Pay in lieu of holiday (PILON) is a payment made to an employee instead of allowing them to take accrued but unused annual leave. In the UK, the rules around PILON depend on whether the payment is made during employment or upon termination, and the type of termination involved. Understanding these distinctions prevents costly legal mistakes.
For HR teams, PILON is one of those areas where a casual approach creates real risk. Paying out holiday when you shouldn’t — or failing to pay when you must — can both lead to tribunal claims.
Key Takeaways
- Pay in lieu of holiday is a cash payment for accrued but untaken statutory annual leave.
- During ongoing employment, employers cannot lawfully pay PILON for statutory holiday — employees must take their minimum 5.6 weeks of leave.
- Upon termination, employers must pay out all accrued unused holiday, regardless of reason.
- Contractual PILON clauses (payments above the statutory minimum) are permitted but must be carefully drafted.
What Is Pay in Lieu of Holiday?
Pay in lieu of holiday occurs when an employer compensates an employee with money rather than time off for annual leave entitlement that has accrued but has not been taken. The payment reflects the value of the untaken leave days.
PILON can arise in several scenarios:
- Termination of employment: When an employee leaves, they receive payment for any holiday they accrued but did not use.
- Contractual PILON clause: Some employment contracts allow payment in lieu of unused holiday at specific times during the year or upon termination.
- Rolled-up holiday pay: A historically controversial practice where employers included an uplift in hourly pay to cover holiday entitlement, rather than granting actual leave.
The critical legal distinction is between statutory holiday (the minimum 5.6 weeks under the Working Time Regulations) and contractual holiday (any additional leave above the statutory minimum).
When Is PILON Legal?
At Termination
When employment ends, PILON is always required for accrued unused statutory holiday. The employer must calculate the amount owed and pay it in the final payslip. This applies regardless of how the employment ended — resignation, dismissal, redundancy, or mutual termination.
During Ongoing Employment
During employment, PILON for statutory holiday is generally not permitted. The Working Time Regulations 1998 require employees to actually take their statutory annual leave — it exists to protect health and safety, not to be compensated as a cash benefit.
However, there are important exceptions:
| Scenario | PILON Permitted? | Explanation |
|---|---|---|
| Termination of employment | Yes | All accrued unused holiday must be paid out |
| Contractual holiday above 5.6 weeks | Yes | Employers can pay out contractual entitlements if the contract allows |
| Rolled-up holiday pay | No (since 2009) | unlawful under Working Time Regulations unless it meets specific criteria |
| Settlement agreements | Yes | PILON is commonly included in negotiated settlement packages |
The Rolled-Up Holiday Pay Controversy
Rolled-up holiday pay — where an employer adds a percentage (typically 12.07%) to each hour’s pay to cover holiday — was ruled unlawful by the European Court of Justice in Robinson v Buckland Engineering. The reasoning was that employees would be deterred from taking leave if the financial incentive pointed toward working instead.
However, the UK government subsequently introduced regulations allowing rolled-up holiday pay for irregular-hours and part-year workers under certain conditions, effective from April 2024. This remains a narrow exception rather than a general permission.
How PILON Is Calculated
The calculation of pay in lieu of holiday depends on the employee’s pay structure:
For Fixed-Rate Employees
If the employee receives a fixed annual salary:
Formula: (Days of accrued unused holiday ÷ Total working days in the year) × Annual salary
Example:
| Detail | Value |
|---|---|
| Annual salary | £35,000 |
| Total working days per year | 260 |
| Accrued unused holiday days | 12 |
(12 ÷ 260) × £35,000 = £1,615.38
For Variable-Pay Employees
For employees whose pay fluctuates, the reference period is typically the 52-week average (excluding weeks with no pay) under the Employment Rights (Employment Particulars and Paid Annual Leave) (Amendment) Regulations 2018.
Formula: (Average weekly pay ÷ 5 working days) × Days of accrued unused holiday
Important: PILON Tax Treatment
From April 2018, the first £30,000 of a statutory PILON payment on termination is tax-free. Any amount above £30,000 is subject to income tax and National Insurance. Contractual PILON payments are always taxable regardless of amount.
PILON on Termination: Step-by-Step
When an employee’s employment ends, follow these steps:
- Calculate accrued holiday. Determine how much statutory holiday the employee has accrued but not taken during the current leave year, based on the proportion of the leave year completed.
- Check for overpayment. If the employee has taken more holiday than they have accrued, the employer can normally recover the overpayment (though this is not always straightforward in practice).
- Apply the correct rate. Use the employee’s normal weekly pay (based on the reference period) for statutory PILON. For contractual PILON, follow the contract terms.
- Include in the final payslip. The PILON payment must appear on the final payslip with a clear breakdown.
- Report to HMRC. Include the payment in the final RTI submission.
Employer Obligations and Risks
What Employers Must Do
- Pay out all accrued unused statutory holiday on termination
- Calculate the payment using the correct reference period
- Clearly distinguish between statutory and contractual PILON in the payslip
- Ensure the final payslip is issued on or before the last working day
Common Mistakes That Create Risk
- Failing to pay PILON on termination. This is the most common and most costly error. Unpaid holiday is a straightforward tribunal claim.
- Paying less than the statutory rate. Using an outdated reference period or incorrect calculation method can result in underpayment.
- Assuming PILON is not owed on constructive dismissal. Even when an employee resigns in response to a fundamental breach, accrued holiday must still be paid.
- Offering PILON during employment for statutory leave. This breaches the Working Time Regulations and removes the health and safety protection that leave is designed to provide.
Frequently Asked Questions
Can I refuse to take holiday and ask for payment instead?
No. During ongoing employment, the Working Time Regulations require you to take your statutory annual leave of 5.6 weeks. Your employer cannot agree to pay you in lieu of statutory holiday during employment, even if both parties consent.
What happens if my employer doesn’t pay PILON on termination?
You can bring a claim to an employment tribunal for unlawful deduction from wages. The tribunal can award the unpaid amount plus interest and potentially an additional award of between two and four weeks’ pay for each breach.
Is the PILON tax-free?
The first £30,000 of a statutory PILON payment on termination is tax-free under current rules. Any contractual PILON payment is always subject to income tax and National Insurance regardless of the amount.
Can my contract include a PILON clause?
Yes. Many employment contracts include a PILON clause that allows the employer to pay instead of giving notice. However, this typically refers to payment in lieu of notice, not holiday. A separate clause is needed for contractual holiday pay in lieu, and it cannot override the statutory requirement to take minimum holiday during employment.
Does PILON apply if I am made redundant?
Yes. Redundancy does not change your right to accrued unused holiday. The employer must pay PILON for all untaken statutory holiday as part of the final payslip. Redundancy pay and PILON are separate entitlements — you receive both.
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