Conrad McDonnell on the taxation of payments in lieu of notice. Conrad McDonnell is a barrister at Gray's Inn Chambers.

Until recently, the tax treatment of payments in lieu of notice (Pilons) made to employees upon dismissal from employment has been relatively certain.

Where there is no provision in the contract of employment for Pilons to be made, they are not emoluments from the employment taxable under s.19 of the Income and Corporation Taxes Act 1988 (ICTA). They have, instead, the character of compensation payments, as in Henley v Murray and fall within the "golden handshake" provisions in s.148 ICTA: the first £30,000 of the sum awarded is exempt from tax.

Where, however, the contract provides that a Pilon is to be paid as an alternative to notice, the accepted position has been that the Pilon is an emolument from the employment – as in Dale v de Soissons. As an emolument from the employment, a contractual Pilon is taxable in full.

Practitioners have been taught the rule, "If it's in the contract, it's taxable." In Mairs v Haughey, doubt was cast on the validity of such a rule – payments which would have been made under a contractual redundancy scheme were held not to be emoluments from the employment.

In EMI v Coldicott, reported in The Lawyer (4 November 1997), the High Court affirmed the traditional view: EMI's arguments based on Mairs were rejected.

The judge held that although entitlement under the employment contract is neither a sufficient nor a necessary condition for the payment to be taxable as an emolument from the employment, certainly it is a relevant factor. Since the Pilon arose from the existence of the employer-employee relationship being, in fact, a payment to terminate that relationship, it was caught by s.19 ICTA.

The decision in EMI has led to fears that all Pilons, even non-contractual Pilons, are now taxable. But while some of the judge's reasoning might suggest such a conclusion, it must be realised that the thrust of the argument in the case concerned whether or not the fact that the Pilon was contractual affected its taxability.

The case was argued on the footing that non-contractual Pilons are not taxable (other than under the "golden handshake" provisions), and the decision should not be taken to suggest any other conclusion.

Note that in EMI a certificate has been granted for a appeal to the House of Lords.