Current status
Differing viewpoints
Diia City outline
The government recently announced a highly ambitious initiative in the IT sector, which it believes will boost the industry.(1) Named "Diia City", the project is a legal framework for IT industries with several promised benefits, including staff engagement options and changes in work permit requirements for foreign workers. Among the key novelties is a "gig contract" – a combination of a freelance and an employment contract – a brand new model of engagement for the Ukrainian market.
At the time of writing, the initiative has not yet been implemented. It involves two draft laws: the first (regarding general legal framework) was approved by Parliament in its final reading on 15 July 2021, and the president's signature and official publication are still pending (a potential veto cannot be excluded, but such a development is unlikely); the second (regarding taxation rules) was approved at its first reading, with the second reading pending.
Once the laws have been passed, their implementation will still be subject to the approval and/or adaptation by the government of relevant bylaws. According to the draft law that has already been approved, the government will have six months to do this.
While the government is enthusiastic about the project, the Ukrainian IT community is not unanimous in its views. Indeed, the initiative has been criticised as an attempt at over-regulating the industry, something that may complicate or even impede the use of existing business models to which the sector is accustomed and has adjusted over the last ten years.
Currently, the majority (up to 90%) of IT businesses operating in Ukraine engage IT personnel as contractors rather than employees. This allows them to benefit from a 5% flat tax as opposed to 19.5% plus 22% in payroll taxes. This way of doing things – with "private entrepreneurs" as service providers and the company as a customer – is therefore the most common and popular in the Ukrainian IT industry. In practice, the clear tax benefit often overrides the potential risk of being classified as an employee rather than a contractor.
There are additional points of concern around the Diia City initiative, such as specific reporting and audit requirements, and industry-specific salary thresholds as outlined below in greater detail. In view of the current strong political push concerning the initiative, however, the chances of its approval and implementation are significant, despite its mixed reception from the industry.
The following outline is based on existing draft law and information available to date.
The Diia City framework will apply to:
- the legal entities of IT sector meeting the specific access criteria outlined below (the so-called Diia City Residents); and
- IT staff engaged by Diia City residents.
Access criteria
To become a Diia City resident, a legal entity needs to meet the following criteria, among others:
- it must be incorporated in Ukraine;
- it cannot have non-profit entity status;
- the state, municipalities, state- or municipally-owned companies, Russian companies/residents or FATF-blacklisted companies cannot be among its founders (either directly or indirectly);
- registered types of activities related to IT, cyber-sport (gambling not included), cyber-security, robotic technologies, IT-education, virtual assets services must be included;
- at least nine employees/gig contractors, as defined below, must be hired/engaged;
- the average monthly remuneration payable to employees/gig contractors must not be less than €1,200 per person;
- IT activity-related income must constitute at least 90% of the legal entity's overall proceeds;
- it must not be subject to Ukrainian or international sanctions;
- it must not be subject to winding up or bankruptcy proceedings; and
- it must not have tax arrears of more than 30 days.
Those legal entities (incorporated in Ukraine and not founded by a Russian resident) that meet only some of the criteria listed above may still obtain Diia City resident status provided that the missing criteria are fulfilled within the relevant grace period.
Diia City residents will be obliged to submit specific reports to the regulator so that the regulator can monitor the Diia City resident's compliance with the Diia City eligibility criteria outlined above. These reports will need to be approved by an independent auditor. This requirement was previously among the key concerns flagged up by the industry as being excessively burdensome.
Staffing of Diia City residents
Staff
Diia City provides a flexible framework for engaging personnel, as an alternative to the existing archaic model. In particular, the following options will be available under the Diia City framework:
- employment – income tax at 5% rather than the usual 18% (payable by the employee), social duty (payable by the employer) at 1,320 hryvnia (£35) as opposed to 19,800 hryvnia (£530) and greater flexibility in regulating labour relations by the parties rather than the current rules of employment;
- employment as a contractor (tax regime the same as that in existence, ie, income tax from 5%); and
- gig contract – a new concept (details below).
A gig contract is a civil law contract for the engagement of an IT specialist, with social care guarantees similar to those in a regular employment contract (length of the working day, holiday, sick leave, maternity leave), but with an absolute ban on reclassification as an employment contract without the agreement of the parties.
The principal difference between a gig contract and a contractor agreement is that it allows the worker similar benefits and social protection to those provided to employees, but without the risk of being reclassified as an employment contract as under existing models. Furthermore, as opposed to employment contract, the gig contract allows the parties much more flexibility in regulating their terms (including the contract termination).
The proposed taxation regime for a gig contract is as follows:
- income tax at 5%;
- military duty at 1.5% (the rate is similar to that currently applied to employees); and
- social security duty up to 19,800 hryvnia (£530) – the rate is similar to that currently applied to employees, rather than the 1,320 hryvnia (£35) currently applied to some contractors.
As a result, the tax burden applicable to a gig contract appears to be considerably lower than that of an employment contract, yet to some extent larger than that of contractors. However, a gig contract runs little risk of being reclassified as a contract of employment (whereas in the case of a contractor, such a risk is more real), while legally allowing the gig contractors similar benefits and social protections to those that are traditionally offered to employees.
The work-for-hire IP created under the gig contract shall be allocated as follows: moral rights for the IP (ie, authorship) stays with the gig contractor, while the proprietary IP is allocated to the Diia City resident, unless otherwise agreed in the gig contract.
Management
If established by the charter of a Diia City resident and agreed at the shareholders' meeting, functions of its executive body may be entrusted to a legal entity – the managing entity. This is new in Ukrainian law. Indeed, to date, only individuals may serve as a company director/management board member and, therefore, the full burden of liability for the company's activities lies with such individuals. One of the main aims with this new concept has been to indemnify company directors who act in good faith from such liability.
Diia City benefits
Tax benefits for Diia City residents
Diia City residents will be free to choose between 18% corporate profit tax and 9% distributed profit tax. The different options for personnel engagement (outlined above) will allow Diia City residents to determine an optimal payroll tax burden and, hence, give them more flexibility in head count formation.
Variety of options for personnel engagement
Further to the options outlined above, it should become easier to hire foreign IT staff. In particular, foreign gig contractors will not require a work permit and thus would save one-two months in time and also certain costs for the engaging company. These gig contractors will still be eligible to formalise their long-term stay in Ukraine for the period of the gig contract.
Non-competes and data protection instruments
Diia City residents will be free to enter into non-compete and confidentiality agreements with its staff. It is proposed that such agreements may (and in some cases must) provide for relevant compensation to the party bound by the relevant undertakings. Non-solicitation restrictions in the initial draft law were removed after the second reading as they were heavily criticised by the IT community for being excessively severe, which could affect the ability of IT staff to change jobs.
Even in their limited version, however, the non-compete provisions are a breakthrough in labour law. Indeed, even now the current scope of permitted non-competes/non-solicitations is limited by the position of company officers.
Additional protection from unauthorised state inspections and seizure of equipment
Any inspections of Diia City residents by state authorities will only be possible if authorised by the head (or deputy head) of the inspecting body.
Any searches or seizures of Diia City residents' equipment by law enforcement authorities will be subject to:
- prior written request; and
- authorisation by a prosecutor responsible for the region (oblast) or a higher-level prosecutor.
Stability
The draft law promises that the Diia City framework and benefits, once implemented, shall remain unchanged for at least 25 years, unless the modifications make the regime more advantageous. Based on past experience, however, the market is viewing this guarantee with caution.
For further information on this topic please contact Aleksandra Yevstafyeva or Olga Podobiedova at Egorov Puginsky Afanasiev & Partners by telephone (+380 44 498 8282) or email ([email protected] or [email protected]). The Egorov Puginsky Afanasiev & Partners website can be accessed at www.epam.ru/en.
Endnotes
(1) Further information on the government's presentation is available here.