Payment in lieu of notice and what you must pay when ending employment early

Ending an employee's employment immediately, with a payment instead of the notice period, is a routine decision for small and medium businesses. It also has a fixed legal price. Under the Fair Work Act 2009 (Cth), if you terminate employment without the employee working out their notice, you must pay them in lieu of notice at their full rate of pay for the hours they would have worked. That rule sits inside the National Employment Standards (the NES), so it applies to almost every private-sector employer in the country, and getting the amount wrong can trigger back-pay claims, civil penalties and unfair dismissal proceedings.

This guide sets out who the obligation applies to, how to calculate a lawful payment in lieu of notice, what else must go into the final pay, how tax and superannuation apply, and what happens if you get it wrong.

Who the notice obligation applies to

The NES notice rules apply to most employers and most employees, but not all. An employer that is a national system employer, which covers the vast majority of private-sector businesses, must meet the notice requirements in Division 11 of Part 2-2 of the Act. Before you work out any payment, check whether the employee is excluded under s 123 of the Fair Work Act:

• Casual employees: not covered by the NES notice rules at all.
• Employees on fixed-term, task or seasonal engagements: excluded, unless the arrangement was a sham designed to avoid the rules.
• Dismissals for serious misconduct: no notice or payment in lieu is required, though you should only rely on this where the conduct genuinely meets that high bar.
• Daily-hire building and construction workers, and some meat industry workers: these workers have their own notice arrangements.

For everyone else, three things set the size of the obligation:

• Length of continuous service: drives the minimum notice period under the NES.
• Age and service together: can add a week on top.
• Your employment contract, modern award or enterprise agreement: can require more notice than the NES minimum, and the higher figure is the one you must meet.

The same scoping check matters for redundancy pay. A small business employer, defined in s 23 of the Act as an employer with fewer than 15 employees, is exempt from NES redundancy pay, as is any employee with less than 12 months' continuous service.

The core duty: give notice or pay in lieu

Under s 117 of the Fair Work Act, an employer must not terminate employment unless it has given written notice of the day of termination, and that day cannot be before the notice is given. The notice period must be at least the minimum worked out from the NES table:

• 1 year of service or less: 1 week
• More than 1 year, up to 3 years: 2 weeks
• More than 3 years, up to 5 years: 3 weeks
• More than 5 years: 4 weeks
• Over 45 with at least 2 years' service: add 1 week to whichever row applies

Rather than have the employee work that period, s 117(2)(b) lets you pay in lieu. The payment must be at least the amount you would have been liable to pay the employee at their full rate of pay for the hours they would have worked had employment continued until the end of the minimum notice period. Employment ends immediately, the notice period is not worked, and the payment stands in for the wages those hours would have produced.

The NES minimums are a floor, not a ceiling. If the contract, award or enterprise agreement provides a longer notice period, or expressly allows payment in lieu, apply the instrument's terms. A senior or executive contract that gives three months' notice means a payment in lieu worth three months at the full rate, not the NES minimum.

Pay at the full rate, not the base rate

The most common miscalculation is paying the notice period at the employee's base rate. The Act defines the full rate of pay in s 18 as the rate payable to the employee including:

• Incentive-based payments and bonuses: payments tied to performance that would have been earned on those ordinary hours
• Loadings: such as shift or weekend loadings that apply to ordinary hours
• Monetary allowances: amounts payable for the ordinary hours in the notice period
• Overtime or penalty rates: where they attach to the hours that would have been worked
• Any other separately identifiable amounts: items the instrument identifies as payable for those hours

Those components are exactly what s 16 of the Act excludes from the base rate of pay. The distinction matters: the base rate is what you use for annual leave payouts and redundancy pay, but the full rate is what the notice payment in lieu must be calculated on. Paying base rate only for notice in lieu understates the entitlement and breaches s 117.

Work from the employee's usual pattern of work. If they have a fixed roster, apply the hours on that roster across the notice period. If hours vary, use a fair average of the ordinary hours they would have worked, consistent with the award or agreement and your payroll practices. Include the loadings and penalties that would have attached to those particular hours.

As an example, take an employee with six years' service who is entitled to four weeks' notice and works 38 ordinary hours a week. Their base rate is $32 an hour, a 15 per cent loading applies to ordinary hours, and they would have earned a production bonus on those hours. The payment in lieu is 152 hours at the full rate, which is base rate plus the loading plus the bonus, not 152 hours at $32. Items that would not have been paid for ordinary hours in the notice period, such as a discretionary bonus or a reimbursement for expenses, do not form part of the calculation.

Settle the rest of the final pay as separate line items

Payment in lieu of notice covers only the notice value. The rest of the final pay is separate, and each entitlement has its own legal source.

• Unused annual leave: must be paid out when employment ends under s 90(2) of the Act, at the base rate for the hours the leave would have covered. Leave loading applies as well if the award, agreement or contract provides for it.
• Long service leave: is governed by state and territory legislation, and the rates and accrual periods differ between jurisdictions, so check the rules that apply to your state.

• Redundancy pay: applies where the termination is at the employer's initiative because the job is no longer required, or because of insolvency. Under s 119 of the Act, the scale at the base rate of pay is:

  • 1 to 2 years' service: 4 weeks
  • 2 to 3 years: 6 weeks
  • 3 to 4 years: 7 weeks
  • 4 to 5 years: 8 weeks
  • 5 to 6 years: 10 weeks
  • 6 to 7 years: 11 weeks
  • 7 to 8 years: 13 weeks
  • 8 to 9 years: 14 weeks
  • 9 to 10 years: 16 weeks
  • 10 years or more: 12 weeks

  Under s 121 of the Act, no NES redundancy pay is owed where the employee has less than 12 months' service or the employer is a small business employer at the relevant time.

Redundancy also carries process obligations. Under s 389 of the Act, a dismissal is only a genuine redundancy if the job is no longer required due to changes in operational requirements, the employer has complied with any award or agreement obligation to consult about the redundancy, and redeployment within the business or an associated entity was not reasonable. Payment in lieu of notice does not replace consultation. If you skip it, the dismissal is not a genuine redundancy and an unfair dismissal claim can succeed even though the notice payment was correct.

Tax and superannuation on the final pay

A payment in lieu of notice is treated as ordinary salary and wages for tax purposes. It is subject to PAYG withholding, reported through single touch payroll, and appears in the employee's income statement rather than as an employment termination payment. The same applies to the payout of unused annual leave, which is taxed as ordinary income, though some termination payments such as genuine redundancy payments above the tax-free threshold have different treatment.

Superannuation treatment differs between the components of the final pay. The ATO's guidance on payments when a worker leaves is that employment termination payments and unused leave payments do not form part of ordinary time earnings, so no superannuation guarantee is payable on those amounts. A payment in lieu of notice is different in character: it is a payment in respect of the ordinary hours the employee would have worked, and the ATO's ordinary time earnings guidance treats payments in respect of ordinary hours as ordinary time earnings on which superannuation is generally payable. Because characterisation can be fact-specific and the rules are changing, run the breakdown past your payroll provider or accountant alongside your employment law advice before you pay.

Consequences of getting it wrong

The notice and final-pay obligations are enforceable, and the exposure is real.

• Civil penalties: A failure to pay proper notice in lieu is a contravention of a civil remedy provision. Under s 539 of the Act, the maximum penalty for an NES contravention is 60 penalty units, or 600 penalty units for a serious contravention. For a body corporate, s 546 of the Act multiplies those amounts by five. With the Commonwealth penalty unit at $330 since 7 November 2024, that means up to around $19,800 per contravention for an individual and $99,000 for a company, with far higher maximums for serious contraventions, and each underpaid employee and each pay component can be a separate contravention.
• Back-pay orders: The courts can order the shortfall to be paid, and the Fair Work Ombudsman actively investigates and litigates underpayment of final entitlements.
• Unfair dismissal exposure: Payment in lieu does not cure a dismissal that was harsh, unjust or unreasonable. Under s 385 and s 387 of the Act, the Fair Work Commission weighs the reason for dismissal, whether the employee was notified of it and given a chance to respond, whether warnings were given for performance issues, and the size of the business. A termination that skips a fair process, or that is a redundancy without consultation, can be reinstated or compensated even where the notice payment was correct.

A compliance checklist for the final pay

Before you terminate with payment in lieu, work through these steps:

• Confirm the notice period: apply the NES table to the employee's service and age, then check the contract, award and enterprise agreement for anything longer.
• Check the exclusions: confirm the employee is not a casual, a fixed-term or seasonal hire, or being dismissed for serious misconduct, in which case the notice rules may not apply.
• Price the payment in lieu at the full rate: include loadings, allowances, incentive payments, bonuses and penalties that would have attached to the ordinary hours in the notice period, on the employee's usual roster pattern.
• Separate the other entitlements: pay out annual leave, long service leave and redundancy pay as distinct line items, and check the small business and 12-month thresholds before assuming redundancy pay applies.
• Run tax and super past your payroll advisor: withhold PAYG, report through STP, finalise the employee's STP record, and confirm which parts of the final pay attract superannuation.
• Document the decision: give written notice of the termination day, record the reason, the calculation and the consultation steps, and issue a detailed final payslip.
• Separation certificate: offer one promptly if the employee asks for it for Services Australia.

Where a lawyer earns their fee

The judgement calls in a payment in lieu are where a practitioner adds value. A lawyer can review the employment contract, award and enterprise agreement to confirm the notice entitlement and any payment-in-lieu terms, verify that the calculation picks up every component the full rate of pay requires, and characterise the dismissal correctly, because whether it is a redundancy, a performance termination or a serious misconduct dismissal changes the entitlements entirely. Where the exit is sensitive, a lawyer can draft the termination letter and a separation agreement, and advise on unfair dismissal and general protections risk before the decision is locked in. If the Fair Work Ombudsman is already involved, legal advice on responding to the investigation should come first, not last.

The figure that trips most employers up

If there is one calculation to get right this week, it is the difference between the full rate of pay and the base rate of pay. The payment in lieu of notice must be priced at the full rate, including the loadings, allowances, bonuses and penalties attached to the ordinary hours the employee would have worked, while annual leave and redundancy pay run on the base rate. Paying notice in lieu at base rate only is the most common underpayment in this area, and it is the easiest to prove. Before you authorise any final pay, pull the roster, pull the award or agreement, and price the notice period component by component. If the breakdown does not survive that check, get advice before you pay rather than after the Fair Work Ombudsman does the arithmetic for you.