In November 2020, Georgia became another post-Soviet country, after Belarus, Moldova, and Uzbekistan, introducing a special tax regime for the IT industry. A few days later, meeting with the Minister for Economy of Georgia, Natia Turnava, we were glad to welcome the representative of the leading global engineering company, EPAM Systems, that started working in Georgia thanks to the new 5% flat rate special tax regime for IT companies.
Georgia’s IT industry is just started being developed, as the authorities have just recently started to create appropriate conditions to attract the global tech companies and to develop the local IT industry to diversify the local economy heavily dependent on agriculture and tourism hit by the pandemic outbreak.
However, in the post-Soviet region, there is a country with over 200,000 people working in the IT industry, generating $4 billion of exports – 8% of the country’s total export. This country is Ukraine, whose highly professional IT developers are well-known throughout the global IT industry.
Unfortunately, unlike in Georgia, the Ukrainian authorities did not notice the gold mine that has been sitting right in front of them until recently. The IT industry has grown entirely relying on a private initiative, without any support from the state and in fact – with its tangible opposition. For example, the total tax liability of an IT specialist’s salary in Ukraine is 41.5%. By Western standards, the figure is quite reasonable, but it does not withstand competition from neighboring countries like Belarus, Moldova, and Romania, where special tax regimes with single-digit taxes have been introduced.
IT is a highly versatile industry, and if a company is not satisfied with working conditions in one country, they can easily move to a different country. Most Ukrainian companies, however, have chosen a different model – staying in Ukraine and moving their work to a “gray area” where the companies formally are operating legally but the actual tax fraud is embedded in their activity.
Most IT companies do not actually hire anyone, but instead, have thousands of contracts with individual entrepreneurs. This model allows companies to reduce taxes, and avoid the need to comply with the outdated labor code that was developed half a century ago during the Soviet era but is still in force in Ukraine.
As a result, while companies save on taxes, they become completely defenseless in front of the law enforcement agencies. At any time, these businesses can be held liable for violating the law, leaving them unable to register intellectual and other property rights on their product in Ukraine, leaving their employees deprived of any social guarantees.
This means there are two realities when working in the country: “de jure” and “de facto.” According to official statistics, a Ukrainian IT industry worker received an average salary of Hr 12,000 in 2019 (about $444). On the contrary, a survey among the market players on the DOU website reflected completely different figures, recording an average salary of Hr 48,200 (around $1,785), which means that three-quarters of the salary is not being taxed.
The big advantage for Ukraine is that President Volodymyr Zelensky and his team, who came to power in 2019, not only position themselves as supporters of the transition from a natural resource-oriented economy to a knowledge-driven model, but it’s just natural to them. The newly created Ministry of Digital Transformation is made up of mostly IT entrepreneurs in their past.
The ministry has already done a lot of work, by launching the “state in a smartphone” project, which allows citizens to have access to a variety of online government services, and in the future promises a transition to a digital democracy, such as with online elections.
And yet the main brainchild of this new ministry is Diia City, which will allow the Ukrainian economy the chance to benefit from a special legal framework for the IT industry. The foundations of the new legal framework are outlined in the draft law, ‘On Stimulating the Development of the Digital Economy of Ukraine’, also known as Bill 4303. This document has been developed by the Ukrainian government in cooperation with representatives of the IT industry, as well as with members of Verkhovna Rada.
“Diia City” is designed as an exterritorial special legal regime to be operated throughout Ukraine. To apply for a Diia City residence, a company must meet certain criteria: an average salary of at least $1,400, at least nine employees, and the share of income from core IT activities must be more than 90%. For the startups, there is another, more simplified, threshold.
The main advantages that should encourage IT companies to register with Diia City and abandon the shadow economy include:
- Salary taxation would drop from 41.5% to 6.5% with a small social contribution on top, regardless of the salary size. The corporate income tax will also be replaced by a 9% tax on withdrawn capital;
- A Western model of employment will be introduced instead of the outdated labor code;
- Increasing the sanctioning for certain activities of the police, the prosecutor’s office and the tax inspectorate in relation to IT companies regarding exceeding their authority;
- Finally, Bill 4303 guarantees the transition to the European system of intellectual property protection.
It is important to note that participation in Diia City is completely voluntary. If a company considers that working, as usual, is the best option for it, it is their inalienable right.
The optimism towards Diia City is based on this project’s comprehensive approach to solving a broad range of issues. The goal of Diia City is not to create preferences for a single sector of the economy, but to create a functional environment for the development of all high-tech industries. Apart from that, 200,000 employees in this industry will receive fair social guarantees from employers, according to the standards in a civilized society. While now, all these people have quite limited rights at work.
As it often happens in Ukraine, there immediately appeared private alternative bills, 4303-1 and 4303-2, to serve the interests of certain players on the market, rather than create a transparent and competitive ecosystem.
It is important to note that the provisions of the 4303 bill on intellectual property rights, venture capital investment and corporate structuring mechanisms reflect the legal practices of the EU. This is very important for Ukraine, which is at the stage of a comprehensive harmonization of legislation within the EU in the framework of the Association Agreement.
Thanks to the changes outlined in Diia City, Ukraine has every chance to become a comfortable location not only for local IT companies but also for global IT industry players. Foreign companies, especially Western ones that demand high standards of transparency and zero tolerance for corruption, have an opportunity not only to develop their products with the local companies but also to open their own R&D centers in Ukraine.
According to the most conservative estimates, due to the liberalization of the legal framework, the capitalization of the Ukrainian IT-industry may increase more than twofold over the next 5 years.
Although the Diia City project looks like a win-win for everyone, the struggle in Ukraine for its adoption is not over yet. And right now, it is important that the Western allies of Ukraine, such as international financial institutions and global development agencies, US and European Union, will support the Ukrainian government and the Ukrainian IT industry in implementing this initiative to set up a modern IT ecosystem in Ukraine – transparent and attractive for the foreign investors.
