Tech deep dive – Issue I, 2021
Notable IT industry trends and developments in Ukraine
Greetings from Kyiv!
We are pleased to share the first issue of our newsletter dedicated to the technology related trends and legal developments in Ukraine. This issue provides a brief overview of the notable IT industry developments during the beginning of 2021 and looks at possible (and, in fact, highly debatable) tax changes for the IT industry, which might not only affect local IT businesses, but may also be relevant for foreign customers outsourcing IT services in Ukraine.
Overview of trends and industry developments in January-February 2021
Ukrainian IT industry continues to benefit from the ever-growing business demand for digitalization and IT solutions. The first sign is an increase in the number of open vacancies that are accumulating and balancing at the level of about 10,000 IT professionals. This is again the employee’s market where IT professionals choose a company they would like to work with.
Ukrainian IT services outsourcing market expects to get a slice piece from the expected 4 per cent growth of the worldwide IT industry spending in 2021, according to Gartner. Ukrainian IT sector is also expecting recovery of the economy in the US and the EU, where its key clients are operating.
Major tech-related trend on the IT industry market is the continuing attempts by the Ukrainian authorities to introduce additional regulation for the IT industry. Special tax regime for the IT companies called Diia City (https://city.diia.gov.ua/en/) continues to be the most controversial issue on the IT market. The issue is actively discussed by the government and the representatives of the Ukrainian IT industry. Namely, the Ukrainian IT industry initiated an alternative draft law on Diia City tax regime (with official registration No. 4303-2 in the Ukrainian Parliament) that is now ‘competing’ with the draft law submitted by the Ukrainian Government to the Parliament (No. 4303 in the Parliament). The IT industry insists on transparency, avoidance of overregulation and flexibility when choosing between the employment model and independent contractors model. Given active public debate on the issue, additional developments and delays in the adoption of the law are expected during the first half of 2021. In the second part of this newsletter, we provide a more detailed summary of the upcoming regulation for the IT industry.
On 8 February 2021, the Ukrainian Government has approved the draft law aimed at strengthening protection of the employees’ rights. General idea of the draft law is to introduce a definition of ‘employment relations’ and systematize the list of factors indicative of employment relations (availability of any of the above three factors would suffice for requalification to the employment relations). The approved draft law is based on the previous initiative and mostly recite the previously elaborated factors (click here to read our previous overview). This may be a quite early stage for the draft law to become the law, but it shows that Ukrainian authorities are still trying to move this issue forward and introduce additional regulations in this area. Follow-up review of the existing contractual arrangements with the local developers may be scheduled in mid-term by the foreign customers, while Ukrainian IT outsourcing companies already widely criticize the initiative.
Last but not least, on 17 February 2021, Ukrainian “Google tax” bill passed the first reading in the Parliament. The bill introduces 20 per cent value-added tax (VAT) on some electronic services provided via the Internet. The term ‘electronic services’ is expected to include, among others, online supply of pictures, e-books, e-magazines, audiovisual works, video on demand, games (including games of chance), cloud services for data storage, digital advertising services, online supply of software (including updates). Being inspired by statistics that similar ‘Google tax’ has been introduced in 80+ countries, as well as by the amount of potential additional tax of USD 3 billion, the Members of the Parliament are likely to vote for the bill in its second reading. Thus, it may be adopted by the end of 2021 with effect from 1 January 2022 (unless the business would be able to win a bit more time and postpone the effective date).
Tax changes on horizon for IT industry: Diia City tax regime
The independent contractor model is the most widespread model for engaging Ukrainian IT professionals. This is mainly due to the fact that IT professionals with private entrepreneur status may use the simplified tax regime. Tax law splits private entrepreneurs into four groups for the simplified tax regime, depending on their revenue and type of service provided IT developers registered as private entrepreneurs under Ukrainian law and performing IT activity are generally entitled to choose 3rd group of the simplified tax regime. Single tax rates for the 3rd group can be 5 per cent (if an IT specialist decides not to pay VAT of 20 percent) or 3 percent (if an IT specialist decides to pay VAT of 20 per cent). The 3rd group also allows rendering services to legal entities, including foreign entities. In comparison, employees pay a 19.5 per cent tax on their income, while employers pay an additional 22 per cent tax from the gross amount of salary. According to the DOU.ua survey, almost 90 percent of earnings are attributed to the IT specialists with the private entrepreneur status (PE-model).
For quite a longtime Ukrainian IT industry practically enjoys an immunity from overregulation. Furthermore, the PE-model does not involve high legal risks, particularly, tax risk, for either IT professionals or the companies that engage them. However, every new government considers changing the taxes regime for IT industry. Since every time such initiative is not viewed favourably by the IT industry players, the status quo remain year on year.
Despite the heavy critics of the proposed tax changes by the IT industry, it looks like this time a new initiative called Diia City (https://city.diia.gov.ua/en/) has good chances to be adopted by the Ukrainian Parliament. It is more of a question when, and whether the IT industry pushing for the alternative draft law No. 4303-2 can reach a compromise on the scope of regulation with the Ministry of Digital Transformation (Ministry) pushing for its initial draft law No. 4303.
Where the representatives of the IT industry and the Ukrainian authorities build a consensus is an issue concerning the types of companies that would be allowed to apply for Diia City tax regime. In particular, only IT companies are eligible for Diia City tax regime. Namely, only those IT companies which provide software services (e.g., software and game development, quality assurance and support; planning and designing integrated computer systems that combine hardware, software, and communication technologies) are expected to be eligible to apply for Diia City ‘residence’.
Although at the first glance any potential impact of the tax reform constitutes a risk for the local IT business, the following steps can be advisable for the foreign contractors to mitigate any potential impact on the arrangements with the local IT professionals:
- monitor development of the tax reform, maintain an open dialogue with the local IT service provider(s) and conduct (or ask the IT service provider to conduct) a regular impact assessment to understand if the situation is still manageable or (i) it is necessary to re-negotiate the existing agreement with the local IT service provider; or (ii) it is time to restructure the current contractual arrangements, including to change the local IT service provider or find an intermediary/alternative service provider and have them on standby; or (iii) incorporate a local subsidiary and employ dev team
- do not lose sight of the bigger picture as not only tax reform and tax authorities may create problems. Changes in taxes will not eliminate reclassification risks. Monitor the local labor protection authorities’ enforcement practice and potential changes to labor laws concerning reclassification of customer-independent contractor relations into employment relations. Labor law reform is another highly debatable issue in Ukraine
- check whether existing agreements ensure sufficient flexibility for your company to amend and terminate such agreements with the local IT service providers
For further information please contact Nazar Chernyavsky or Oleg Klymchuk.
Information contained in this overview 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.
