Sovereign on how to manage Middle East end of service obligations

The lure of a tax-free income is undeniable – although when you consider the overall quality of life in the UAE, it is hard to believe it was once considered as a financially motivated "hardship posting" for expats.

The "gold-plated" expat remuneration package may be far less common these days, but Middle East-based employers are notably now having to step up their pension provision in order to attract and retain the best talent.

The UAE – like most of its neighbouring countries – does not have a system of mandatory retirement provision for expat workers, although this has been touted for some time. Instead there is an end of service "gratuity", where a lump sum is paid to the employee when they leave employment. This sum is based on the employee's salary and length of service and therefore takes the form of a "defined benefit".

While a defined benefit structure is generally highly-prized by employee, it leaves the sponsoring employer with an open-ended funding liability. Those familiar with pensions will know that cash guzzling defined benefit pensions are now being phased out in most parts of the world in favour of lower cost "defined contribution" pensions.

In order to contain costs, plan ahead and prevent future cash flow issues, most operators of defined benefit pensions employ actuaries to help them manage and fund their obligations. Companies operating in the Middle East, however, have traditionally adopted an altogether more relaxed approach.

Although gratuity liabilities are declared on the company's balance sheet, often the capital has actually been ploughed back into the business – leaving gratuity obligations entirely unfunded. This may be tolerable when business is good but it can create very serious problems if staff cuts are necessary during leaner times.

Not surprisingly, employees too can be alarmed to find out there is no advance provision for their end of service benefit – particularly the long term employees who have most at stake. For them the obvious question is what happens if the company goes under? The obvious answer, unfortunately, is that it is highly unlikely that they will see their gratuity promise.

There is evidence that businesses are waking up to this issue. More UAE companies are now funding in advance for their gratuity obligations and are also offering additional savings options for employees. Even better, many companies are electing to use a trust-based defined contribution pension or savings arrangement.

Under such a structure, the value of employer contributions can be set against gratuity obligations, whilst at the same time employees have a cost effective and safe means of making additional voluntary contributions (AVCs). The structure of such schemes is fluid and can be tailored exactly to the requirements of the business.

Most importantly, a trust-based scheme provides a means to legally separate any funds set aside to cover gratuity obligations from the actual assets of the business. This means that those funds are ring-fenced for their intended purpose, regardless of what the future holds for the business.

Advance planning is not only prudent but advantageous. It will save the business money over the longer term, provide valuable peace of mind for the workforce and really differentiate the employer from its competitors when it comes to recruitment.

Sovereign is a market leader in the provision of international pensions. One of the largest independent trust companies in the world, the group has built assets under administration in excess of US$5 billion. Sovereign employs a team of legal specialists, accountants, pensions technicians and tax advisors across its global office network and offers a range of six Qualifying Recognised Overseas Pension Schemes (QROPS) across three jurisdictions and three Qualifying Non-UK Pension Schemes (QNUPS) across three jurisdictions.

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