Diia City Regime for Tech Companies in Ukraine: still popular in spite of the war

IT industry has been a strong driver of Ukrainian economy for many years, generating more than 4% of Ukraine’s GDP and growing by 25-30% annually (2021-2022). And even during the war, according to the data of IT Ukraine Association, as a result of ten months of 2022, the industry brought USD 6 billion in export revenue to the economy of Ukraine and reached a growth mark of 10% compared to the previous year.

At the same time, the industry had many issues: IT workers were mostly engaged as private entrepreneurs on the basis of commercial contracts (thus having lower tax burden), but often had all labor related guarantees (vacations, breaks, social benefits etc.). To this can be added the widespread use of non-competition clauses and other provisions in agreements with employees that were not enforceable in Ukraine.

Although there were obviously all the grounds for requalification, in fact, the inspection authorities hardly touched the industry, that brought enough money to the budget. At the same time, it was clear that this lenient policy could not continue, as such a blind eye was a bad example for other employers. The IT industry has long refused to work under labor laws (which are quite regulated, just like the European ones), so another elegant solution was found for them - they came up with a separate category of employees, but at the same time retained preferential taxation under the Diia City legal regime.

These are the main novelties, introduced by the Diia City Laws (guaranteed for 25 years):

Qualification criteria

Diia City is not a physical economic zone, but a special legal and tax regime, that any Ukrainian company may apply for online.

To become a Diia City resident a company must

• be registered in Ukraine
• derive at least 90% of revenue from certain activities as indicated in Diia City Laws (R&D and IT-related activities, cyber sport, digital marketing, computer games, data processing, SaaS etc.)
• have at least 9 gig-contractors and employees
• pay an average monthly salary in the amount of at least €1,200 to its gig-contractors and employees

Start-ups have additional criteria (not more than â‚´7,5 million annual income and registered not earlier than 24 months before the application), but must not meet criteria for headcount and salary mentioned above. 

Additionally, there are some negative criteria that prevent from applying for the status: for example, non-profit organizations, state-owned companies or companies registered abroad, companies with direct or indirect shareholders registered in Russia may not become Diia City Residents.

The decision on granting the status is taken within 10 days.

Corporate

Diia City Laws clarified that the shareholders’ agreement between shareholders of the company-Diia City resident may be governed by foreign law (if there is a foreign shareholding). Option agreements and convertible loan instruments in respect of shares in the charter capital of Diia City residents are also possible.

Moreover, as a novelty in Ukrainian corporate laws, a legal entity may act as the director of a Diia City resident (applicable only to the companies incorporated in a form of a limited liability company or an additional liability company).

Engaging workforces

Diia City laws introduced a third category of workers for Diia City residents: gig-contractors.

Thus, Diia City residents have several options to engage workforce: based on a labor contract, a gig-contract and other civil law/commercial contracts.

Gig-contracts are in a fact a mixture of labor and civil-law/commercial agreements. Among other things, they adopted some principles of labor agreements, including the following:

• working hours – not more than 8 hours per day, 40 hours per week;
• obligatory social benefits (sick leaves, maternity leaves, vacations, occupational safety guarantees, other benefits as envisaged by the Diia City Laws);
• gig-contractors could be obliged to follow all internal corporate policies.

Still, the relationship with gig-contractors does not fall under the labor law and is construed based on the principles of commercial contracts with freelancers acting as independent contractors.

Thus, no work permit is required, if gig-contracts are concluded with foreigners (would have been obligatory if the foreigner is employed).

Another important novelty is the possibility to include non-compete clauses into agreements or conclude separate non-compete agreements with all categories of workforces of a Diia City resident. 

However the non-compete agreement/clause must define the following:

• term of the non-compete obligation (not longer than 12 months after termination)
• territory  of the non-compete obligation
• the list of activities to be considered as competing
• remuneration for compliance with such non-compete obligation

The list of competing activities that could be forbidden may include the following: concluding employment contracts, gig-contracts or any other civil or commercial contracts with persons conducting similar activity as such Diia City resident, conducting competing activities as a freelancer, holding (directly or indirectly) shares or position in a governing body in another legal entity, conducting competing activity as well as other restrictions as may be stipulated by such non-compete agreement.   

Taxation

Diia City Laws stipulate additional tax incentives, applicable to Diia City residents, their shareholders and employees/gig-contactors.

Employees and gig-contractors pay the following taxes/deductions:

• Personal income tax – 5%
• Military duty - 1,5%
• Social security deductions – 22% from the minimum salary (less than €40 per month)

Personal income tax and military duty are paid on their behalf by Diia City resident as a tax agent.

Diia City residents may choose between payment of a classical corporate profits tax (18%) or a distributed profits tax (as a rule, 9%) applicable to profits distributions.

There are also additional tax incentives for individuals-shareholders of Diia City residents.

Next steps

Diia City legal regime may indeed be of great interest to many IT companies, including multinationals with subsidiaries in Ukraine, as the law does not contain restrictions on the presence of foreign shareholders. Also, potentially, companies operating in other industries, but having separate departments engaged in activities provided for by the Diia City Laws, may consider restructuring or spinning off such departments to be able to benefit from the incentives offered by the Diia City Laws.

Authored by Alesya Pavlynska