Legacy Gratuity: What it is, Why it matters, and How to handle it

Once a company decides to switch over to the new alternative End of Service Benefit (EOSB) gratuity saving scheme one of the first question everybody has is: what happens to employees’ gratuity that has been accumulated up & until the point of switch-over to the new system?

That gratuity is called “Legacy Gratuity”, and in today’s article we will be exploring this in detail.

UAE Mainland: Frozen Gratuity

Some readers of our last article ("MOHRE Consultation Period to end soon") were surprised to learn that the legacy gratuity is frozen at time of switch-over to the new system. In fact,  Cabinet resolution 96/2023 article (5) states:

" 3. Discontinue the use of the current end-of-service benefits system for employees who are selected to participate in the alternative system. However, employers are required to calculate benefits due to beneficiaries in accordance with the Decree Law prior to implementing the alternative system and must pay them upon the termination of the employment relationship, based upon the beneficiary's basic salary as of the time of participation. "

In other words, for calculation of the legacy gratuity, the basic salary at time of participation in the new alternative system is used. What does that mean? Simply put, in case an employee is awarded a pay rise after switch over, his legacy gratuity remains the same and does not increase.

Unsurprisingly, we have heard feedback from employees that they feel this makes the new system less attractive.

What’s happening in the DIFC?

The DIFC was facing the same problem 5 years ago when DEWS (the DIFC Employee Workplace Savings plan) was introduced on a mandatory basis. How did they handle this topic? The DIFC Employment Law Amendment (DIFC Law No. 4 of 2020), Article 66(3)(c) states:

"All references to an Employee's Basic Wage and Annual Wage shall be to those applicable to the Employee on the Employee's Termination Date."

In other words, the legacy gratuity is calculated on the employee’s last salary, not the salary at time of switch-over to DEWS. Hence, the DIFC’s workplace saving plan is more generous than the Mainland’s EOSB saving plan.

What should companies do?

Given this discrepancy, and given the fact that the Mainland regulation makes the new scheme somewhat unattractive when it comes to legacy gratuity, what should firms do? Here are four scenarios how companies might handle this issue:

1. Multiple Legal Entities

Let’s first examine the case where a company maintains several legal entities in the UAE – say, one on the mainland and one in the DIFC. (Actually, this is more prevalent than you might think!).

Such a company is faced with the fact that employees have different levels of employee benefit – one can only imagine the chat at the watercooler between Ahmed (who works in the DIFC) and Sara (who works for the same company in the Mainland) once they compare notes on their benefits!

In such a scenario many companies might choose to raise the bar for everyone, ie to index the legacy gratuity for the Mainland folks on a mandatory basis, so that everybody is treated the same.

2. Kick the can down the road

Another possible solution for companies thinking about enrolling into the new alternative EOSB saving scheme is the following: At present, companies can choose who to enrol, they do not need to enrol the whole company immediately. This opens the path for companies to enrol new employees only – who by definition have zero legacy gratuity. That is a neat way to side-step the problem for the time being, to dip a toe in the waters of the new system, without upsetting the apple cart. Of course, that way the problem is not resolved, but merely postponed. At a future point in time – perhaps once the new scheme becomes mandatory – the tough call needs to be made.

3. Pay more – and use it to your advantage

Yet another way of looking at it is to see a voluntary extra benefit as a competitive advantage. Let the Finance Department run the numbers – perhaps the overall impact is manageable, particularly as it will be felt not in one go, but smoothened over several years, as and when employees leave.

If management decides to pay something extra – why not make a big song and dance about it and use it as a competitive advantage to attract & retain talent? For instance, your company could be “the only company in the industry that pays an increased legacy gratuity based on employees’ well-deserved pay rises”. And don’t forget – this extra payment may well qualify as a tax-deductible expense, reducing the corporate tax bill of your company!

4. Pay out now & Invest

Both Cabinet Resolution 96 as well as the Ministerial Resolution 668 are largely silent on how the legacy gratuity has to be settled, except for the article quoted above which states that "The employer shall pay such gratuity upon termination of the work relationship".

Our interpretation is that it is therefore possible for companies to pay out the legacy gratuity at time of switch-over, provided (i) the employee agrees and (ii) the gratuity is invested in the new investment-based scheme, and locked up until the employee separates from the company. That way, the legacy gratuity does not increase with salary increments, but it increases with investment gains.

However, to pay out the legacy gratuity for all employees in one go is a tough ask. We suspect that this is only a realistic option for companies that have been funding their EOSB liabilities in the first place.

Conclusion

As one can see, the topic of “legacy gratuity” becomes quickly more complex the more one looks at the details. And it opens up additional questions of strategic nature – e.g., what level of employee benefits should we give to our employees? What are the competitors doing? And: Can we use Employee Benefits to our advantage in attracting and retaining talent?

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