Why this matters right now
UK settlement agreements since April 2018 typically break down the leaving package into PILON, PENP, statutory redundancy, ex gratia and holiday pay. The PILON figure looks like a payment; the PENP figure looks like tax. Confusing the two is one of the most common reasons employees agree to worse packages than they should - or fail to spot underpayments.
The distinction in one sentence
- PILON = a payment (in lieu of working your notice).
- PENP = a formula (that decides how much of your termination package is taxed as earnings).
You can have PILON without PENP being triggered (if the PILON already covers the notice period as earnings). You can have PENP without a PILON payment (if the employer just terminates early with no formal PILON). Most settlement packages involve both.
Side-by-side comparison
| Feature | PILON | PENP |
|---|---|---|
| What it is | A payment | A tax calculation |
| Where it comes from | Employment contract or agreement | Section 402D ITEPA 2003 |
| Who calculates it | Employer's payroll/HR | HMRC formula, applied by payroll |
| What it represents | Basic pay for the unworked notice period | Amount of the termination package chargeable as earnings |
| Taxable? | Yes, as earnings | Yes, as earnings (no £30k threshold) |
| Applies when | Contract has PILON clause or by mutual agreement | Always, since April 2018, on any termination payment |
| Formula | Basic × unworked notice weeks/months | ((BP × D) ÷ P) − T |
| Interacts with £30k threshold? | No - PILON is separate | PENP is removed BEFORE the £30k is applied |
Worked example 1 - PILON with no PENP charge
James earns £5,000 monthly and has a contractual PILON clause paying 3 months (£15,000) at exit. Employer exercises the PILON, ends employment immediately, and pays the £15,000 alongside a £20,000 ex gratia. Total package: £35,000.
- PILON: £15,000 (paid as earnings under section 62 ITEPA 2003).
- PENP: ((5,000 × 90) ÷ 30) − 15,000 = 15,000 − 15,000 = £0 (contractual PILON already covers the notice period).
- £30k threshold: the £20,000 ex gratia fully within the £30,000 s.403 exemption. Tax on ex gratia = £0.
Net position: PILON taxed as earnings, ex gratia entirely tax-free. Optimal from a tax standpoint.
Worked example 2 - No PILON, PENP charge triggered
Emma earns £3,500 monthly and has no PILON clause. She's made redundant with 3 months unworked notice and a £40,000 ex gratia package. No separate PILON payment.
- PILON: £0 (no clause, no payment).
- PENP: ((3,500 × 90) ÷ 30) − 0 = £10,500 (chargeable as earnings).
- £30k threshold: £40,000 total package − £10,500 PENP = £29,500 remaining. This falls entirely within the £30,000 threshold. Tax on the remainder = £0.
- Net income tax: due only on the £10,500 PENP.
Emma gets much of the same tax treatment as James, just labelled differently on the settlement letter.
Worked example 3 - Non-contractual PILON with PENP interaction
Ben earns £4,000 monthly and has no contractual PILON. Employer wants to terminate immediately and offers a "PILON" of £12,000 alongside £25,000 ex gratia. Total: £37,000.
- PILON (non-contractual): £12,000. This is a damages payment, but section 402D means it enters the PENP calculation.
- PENP: ((4,000 × 90) ÷ 30) − 0 = £12,000 (assuming no other T amounts).
- Applied to the package: £12,000 is chargeable as earnings under section 402D. This exhausts the non-contractual PILON.
- £30k threshold: £25,000 ex gratia fully within the £30,000 threshold. Tax on ex gratia = £0.
Same net outcome as James - the loophole that once existed (calling PILON "damages" to fall within £30k) is closed by PENP.
How to read your settlement letter
Post-2018 settlement letters typically break down into these lines:
- Basic salary to leaving date - normal earnings.
- Accrued holiday - normal earnings.
- Contractual bonus (if applicable) - normal earnings.
- PILON (contractual or non-contractual) - the payment for unworked notice.
- Ex gratia / termination payment - the compensation for loss of office.
- Statutory redundancy pay (if redundancy) - the s.135 ERA amount.
- Total gross package.
- PENP - the formula-derived amount treated as earnings.
- Amount within £30,000 threshold - tax-free.
- Amount above £30,000 - taxable as earnings.
The PENP line is often near the bottom because it's a calculation, not a payment. Check both the PILON figure and the PENP figure carefully - errors are common.
When PENP might be wrong on your letter
Common employer errors that lead to over-taxing:
- Using working days instead of calendar days for D or P.
- Using the wrong last-pay-period figure for BP (particularly for staff paid a mix of salary + bonus).
- Forgetting to deduct T where contractual PILON is paid.
- Applying PENP after the £30,000 threshold (should be before).
- Not applying the "negative → nil" rule.
- Ignoring the cap-at-total-termination-awards rule.
Use the PENP calculator to check the employer's figure. If it differs materially, raise it in writing before signing the settlement agreement.
When to take specialist advice
- Settlement package over £100,000.
- Contractual bonus or LTIP included in the package.
- Salary sacrifice arrangements (pension routing options).
- Restrictive covenants being negotiated as part of the deal.
- Any element the employer describes as "damages" or "compensation for X".
Section 203 ERA 1996 requires you to take independent legal advice on any settlement agreement before it binds you. Use that meeting to check the tax breakdown as well as the legal terms.
Useful calculators
- /penp-calculator/
- PILON calculator
- /settlement-agreement-tax-calculator/
- Settlement agreement calculator
- Redundancy pay calculator
Related guides
- PENP explained
- PILON explained
- PILON tax
- £30,000 tax-free redundancy explained
- What is a settlement agreement
Authority pages
Frequently asked questions
- What's the difference between PENP and PILON?
- PILON is a payment (in lieu of notice). PENP is a formula that HMRC uses to decide how much of your termination package is taxed as earnings. You can have PILON without a PENP charge (if PILON already covers the notice). You can have PENP without PILON. Most packages involve both.
- Which one is taxed?
- Both. PILON is chargeable to income tax as earnings under section 62 ITEPA 2003. PENP is chargeable as general earnings under section 402D. Neither benefits from the £30,000 threshold in section 403.
- Why is PENP on my settlement letter if I have contractual PILON?
- Because HMRC requires the PENP formula to be applied to every termination payment since April 2018, regardless of contract. Where contractual PILON already covers the unworked notice period (via the 'T' variable in the formula), the net PENP figure is usually nil - it appears on the letter as £0.
- Can PENP be nil?
- Yes. Two common reasons: (1) contractual PILON already covers the notice period (T variable cancels out the formula); (2) the formula produces a negative result (statutory rule: negative → nil).
- How do I check my settlement letter has PENP right?
- Use the PENP calculator on this site to verify against HMRC's EIM13880 formula. Compare with your settlement letter figure. Common errors: using working days not calendar days, missing the 'T' component, and applying PENP after the £30k threshold instead of before.
Sources and further reading
- HMRC EIM13880 - PENP formula — HMRC's definitive statement of the PENP formula.
- HMRC EIM13876 - PENP charge to tax — PENP chargeable as general earnings; no £30,000 threshold.
- Section 402D ITEPA 2003 — Statutory basis for the PENP formula.
- Section 403 ITEPA 2003 — The £30,000 termination-payment threshold.
- HMRC EIM14000 - Worked example — HMRC's worked example.
General guide to UK PENP and PILON. Not tax advice. For your specific settlement, take independent legal and tax advice.