the first £30,000 of these is free of tax.

Five questions frequently arise:

1. Will the "pay in lieu of notice" be free of tax and national insurance contributions?

2. If it is free of tax, should it be the gross amount or should it be the net equivalent?

3. Can the employer make deductions from pay in lieu of notice to cover any amounts owing to him by the employee?

4. Has the employee an obligation to mitigate his loss by seeking other employment and giving credit for earnings from that employment?

5. What happens to continuing obligations of the employee (if any - usually restrictive covenants)?

As indicated above the basic answer to 1 is that if the pay in lieu of notice is a contractual entitlement, the whole amount will normally be liable to PAYE tax and NIC's in the normal way (see EMI Group Electronics Ltd v Coldicott (HMIT) CA 1999 IRLR 630, CA). However if the payment is a genuine ex-gratia payment or is genuinely compensation in lieu of damages then the first £30,000 will be exempted. Note that damages are to compensate for loss suffered so if they are to compensate for loss of salary the gross amount would be reduced to take tax into account any tax which would have been payable if the amount had been paid as salary (see British Transport Commission v Gourley HL 1955 UKHL 4 and notes at Compensation/tax on ).

The basic answer to 2 is that the payment need only be the net equivalent (see Wrongful dismissal/damages for ).

The answer to 3 is less easy; it depends on whether or not the pay in lieu of notice comes within the meaning of "wages" for the purpose of ERA 1996 Part II (formerly the Wages Act 1986 - see Deductions from wages etc/deductions from wages, salary or pay and Delaney v Staples HL 1992 ICR 483, HL). If it is "wages" then deductions may not be made, save in special circumstances.

The answer to 4 depends on similar considerations as the answer to 1, ie whether the payment is genuinely compensation in lieu of damages or is in fact a contractual entitlement (see Wrongful dismissal/mitigation of loss and Cerberus Software Ltd v Rowley CA 2001 ICR 376 CA and Maxwell Communication Corporation v Allan & ors High Court on 25th June 2001, Ch Div case 14001 of 1991, not reported).

For the answer to 5 notes at see Restrictive Covenants/a general note .

See also generally notes on Garden leave .