End of Service Gratuity: Is it the Beginning of the End?

- Written by Ivor McGettigan, Partner at Al Tamimi & Co.

End of service gratuity (“ESG”) is a topic that is currently stirring much debate. In particular, it was reported that the World Bank recommended the establishment of a pension fund for expatriate employees to replace or supplement ESGs. It is important to note that any decision to reform the ESG model will impact on the majority of employees and employers in the UAE.

The ESG explained

ESG is a sum of money that an employer is lawfully required to pay an employee upon termination of employment. The payment is based on the employee’s basic salary and length of service. Employees with at least 12 months service are entitled to 21 calendar days’ salary for each year of service in the first five years of employment and 30 calendar days’ salary for each year of service worked beyond five years. The maximum ESG entitlement cannot exceed two years’ salary.

Ongoing discussions

It has been reported that the UAE Government is considering alternatives to the current system.  Research carried out by the World Bank has resulted in the recommendation of the establishment of a pension fund for expatriate employees.

Arguments for change

Where an employer is in financial difficulties and/or becomes insolvent, the employee will have limited prospects of recovering their full entitlement to an ESG.

If an employee believes he has not received his full entitlement to an ESG payment, he is required to refer the matter to the Ministry of Labour. However, those employees who do not have the understanding of how to pursue a claim are at a significant disadvantage.

As explained above, the ESG sum is calculated on basic salary alone.  It is therefore common practice for UAE employers to particularise an employee’s overall income into an artificially modest basic salary and increase additional benefits such as travel and housing allowance.

Arguments against change

• Non-nationals who intend to work in the UAE for a limited period only before returning to their home country prefer to receive a one-off payment rather than having to wait for a foreign based pension scheme to mature when they retire in the distant future.

• If ESG funds are converted into a pension fund and invested in stock markets, there is a risk of those investments depreciating in value before the individual’s entitlement to the pension matures.

• A significant overhaul of the ESG system and the introduction of a multi-billion Dirham pension fund would be a time consuming, expensive and risky process which is not necessary at the present time.

As you can see from the above, there are well founded and persuasive arguments for and against reforming the ESG system and the expat community’s opinion is divided. It is unlikely that a final decision will be made in the near future but it is certainly a debate that should be followed.  With an estimated total value of UAE companies’ ESG liability amounting to more than AED 14.6 billion, it is a matter which will have a significant impact on non-national workers and the UAE economy in general.