The new ambitious project of the Ukrainian government “Diia City” has been presented in the summer this year as a concept of a special legal framework for IT industry. The initiative was reflected in several draft laws, but some have been rejected already. Currently the draft law #4303 with its alternative versions #4303-1, #4303-2 is on agenda.

The government declares beneficial taxation, updated labor regulations and flexible rules of business with individual entrepreneurs (‘IE’). Documents are aimed to create transparent rules for IT business and address its sensitive issues.

In general it is a great idea, implementation of which may rocket up IT business development and create a unique IT hub in Ukraine. Draft laws have prompted heated debates between industry stakeholders and the government. IT business share the sentiment that Diia City is the necessity for the industry, but implementing draft laws do neither suffice needs of Ukrainian IT business nor do they measure up to foreign competing projects.

Diia City is the name for the special legal framework that will apply for at least 15 years nationwide to Ukrainian IT companies. Any Ukrainian company carrying out IT economic activities will be able to join Diia City voluntary by following simple registration procedure. However, the candidates will have to meet eligibility criteria.

Some residency requirements, such as to pay average monthly salary of USD 1400 to IT stuff and to have 90 % of the income flowing from IT business activities only, could not be met by many companies. New companies and subsidiaries of international corporations will be turned down from residency, because they could not afford or business model will not allow them to meet the requirements, although some special rules for startups are prescribed.

Other requirements were for a salary to be 70 % of product’s cost and for companies to have up to 70 % of export profits since the 2nd year of residency in Diia City. These requirements had raised legitimate concern in the IT industry, and later have been dropped by the government. IT businesses pointed out that companies developing the product could meet such criteria, but business with fully-fledged and completed product will find it difficult. The cost of salary will no longer be the major part of product’s price after development. Instead, companies will spend more on marketing and support. As for the export profits, the government proposed very short time span, especially for startups, to find new markets and to capture market share significant enough to achieve export threshold.

One of the major concerns of the industry is that a regulator with overbroad powers may be created. The draft laws feed those worries, for instance, by making intricate criteria for the residency in Diia City. For example, the authority in charge will have discretion to determine additional characteristics of IT economic activities, which a resident should carry out. In fact, it gives power to decide on eligibility of certain candidates that may pose risks of corruption and preferential treatment.

In addition to the powers to decide who can be a resident, the authority also may get the right to oust ineligible residents from Diia City. Residents, apart from requisite IT economic activities, will be allowed to carry out transactions facilitating primary business, for example, advertising and M&A. However, that list of transactions is not exhaustive, so there is no clarity on prohibited transactions. At the same time, authorities will be able to define transactions to be incompatible with resident status. Thus, there will be the risk for a resident to be struck off from Diia City on obscure legal grounds at any time.

Regulators’ powers and red tape have been always the problem for businesses in Ukraine. IT business should be able to plan long-term, be flexible in business strategies and not to turn its operations into compliance minefield.

Currently it is unclear what will be the new tax regulation for the Diia City residents, as there is still no draft law linked to the #4303. The new tax amendments are yet to come. However previous drafts #3933 and #3933-1 were not warmly welcomed by the industry.

The pivot of Diia City is supposed to be lower tax burden for IT companies. Proposals for companies are lower corporate income tax for all residents at 9 % or the same tax only on certain resident’s income at 18 %. Currently business has the opportunity to use limited liability companies registered as single tax payers (3% or 5%) to structure their business. Hence, the proposed tax on corporate income is unlikely to impress investors and incentivize them to join Diia City.

The other part of new mode is taxes on salaries. It is common knowledge that IT business mostly works with individual entrepreneur contractors registered as single tax payers. The tax burden (social security contribution included) on remuneration of contractors is around 7,5 % against 41,5 % on employee’s wages. The new mode offered a lower personal income tax and lower unified social contribution, however the overall tax burden for salary constituted app. 19% (Draft Law #3933) or 15% (Draft Law #3933-1), which still concedes to current tax benefits of working with contractors.

In summary, it is obvious that the government shall propose conditions better or at least not worse in order to get the IT business

interested.

The IT industry has expected sound rules for dealings with IEs from Diia City framework. The draft laws are silent on the changes in contracting with IEs. Thus, from one hand, the residents of Diia City will be able to contract IEs as usual under the civil law contracts.

On the other hand, hidden obstacles for contracting with IEs may occur, as we could see from tax draft laws #3933 and #3933-1. For instance, the draft law #3933-1 proposed additional 18% tax to any payment to IE, a single tax payer (5 %) made by a Diia City resident, which makes no economic sense on further cooperation with IEs.

The draft laws introduce new instrument for Ukraine – gig contracts. Engaging gig-contractors ought to replace the contracting with IEs. Gig-contracts will be designed for a natural person, which is not IE, to perform certain tasks or complete projects under the contract, in which the parties will determine the majority of conditions.

In essence, gig-contract will be a civil law contract, which has some characteristics of employment contracts. For example, it can be concluded for indefinite term, the working hours shall not exceed 40 hours per week unless contractor works flexible or irregular working hours, the gig-contractor will be entitled to sick leave pay.

Although the gig contracts concept is a great idea, the proposed regulation is far from perfection now and shall be more detailed. Moreover, considering the proposed wording of the draft laws, an issue of qualifying a gig-contract as an employment contract and subsequent liability of the resident of Diia City may arise in practice.

Another novelty is the opportunity to conclude NDAs, non-compete and non-solicitation agreements with employees, gig-contractors and individual entrepreneur’s. These contracts are well known in common law system and are essential in the IT industry. However, currently non-compete and non-solicitation contracts are voidable in Ukraine. It is unclear how these contracts will work considering current judicial practice.

Draft laws implementing Diia City still are at the early stage of legislative procedure and the government is serious about launching of the concept on the beginning of 2021. However, at this point, the proposed regulation does not fully meet the expectations of the Ukrainian IT businesses and potential foreign investors. Although the overall concept is great, we hope that the government will not neglect the quality of the law in its turbo regime of the laws adoption.

Partner at GOLAW, attorney at law

Associate at GOLAW, attorney at law

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