Legal peculiarities of starting IT business in Ukraine

If you are considering how to enter IT market in Ukraine and benefit from it in full, this overview will help you understand the major models of work of IT companies as well as the risks associated.

Hiring Ukrainian freelancers directly

Cooperation of a foreign company directly with Ukrainian freelancers is quite a wide-spread business model. This approach prescribes conclusion by the foreign company of software development (or similar) contracts with freelancers and provision by freelancers of respective services on commercial basis. Just to note, to work legally as a freelancer the citizen of Ukraine must register himself as a private entrepreneur that is similar to the sole proprietor in certain other jurisdictions.

Normally, in order to properly structure the work of Ukrainian freelancers, the foreign company hires a local CEO, project managers and supporting personnel (as private entrepreneurs), organises centralized accounting for locals as well as rents office premises.

Such model of work is popular because of its simplicity, flexibility and beneficial taxation. Ukrainian laws prescribe a simplified taxation system (in the described case group 3 will apply), which means that the developers-private entrepreneurs will pay in Ukraine normally 5% income tax and a unified social tax, calculated as 22% of the minimal salary in Ukraine (unified social tax till December 2021 is UAH 1320).

Nevertheless, such a business model contains certain risks. For instance, cooperation of a foreign company with a Ukrainian private entrepreneur under certain circumstances may result in recognition by tax authorities of such private entrepreneur as the representative office of a foreign company in Ukraine, entailing respective procedural and tax consequences for the foreign company.

Setting up a subsidiary in Ukraine

Another popular model is setting up in Ukraine of a subsidiary of the foreign company, most frequently in the form of a limited liability company. The subsidiary is usually financed by the parent company through a kind of services agreement (e.g. development services agreement) or less commonly by means of contributions to the charter capital or loans from the parent company. In turn, the subsidiary enters into software development contracts with local developers-private entrepreneurs and pays them for the services rendered.

Usually (but this is not a rule), under such model the local top management as well as the administrative staff are employed by the subsidiary, whereas most developers are contracted as private entrepreneurs.

Taxation of the private entrepreneurs remains the same as described above, while in relation to the employees the subsidiary shall generally pay: 18% of the personal income tax, 1.5% of the military duty and 22% of the unified social contribution calculated from the actual salary of the employee.

It is pretty obvious that from the taxation perspective of view most of the companies are usually willing to limit the number of employees and to engage private entrepreneurs.

At the same time, such model bears other, no less significant risks. If the contractual relations between the subsidiary and the private entrepreneurs are structured incorrectly from the legal point of view, Ukrainian labour and tax authorities may recognize such relations as hidden employment. Such recognition of labour relations will result in pretty huge fines as well as accrual of additional taxes for each incorrectly contracted private entrepreneur.

Although as of now there are no directly prescribed by the law features of labour relations, the Government of Ukraine is willing to regulate this matter and to stipulate exact criteria, falling under which will mean existence of labour relations with respective requalification of the relations between the companies and the private entrepreneurs from civil law to labor. As an example, among such criteria are: a) provision of means of production (equipment, tools, materials, workplace) by the person in whose interests the work is performed; b) systematic payments to the person performing the work; c) establishment of the duration of working hours and rest time by the person in whose interests the work is performed.

What to take into account?

First of all, there is no IP-BOX regime in Ukraine yet. However, the Government is currently developing a special legal framework for the IT industry, called Diia.City, which shall prescribe exceptional taxation model, flexible employment conditions and a special procedure to interact with regulators. If adopted, the provisions of such regime shall be taken into account when planning to enter Ukrainian market.

Secondly, the legal system of Ukraine is based on the framework of civil law, which significantly differs from the common law system. Thus, the foreign company needs to understand the peculiarities of local legislation, including IP laws, labor laws, tax, civil and commercial legislation. For example, in Ukraine the non-compete clauses are usually unenforceable, while the fact of disclosure under NDA is usually very hard to prove, unless correctly presented in the agreement.

Finally, the legislation of Ukraine is quite rapidly changing in recent years following the ongoing tax reform, labour laws reform, corporate legislation reform, etc. Respectively, one shall always keep this in mind and use only verified and updated sources.

To summarize

Every year Ukraine indeed becomes one of the most high-demanded jurisdictions for starting IT business. Although the abovementioned models of IT business structuring are generally the most common, they usually have alterations and certain features taking into account the needs of the business in each specific case.