Following recent changes in the law, it is now more important than ever that Settlement Agreements explain what will happen (or has happened) to the employee's contractual notice entitlement (including whether there will be a contractual PILON).
Parties can also choose to state whether there is any post-employment notice pay (PENP) tax liability under sections 402B and 402C of the Income Tax (Earnings and Pensions) Act 2003 (ITEPA) (whether there is such a liability will depend in part on what happens to the employee's notice entitlement). It is not a legal requirement to state whether there is a PENP liability but it may assist to do so.
There are three main options when setting this out, although this is for illustrative purposes only.
Option 1 – when an employee works their notice period.
At the Termination Date, you will have completed the period of notice to which you are entitled under your employment contract. We have paid your salary and benefits for that period under this Agreement. The parties accordingly believe that your Post-Employment Notice Period and Post-Employment Notice Pay are nil.
By stating that an Employee has served their full notice period, it can be beneficial in negotiations as it spells out what has happened to this potentially valuable contractual right. It also assists in explaining the tax status of the Termination Payment (which is separate and tax free up to £30,000).
If the employee serves out their full contractual notice period, their "post-employment notice period" for the purposes of ITEPA will be nil as their whole notice period would have been served during their employment (or pre-termination). Applying the formula in section 402D(1) of ITEPA, this inevitably means that PENP will also be nil.
Option 2 - where the employer is exercising a contractual right to make a PILON.
We shall make a payment to you in lieu of your notice entitlement under your employment contract (the PILON). The parties agree that the amount of the PILON is equal to or exceeds the amount given by the formula in section 402D(1) of ITEPA and, accordingly, believe that your Post-Employment Notice Pay is nil.
From a tax perspective, if the PILON is based on normal pay (or more) and covers the full outstanding contractual notice entitlement, PENP will in most cases be nil (pursuant to the statutory calculation in section 402D of ITEPA).
Nevertheless, parties should always check the PENP calculation, following the statutory formula, because there are occasional scenarios where a full PILON might not reduce the amount to nil. This would mean that there might be PENP tax liability payable from the Termination Payment.
If a PILON is being made, it is helpful to make the source of the payment clear. This clause envisages that there is a PILON clause in the contract, but it could be adapted to reflect PILONS that arise through custom and practice (auto-PILONs).
Option 3 – where the employment is terminated without notice
You will not receive notice of termination and are not entitled to payment in lieu of notice under your employment contract.
The third option may be appropriate where employment is terminated without notice and there is no entitlement to a PILON (for example, where the employer considers the employee has committed gross misconduct or because there is no contractual PILON power).
This is of course a rough guide to PENP, but there can be scenarios where much more complex calculations are required.