The IT sector is currently a major global success story for Ukraine. Each year, the industry generates more and more revenue for the government who needs steady fiscal inflows now as never before.
Ukraine, realising and trying to enhance its competitive advantages, has been gradually rooting out any bugs present and adding new legislative features. Today, we’re going to discuss Diia City, the IT sector’s special legal and tax treatment that will celebrate its first anniversary very soon.
Diia City residents include Ukraine’s largest and most successful IT companies. Everyone had their own reasons for getting residency status, but the cool things offered are generally as follows.
The Diia City Act offers a number of well-established English law legal and financial tools that are novel to Ukrainian legislation.
Warranties & Indemnities
The bigger the deal, the higher the chance of the purchasers (investors) ordering due diligence on the target. There is, however, a risk that the company will fail to provide all the documents or information.
Warranties & Indemnities will be there to help, as they will be used to have the sellers confirm key information about the company and its business, financial performance, asset pool, third-party liability, and litigations.
English law contracts with such clauses contain a provision imposing liability on the warranting party, usually in the form of a penalty and damages.
The availability of this tool to Diia City residents plays into the hands of purchasers (investors) and, therefore, enhances Ukraine’s investment appeal.
Liquidated Damages
This is another plus for investors. Contractual parties may stipulate, among other things, when and how much compensation will be paid to either party. On occurrence of any of the adverse events specified in their agreement, the party in breach will have to pay out the compensation agreed in advance.
It is important that such compensation is neither equivalent to, nor does it rule out, such remedies as interest, damages or penalties set out in the Civil Code or Commercial Code.
Liquidation Preferences
Unlike the usual priority rules, the Diia City Act gives preference to claims by creditors or certain company shareholders. This rule is not universal, but it may be applied as provided by the Diia City Act.
Convertible Loan
With Diia City, debt to equity conversions become even more convenient for companies and lenders. A loan agreement itself may provide that, rather than claiming the repayment, the lender will be entitled to demand that the debt be converted into equity and the lender either become a shareholder or receive a bigger shareholding in the company (if the lender is one of its shareholders). Such agreement may even specify the size of the stake to be purchased by the lender.
Option
Promising start-ups often include option agreements in their compensation packages and investment documentation.
For instance, a company and its executives sign option agreements that entitle them to require the company to issue shares or transfer a shareholding to them in exchange for achieving a capitalisation target.
An option is a right of its holder and an obligation of its grantor. Options are becoming increasingly popular both in Ukraine and abroad and constitute a powerful employee incentive tool.
Non-Compete
Non-compete clauses are most common in top executive contracts. Once employed, members of staff gain access to the company’s confidential and proprietary information, which would not be confidential or proprietary if it not for the competitive advantages it gives to the company.
Non-compete agreements restrict employees from entering into employment with competitors. On the one hand, employers and employees may limit non-compete restrictions as they see fit.
On the other hand, companies usually seek to impose non-compete provisions on employees who are often well paid. Income of that level is a kind of compensation for, among other things, such inconveniences after the termination of their employment. A non-compete clause may also provide for compensation to be paid to the employee within an applicable restriction period. It is up to candidates as to whether or not to enjoy good employment conditions, but be subject to non-compete obligations for some time in the future.
Any of the foregoing provisions could not apply to Diia City earlier, unless they were legally laid down in contracts between non-residents only. If a contract was concluded between a resident and a non-resident, it was to be governed by foreign law only.
In addition to the new tools, Diia City provides its residents with a special tax system that contains a number of preferences. Companies can choose between two tax regimes and pay either income tax of 18% or exit capital tax of 9%.
Diia City is also subject to a so-called grandfather clause, which provides that the adopted terms and conditions will remain unchanged for 25 years.
To become a Diia City resident, a company needs to be registered under the laws of Ukraine, engage in qualified activities, satisfy the admission conditions (the main ones of which are mentioned below), and prepare a set of documents.
Operational companies will be admitted if:
-They pay an average remuneration equivalent to EUR 1,200.
-90% of their revenues come from qualified activities.
-They have at least nine employees/gig professionals in the reporting period.
Residency criteria have been simplified for the duration of martial law: failure to satisfy the minimum employee number and average salary requirements may not be a reason for depriving a company of residency status until martial law is lifted.
Start-ups will be admitted if:
-Their annual income is up to UAH 7,500,000.
-90% of their revenues come from professional activities.
-They have been registered for at least 24 months before the filing date of the residency application.
The qualified activities are:
-Software development and testing, including publishing of computer games;
-Publishing and distribution of software, including SaaS;
-Cybersports;
-Training in computer literacy, programming, software testing and maintenance;
-Cybersecurity;
-R&D in IT and telecommunications;
-Digital marketing and adverts using resident-developed software;
-Virtual asset services;
-Robotics;
-Development, introduction and maintenance of solutions for international card payment systems;
-Manufacturing of technology products for defence, industry and household applications;
-Hosting, including cloud-based data centres.
Companies that are willing to become Diia City residents, but are not certain as to whether their activities fall within those listed above, are encouraged by representatives of the Digital Transformation Ministry to seek advice on which activity may be considered related thereto and can, therefore, be specified for registration purposes.
Registration will require an applicant:
-To fill in their details: tax identification code, name, and form of incorporation;
-To specify the activities the company plans to carry out as a resident;
-To fill in employee details;
-To attach a power of attorney, if necessary;
-To sign the application electronically.
Given the foregoing, Diia City is an attractive system for Ukrainian IT businesses and foreign investors. Getting lower operating expenses and hedging risks through M&A deals make the Ukrainian jurisdiction more appealing to investors, and this, in turn, is crucial to financing government spending with taxes and levies. The government will spend 90% of its 2023 budget to enhance Ukraine’s defence capabilities and, therefore, to secure russia’s inevitable defeat in the unprovoked war that it started.
Glory to Ukraine!
