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28 July 2021

Tech deep dive – Issue II, 2021

Notable IT industry trends and developments in Ukraine

Greetings from Kyiv!

We are pleased to share the second issue of our newsletter dedicated to technology-related trends and legal developments in Ukraine. This issue provides a brief summary of recent IT industry developments during the first half of 2021, as well as provides an overview of the adopted law that introduces a new regulatory framework for the IT industry in Ukraine.

Overview of trends and industry developments in H1 2021

The IT industry continues to provide optimism and good news about further enviable development with about 20 per cent annual sector growth. This includes the increasing revenue of the Ukrainian IT sector and record-high amount of VC and PE investments of USD 571 million in 2020 despite (or thanks to) the coronavirus crisis; ever-increasing 200,000+ IT specialists capacity; as well as high ratings by reputable software development and IT outsourcing rankings (the Ministry for Development of Economy, Trade, and Agriculture of Ukraine offers a good overview for the last several years). Sometimes I find myself thinking that it is too good to be true. However, noticing the increasing volume of legal work on my table and the number of M&A transactions in the IT sector that we and other law firms are handling, I can conclude that it is likely to be true.

On the one hand, objectively there are not that many unicorns made in Ukraine and by Ukrainians (Grammarly, GitLab, and Ring are among the relatively few). Moreover, we are just starting to see a possible shift from outsourcing to product companies with global potential (eg, Monobank, Nova Poshta, Rozetka). I also recognize that on a global scale, the success of the Ukrainian IT industry may look small-scale. However, on the other hand, without doubt, the current industry growth inspires further development, increases the volume of M&A transactions, and cannot go unnoticed by the Ukrainian authorities striving to regulate more and secure additional sources of taxation.

On 28 June 2021, the President of Ukraine signed the so-called Google Tax Law. The adopted law introduces VAT on the supply of electronic services by non-resident companies to final customers in Ukraine. Starting from 1 January 2022, if the volume of VATable supplies of a non-resident company in 2021 exceeds UAH one million (circa EUR 30,750), such company will be required to (i) register as a VAT payer in Ukraine using a special procedure, (ii) file simplified VAT returns and (iii) pay Ukrainian 20 per cent VAT charged on top of the value of electronic services supplied to the final customers in Ukraine. My colleagues Svitlana Musienko and Anton Kerimov-Varanytskyi have highlighted more details on the introduced regulation (please follow the link here to read the full overview).

In less than a month since the Google Tax Law was signed into law, the Ukrainian Parliament adopted in the second hearing the draft law “On Promotion of Development of the Digital Economy in Ukraine.” The adopted law is a part of the new regulatory framework for the IT industry in Ukraine. And there is more to come. The new taxation regime for the IT industry is a key missing piece of the puzzle from the Diia City (https://city.diia.gov.ua/en/) picture that is expected to be added to the new regulatory picture this autumn. In addition, a virtual assets law is also expected to be adopted by the end of 2021. A more detailed summary of the adopted law and thoughts on further perspectives is provided in our article below.

Ukraine is also on the way to aligning its personal data protection regulations with EU standards. On 7 June 2021, the Ukrainian Parliament received a draft law “On Personal Data Protection.” The key objective of the draft law is to align the Ukrainian data protection landscape with the General Data Protection Regulation (EU) 2016/679. For more information on what to expect in terms of personal data protection, please click here to dive into a five-minute overview of the key changes businesses can expect if the draft law passes in its current form.

To sum up, plenty of legislative initiatives are underway and we’ll see how all this will play out. More news about the IT industry trends and developments is coming soon. Stay tuned!

A new chapter of IT industry regulation in Ukraine is about to begin soon: the look behind the looking glass for the IT industry that is far from reality or a level up?

On 15 July 2021, the Ukrainian Parliament adopted in the second hearing draft law No. 4303 “On Promotion of Development of the Digital Economy in Ukraine.” The adopted law is a part of the new regulatory framework for the IT industry in Ukraine that is driven, promoted, and implemented by the Ukrainian Government, predominantly through the Ministry of Digital Transformation (the “Ministry“) under the Diia City brand name (https://city.diia.gov.ua/en/) (the “Diia City Law“).

Diia City is expected to become a virtual free zone for doing business by IT companies in Ukraine (the “Diia City Model“) and is set to have a beneficial tax regime as well as flexibility for engaging Ukrainian IT specialists.

While we are all waiting for the President to sign the Diia City Law into law, we provide a brief summary below of key regulatory ‘benefits and perks’ to expect.

Lifetime

The Diia City Model is introduced for an indefinite term but, in any case, for at least 25 years (previously it was planned for 15 years). The 25-year term will be calculated from the date when information about the first Diia City resident is entered into the Diia City Registry. Section 3 of the Diia City Law stipulates a guarantee for the stability of the Diia City regulatory framework unless further changes to Ukrainian laws and regulations provide a more beneficial regime for Diia City residents.

Voluntary or mandatory?

Diia City is voluntary. Self-determination is one of the principles of the Diia City Model under s. 2 of the Diia City Law. Direct or indirect coercion into acquiring Diia City residency status is expressly prohibited.

However, it remains to be seen how beneficial other options will be for IT companies to operate. The tax burden will be a decisive factor for IT companies when choosing between Diia City residency and other possible options. Notably, the taxation part of the new regulatory framework for the IT industry is not covered by the adopted Diia City Law and is expected to be adopted in autumn 2021. The founding fathers of the Diia City Model declare a 5 per cent personal income tax model, reduced amounts of mandatory social contribution; and introduction of loyal corporate income tax regulation (18 per cent of corporate profits tax or 9 per cent of tax on distributed profits). However, the IT community doubts this taxation model will be adopted as promised and continues close monitoring of further developments.

Who is eligible to become a Diia City resident?

Only a legal entity incorporated in Ukraine may become a Diia City resident. To be eligible for Diia City residency status, such local legal entity should: (i) be engaged in at least one type of the IT sector activities listed in para. 4 of s. 5 of the Diia City Law (e.g., computer programming, games development, SaaS, cybersecurity, virtual assets service providers, robotics). The list of eligible activities in the area of IT is quite comprehensive; (ii) the amount of average monthly remuneration paid to employees and gig-specialists should not be lower than the equivalent of EUR 1,200; (iii) the average monthly number of employees and gig-specialists should not be less than nine individuals; (iv) income from the eligible activity in the IT industry in the first three months after registration as a Diia City resident must be at least 90 per cent of the total income for such period. Moreover, the amount of income from the eligible activity in the IT industry received for a year of the Diia City residence must be at least 90 per cent of the total income for such period (if total income is in place).

Good news for start-ups, ie, local legal entities established not earlier than 24 months before the residency application submission date. They can also become Diia City residents without the need to comply with the above average monthly remuneration requirement and minimum staff requirement during the initial period of residency. The initial period of residency means a part of the year when the Diia City residency was acquired and the whole next year (by 31 December). After the initial period, the average monthly remuneration requirement and minimum staff requirement will apply to such Diia City residents.

Paragraph 2 of s. 5 of the Diia City Law provides for twelve criteria for legal entities, which are not eligible for the Diia City residency status (eg, entities that do not comply with the requirements regarding disclosure of information about ultimate beneficiary owners).

Engagement of IT specialists and more straightforward IP rights assignment

According to para. 4 of s. 4 of the Diia City Law, a Diia City resident is free to:

  • employ IT specialists based on the employment contract. This option was not available before. Notably, Ukrainian law differs between employment contract and employment agreement, where an employment contract is a more flexible form of employment agreement. Section 16 of the Diia City Law stipulates that the parties to the discussed employment contract are free to agree on employment term, rights, and obligations of the parties (including material liability), working conditions, grounds for termination of the employment contract, including early termination, as well as other terms of employment arrangements. Losing Diia City residency status does not affect the validity of the employment contract

According to the anticipated amendments to s. 440 of the Civil Code of Ukraine:

  • proprietary intellectual property rights in software and databases created in connection with fulfillment of the employment agreement (contract) shall vest with employer unless agreed otherwise
  • proprietary intellectual property rights in products other than software and databases and which are created in connection of the fulfillment of the employment agreement (contract) shall jointly vest with employer and employee unless agreed or stipulated in the law otherwise

The relevant proprietary intellectual property rights shall vest with the employer from the moment of creation unless agreed otherwise.

As soon as the Diia City Law is in effect, it will also become possible to include the author remuneration to the salary of IT specialists. For the time being, such inclusion does not comply with the Ukrainian law requirements.

  • engage IT specialists based on a gig contract. Gig contract is a novelty in the Ukrainian law. Gig contract is a civil law-based agreement concluded between a Diia City resident and IT specialist under which the latter undertakes to provide services and/or conduct work on orders from Diia City resident and such resident undertakes to pay for the services/work, as well as ensure basic social protection (e.g., paid vacation, sick leave, maternity/paternity leave) as stipulated in ss. 19-23 of the Diia City Law. The subject matter of the gig contract may relate to exercising a function of a certain job position (eg, chief IT engineer or data protection officer)

Gig contract is neither treated as formal employment (para. 8 of s. 17 of the Diia City Law) nor as entrepreneurship requiring from IT specialist to be registered as an individual entrepreneur under Ukrainian law (para. 7 of s. 17 of the Diia City Law).

Section 24 of the Diia City Law simplifies the assignment of proprietary intellectual property rights under gig contracts between the Diia City resident and IT specialist. As a general rule, IP rights should be vested with to the customer under the gig contract by virtue of legislation from the moment of creation. Parties to the gig contract are free to agree otherwise in the contract regarding the assignment of IP rights and the moment when such rights should be deemed as assigned to the customer under gig contract.

  • engage IT specialists as private entrepreneurs under Ukrainian law based on the civil law-based agreements. The Diia City Law does not provide for any specific regulation for such type (as of July 2021, the most widespread form) of engagement of IT specialists. The future of this form of engagement of IT specialists will become clearer when the tax part of the Diia City regulatory framework is introduced. What is clear now is that this type of engagement of IT specialists is not taken into account for the purpose to ensure compliance with Diia City residency requirements (as outlined above).

According to the anticipated amendments to s. 440 of the Civil Code of Ukraine, proprietary intellectual property rights in a commissioned work shall vest with a customer from the moment of creation unless agreed or stipulated in the law otherwise.

IT specialists are also free to choose the preferred form of cooperation with Diia City residents.

Non-compete, non-solicitation, and other new legal instruments for Diia City residents

The Diia City Law makes it possible to agree on non-compete and non-solicitation clauses. Section 27 of the Diia City Law provides for that non-compete and non-solicitation agreements should be in written form, and it should be a consideration for the commitment of the IT specialist to adhere to non-compete and non-solicitation restrictions. Section 27 also providers for essential terms for the non-compete and non-solicitation agreement as well as a non-exhaustive list of non-compete and non-solicitation restrictions that can be imposed.

Until recently, there have been some obstacles, mainly in the currency control domain, which prevented the implementation of share option plans in the way they are typically structured abroad. Following substantial liberalisation of the Ukrainian currency control regime, share/stock option plans may be operational for Ukraine. Section 30 of the Diia City Law provides a framework regulation for a right to purchase the Diia City resident’s shares upon fulfilment of an agreed condition. More detailed regulation is expected for share/stock options within the Diia City regulatory framework.

Section 29 of the Diia City Law provides for special regulation on loan agreements for Diia City residents with alternative ways to fulfil a debtor’s obligations (debt-to-equity swaps), which set out the creditor’s right to convert debt into company’s capital or increase the creditor’s stake in the Diia City resident. The additional regulation is aimed at creating additional favourable conditions for investments into IT companies.

When in effect?

The Diia City Law is to become effective from the official publication date. It is not fully clear yet whether the President will sign the Diia City Law, which is the legislative stage that precedes official publication.

According to the Final and Transitional Provisions of the Diia City Law, virtual assets service providers will not be eligible to become Diia City residents within six months from the Diia City Law publication date. The lack of regulation for the virtual assets market delays the applicability of the Diia City Law to virtual assets service providers. In December 2020, the virtual assets draft law No. 3637 was adopted in the first hearing and is expected to be finally adopted within the declared six-month term.

For further information, please contact Oleg Klymchuk.

Information contained in this legal alert is for general information purposes only, does not constitute legal or other professional advice, and should not be relied upon as a substitute for specific professional advice tailored to particular circumstances.

 

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