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Salary indexation. What are the risks?

authors: Alexander Shemiatkin, Tetiana Suchyk

source: “Kyiv Post Legal Quarterly”,Vol. 3, Issue 1 (2016)

28 March, 2016 Press

Salary indexation is a state guarantee provided to each employee under the legislation of Ukraine. However, in recent years, not many employers in the private sector have been concerned about this guarantee.

Until 2015,failing to index salaries merely resulted in an administrative fine being imposed on companies, and the fines themselves were small – up to Hr 1,700 (or $63). Only under the worst case scenario, under very particular circumstances, could violations have resulted in criminal charges. There was also a risk of civil litigation, with employees claiming the balance of unpaid indexed salaries. However, despite the fact that such civil lawsuits have indeed occurred, many employers still turn a blind eye to the matter of salaryindexation.

But at the beginning of 2015, stricter financial penaltiesagainst employers who fail to provide their employees with the minimum state guarantees for remuneration of labor were introduced to the Labour Code of Ukraine. Salary indexation is considered one of these state guarantees.

The sanction for the above violation is a fine imposed on an enterprise at the level of 10 subsistence minimum wages for able-bodied individuals, which is now UAH 13,780 (or $510). Such a fine is to be imposed for the violation of salary indexation of each employee. Therefore, in calculating the fine, the sum of $510 is multiplied by the number of employees. For example, if there are 100 employees at the enterprise, then the fine for failing to index salaries would be $51,000. As can be seen, the sum of fine, depending as it does on the number of staff, could be quite significant. Moreover, such fines can be imposed retroactively.

But these finesremained off the radar for employers until February 2016, as no procedure for imposing the fine was established until then. Basically, employers could be found liable for a fine, but there was no mechanism for imposing it. That changed on Feb. 10, 2016, when a resolution issued bythe Cabinet of Ministers of Ukraine determining the procedure for imposing the fine came into effect. The imposition of such fines is now a realpossibility.

So considering the above, the issue of salary indexation now requires the careful attention of every employer.

In view of this, let us consider in more detail the basic rules of salary indexation.

Firstly, salary indexation is obligatory for all enterprises from March 1, 2003 (when the Law of Ukraine ‘On Indexation of the Population’s Incomes’ came into effect). Therefore, starting from this period, the salary of each employee should have been indexed. Taking this into account, the overall amounts of indexation for the whole period of non-indexation might appear significant. But before jumping to any conclusions and picturing huge amounts of unpaid indexation, it is worth noting that if the employer continuously increased salaries there might had been no need for indexation, or the sum could be insignificant. In the first place, the respective calculations are required.

Secondly, we have to emphasize that salarieshave to be indexed no matter what size they are – Hr 1,500 or Hr 20,000 for example. An employer might pay high salaries, which guarantee agood standard of living to an employee, but still be obliged to index them.

However, it’s worth noting that not all of the salary has to be indexed, but only the subsistence minimum wage for able-bodied individuals. For example, if an employee’s salary equals Hr10,000, only Hr 1,378 (or $51) is liable for indexation – this is the base sum for calculatingthe indexed sum.

Next, the base sum is multiplied by the index of price growth, which basically reflects the growth in consumer prices due to inflation. For employers, it is important to remember that the sum of indexation greatly depends on the length of time sincethe employee’s last raise. The general rule: the more recent the salary increase, the smaller the sum ofindexation. For example, if an employee’s increase salary was in January 2014, then the sum of indexation for March, 2016 will be Hr 1,064 (or $39), which has to be paid in addition to employee’s salary, regardless of its size (i.e., if an employee’s salary wasHr 20 000, then he/she, after indexation, should be paid Hr 21,064). If the employee’s salary was last increased in January 2015, then the sum of indexation would be Hr 523 (or $19), which is half the amount. However, in this case the size of the salary increase also has to be taken into account.

There are many other factors that influence salary indexation. For example, many employers in times of high inflation x decided to pay extra bonusesto support their employees standards of living. Thus, employees’ incomeincreased,and in this case employers fairly expect that the payment of such bonuses would affect their obligationswith respect to indexation. However, there are doubts over whether such bonusescan be included when calculating the sum of indexation. So, it appears that even if the sum of the bonus covers the sum of indexation, the employer is nevertheless still obliged to pay the sum of indexation.

To sum up, employers should expect a revival of activity by the state authorities concerning the issue of salary indexation. Therefore, it is advisable to analyse all periods of salary accrual and payment, with a view to meeting salary indexation obligations, as well as reviewing the structuring of employees’ salaries in general.

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