The
Court of Appeal’s ruling to reverse its decision on notice payments may have
tax implications for Pilons
It
often suits companies to dismiss an employee without giving the full notice
period. Is the employee entitled to his full pay for the balance of the notice
period, even if he gets a new job in the meantime?
The
answer to this question can make a big difference to an employee’s termination
pay as Rowley found when he was dismissed by Cerberus Software. Cerberus purported to dismiss Rowley summarily
for gross misconduct. A tribunal found there was no justification for this.
Rowley’s notice period was six months, but he started a new job after only a
month. Did Cerberus owe him one or six months’ pay? The answer depends on the employment contract.
In
some contracts the employer is expressly entitled to terminate the contract
without notice by making a payment in lieu of notice (Pilon). If the employer
terminates summarily and makes a Pilon, there will be no breach of contract.
The employee is then entitled to the full amount of notice pay as a debt from
the company. This is on top of anything he may earn in new employment.
But
if there is no contractual Pilon clause, the employer will break the employment
contract if it does not give the right notice period. Crucially, the employee
is then entitled to damages for breach of contract, instead of a contractual
debt. The employee has a duty to minimise the damages he suffers by trying to
find a new job. What he earns in new employment will be deducted from what his
old employer owes him for breach of contract.
The
terms of Rowley’s contract were therefore vital. The contract said that
Cerberus "may" make a Pilon. What does this mean? The EAT said it
meant that Cerberus had two choices when dismissing Rowley. It could either
give him six months notice of termination or dismiss him without notice and pay
him six months in lieu as a debt. Since Cerberus had not given Rowley any
notice of termination, it had evidently opted for the second choice and now
owed him six months’ money in full.
The
Court of Appeal has just overturned that decision on the basis that Rowley’s
contract said the company "may" make a Pilon. This meant that when
Cerberus dismissed Rowley without notice, it could elect whether or not to make
a Pilon. Because it had chosen not to do so, the company had breached the
contract and owed Rowley damages, not a contractual payment as a debt. Rowley,
therefore, had to give credit for his earnings in his new job, so he was due
one month’s pay, not six.
The
decision may have implications for taxation of Pilons. The first £30,000 of Pilons is often tax
free if it represents damages for breach of contract, but taxable if it is a
contractual payment.
The
decision in Rowley may be helpful where companies have reserved the contractual
right to make a Pilon. If the company does not make a Pilon, but agrees a
payment to the employee to settle his claim, the employee could argue that,
under Rowley, the payment represents damages and, therefore, is tax free up to
£30,000. Doubtless the Revenue will resist this argument.
Companies
will still be concerned to make contractual payments under Pilon clauses when
they want to enforce the contract after termination ñ non-compete clauses, for
example. This is because such provisions are not enforceable if the employee
has been dismissed in breach of contract. The Pilon will be fully taxable and
the company will have to bite the bullet of being liable for all the Pilon,
even if the employee starts a new job during the notice period.
Key
points
–
Avoid Pilon clauses in contracts unless you will need to enforce contractual
terms after termination
–
If you must use one, express it so it is at the company’s option
–
If you need to enforce the contract, elect to make a Pilon to avoid a breach of
contract
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–
Otherwise, do not make a Pilon.
Negotiate to pay damages for breach of contract
By
Jill Kelly, a partner with Tunbridge Wells law firm Thomson Snell &
Passmore
