Zelensky signs Diia City bill that changes taxation for tech firms

President Volodymyr Zelensky on Dec. 18 signed a bill creating a special taxation system for tech firms.

Bill №5676, approved by the parliament on Dec. 14, is the second of three laws that are necessary to create the Diia City system. Diia City is a collection of tax, employment and legal benefits that Ukrainian and foreign IT firms will be granted in an attempt to boost Ukraine's tech industry.

Under the latest bill, tech firms that participate in Diia City and use labor contracts will pay fewer taxes, while firms that already save on taxes by contracting employees as individual entrepreneurs will not receive special benefits. The bill requires them to gradually switch to labor contracts over the next five years.

The concept of Diia City has been controversial among tech firms. They have said the current system works, argued that it brings millions of dollars to the state and they don't understand why the state would disrupt an already working system.

The government, on the other hand, says Diia City will attract foreign investment and encourage tech companies to register in Ukraine. Ukraine's Ministry of Digital Transformation submitted the first bill, defining how Diia City works, to parliament in November 2020. It was passed on July 15.

Taxation

The new bill reduces taxes for tech specialists that have full employment contracts: instead of 18% income tax, they will pay 5%. Other taxes, including a 1.5% military levy and a social security contribution of $52 (22% of the minimum wage) remain unchanged.

The total tax levy for tech firms under the new bill has been changed to 28.5% from 41.5%. These changes are only applied if the tech specialist earns less than 240,000 euros a year.

The bill also introduces a new 9% corporate tax imposed on dividends, royalties, interest or financial assistance. Ukrainian companies can pay it instead of income tax.

By introducing the corporate tax the state wants to encourage tech firms and startups to register their businesses in Ukraine rather than in offshore countries like Malta or Cyprus where these taxes are smaller.

Employment

Instead of hiring full-time employees in Ukraine, most tech firms prefer to hire individual entrepreneurs, who work as contractors.

The new Diia City bill will allow tech firms to keep hiring individual entrepreneurs until 2024. Then, companies must switch to gig contracts or employment contracts, reducing their expenditures on private entrepreneurs to 50% in 2024 and to 20% in 2025.

That is the requirement that sparks the most controversy in the local tech community. As of today, over 95% of tech specialists work as private entrepreneurs in Ukraine. They don't sign employment contracts, but pay a 5% income tax – one of the lowest in Europe.

Ukrainian tech firms love this form of employment because they can save a lot on taxes and have more flexible terms of work. However, in recent years local startups have started to complain that they struggle to explain to foreign investors that individual entrepreneurs are legal and transparent entities in Ukraine.

The government said that by employing individual entrepreneurs, tech firms want to save on taxes and social benefits for employees that are regulated by Ukraine’s labor code.

To make the transition to official employment easier the bill introduces the new tech employment category – a gig worker. Gig workers don’t have to register as individual entrepreneurs and they are not regulated by labor law.

Their working conditions are determined by gig contracts between tech specialists and employers. Compared to employment contracts that remain valid even after companies leave Diia City, gig contracts expire three months after workers depart the economic zone.

Criteria

The rules of Diia City only apply to companies that work in the information technology industry, employ at least nine people and pay salaries of at least 1,200 euros per month. Startups can pay lower salaries in the first year of their residence.

Diia City will accept tech specialists that develop software and computer games, work with virtual assets and robotics, provide cybersecurity services, own e-sports businesses or create digital ads. The government will expand this list in the future.

Tech companies can join and leave Diia City at will – it doesn’t replace the current system. The government promises that it won’t change this version of the bill for the next 25 years.

What's next

To fully enact Diia City, the parliament has to pass the third bill that determines how tech companies will interact with law enforcement. The Ministry of Digital Transformation expects Diia City will start accepting its first residents next year.

After hundreds of amendments to the first version of the bill, Ukrainian tech firms have finally accepted it but said that they need more time to analyze it.

"We are cautiously optimistic about the Diia City project as the government considered most of the amendments suggested by tech firms," said Olena Samborska, HR director of Ukrainian tech company Luxoft.

"We accept the bill, but our attitude is still ambiguous. Diia City has many controversial aspects that can negatively affect the work of IT companies in general and each employee in particular," according to Serhiy Skurikhin, CEO of tech company ZONE3000.

Ukrainian startups are even warier. They said that by registering their business in Ukraine they couldn't attract foreign investment. Besides, many startups simply cannot meet Diia City's criteria for residence.

"Startups often do not have high salaries and the number of people they employ changes constantly," CEO of the startup Recoshelf Yaroslav Parkhisenko told Ukrainian media dev.ua.