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Understanding Gratuity Liability under the UAE’s New Labor Law

Date published: 15/3/22

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Last month, the UAE witnessed the biggest overhaul of its labor laws since 1980. The changes are aimed at attracting and retaining highly skilled and diverse workers from around the world and putting the UAE inline with the rest of the developed world when it comes to strengthening employee rights, safeguarding workers against discrimination, and offering more flexibility to them. But what does the new UAE labor law mean for gratuity calculations and what can SMEs do to prepare for the road ahead?

What do SMEs need to know about Gratuity in the New Labor Law?

Unlimited Term employment contracts don’t exist anymore. Starting from February 2022, all companies have a one year grace period to convert unlimited term contracts into limited and renewable contracts of up to 2 years. There is only one exception. When companies are working with high skilled consultants, the contract can be project-based and non-renewable for 3 years.

Before the new labor law was enforced, employees who worked with a company for less than 3 years had their gratuities calculated at 7 days per service year, if they served a company between 3 and 5 years, the gratuity was calculated at 14 days per year. If they worked with a company for more than 5 years, their gratuity was calculated at 21 days per year (as per their basic pay).

The gratuity rules under the new law simplifies this calculation. Now, if an employee serves a company for less than 5 years, their gratuity is calculated at 21 days for every service year and if they work for more than 5 years with a company, their gratuity is calculated at 30 days per service year. The daily wage is calculated based on the basic salary of the employee.

To put this into perspective, that’s a 32% jump in gratuity liability that SMEs need to account for by Feb 2023. Depending on how complex a company’s workforce may be, this change could mean a huge difference in the “Total Gratuity Liability” on their balance sheet. Moreover, the new labor law removes the distinction between “resignation” and “termination” or “lay off”. The new law considers all of these reasons to be the same, and the employee is entitled to full gratuity pay regardless of the reason why the employment ended. A big change from the previous mandate that will lead to a difference in gratuity calculations and the overall liability on any company’s balance sheet.

How can employers adapt to the new gratuity rules under the new labor law?

‍There is no doubt that this major change in the rules would have a great impact on employer’s current situation from both financial and workforce planning perspectives. Human Resources departments will have a lot of work to do to update employee records to reflect the new rules. Finance departments will also have to make major adjustments to their gratuity calculations and forecasts. Senior Management would need to consider the impact of the new rules on the cost of hires and review their expansion and/or restructuring plans.

Understand how the new labor law affects their current gratuity liability

The number one thing a company can do to prepare for this big change is to understand to what degree the new law affects them and then transition towards it. This will depend mainly on the size of their workforce, the average length of service of existing employees, and the overall size of their payroll.

 Calculate their gratuity liabilities inline with new rules

The second thing that they can do is to calculate gratuity liability under the new UAE labor laws to try to gauge the effect of the new laws on their current and future liability.

Start preparing gratuity funds separately from monthly cash flow

And finally the key step here is to prepare the required cash flow to meet their growing liabilities. Not doing so poses a huge risk. The ministry of human resources and emiratisation has put in place hefty fines against employers who don’t fulfil their obligations towards employee end of service benefits, these fines could reach upto 1 million dirhams for each violation. This fine could cause a significant damage to a company’s cash flow.

‍There has been a common misconception by majority of SMEs in the UAE that end of service benefits is only due when an employee leaves the service. This led to many companies not accounting for gratuity liability on their balance sheet on annual basis and not being able to get audited financial reports. This is about to change after the recent changes to financial reporting standards being introduced by the ministry of finance.

It all plays into the 9% corporate tax that will be introduced from June 2023. Even though gratuity becomes payable only when an employee leaves, keeping this sum within the company account means SMEs will most likely incur a 9% corporate tax on these payables from next year, leading to duplicate expenses – a scenario which should be avoided at all costs.

Establish workplace saving programmes

‍The proposed changes to gratuity calculations and payment in the UAE is getting the country closer to international standards of workplace savings schemes. Employers in the region can take essential steps to get ahead of their competition by establishing a workplace savings scheme that will help them as the company manage its liability, and act as a talent retention tool as well.

Expenses are what a company is invoiced for or what was forecasted and set aside. But gratuities don’t become payable until an employee leaves. When SMEs work with third-party workplace savings programmes, this money is provisioned for, and segregated from the company’s cash flow. But most importantly, reported as an employee benefit (cost) rather than cash asset.

In return, businesses receive a statement confirming that the money is held in safe custody and can only be drawn for employee gratuity thereby avoiding unnecessary corporate tax levy. From an accounting perspective, it can now be marked as ‘expense’. If the employee leaves without completing one year with a business (when the gratuity amount starts to accumulate) then the withheld funds are released back to the company.

Conclusion

‍The recent changes in labor law in respect to gratuity calculation would have a major effect on businesses, especially SMEs with limited resources to adapt fast to that change.

Regulations are changing and the UAE is fast positioning itself as a top global destination for workers and business owners alike. As the first country in the region to have updated its labor laws to secure employee rights, we expect other regional players to also follow suit.

This is a huge step in the right direction for the country and will put UAE inline with the rest of the developed world when it comes to safeguarding employee rights and making the country an attractive place to live and work.