How Diia City will affect IT companies and professionals. Review of the final version of the Bill 4303
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How Diia City will affect IT companies and professionals. Review of the final version of the Bill 4303

On July 15, 2021, the Verkhovna Rada of Ukraine voted in favor of the Bill No.4303 on “Stimulating the Development of the Digital Economy in Ukraine.” The DOU editorial board decided to find out how the IT-sphere will function in the new conditions. So we analyzed the bill’s final text together with Serhiy Barbashin, IT attorney and managing partner at TRUSTME Law Firm, and Oleg Chip, the company’s senior lawyer for intellectual property practice.

New laws, such as implementing a legal regime in Diia City, could affect companies, industry, and investments.

As it is known, the explanatory note to bill No.4303 aims to stimulate the development of the digital economy in Ukraine, attract investment, build digital infrastructure and attract talented workers.

Status

The President has not yet signed the bill at the time of writing, so it has not yet entered into force. Only after it is signed by the President and officially published it will acquire the status of a law. Please note that the President has the right to veto laws passed by the Verkhovna Rada of Ukraine and then return them for reconsideration by the Rada. The regulation comes into force the day after its publication.

Specific provisions, such as the activities of service providers related to the circulation of virtual assets as a type of activity stimulated by the legal regime of Diia City, come into force six months after the entry into force of the law. In addition, the Cabinet of Ministers of Ukraine must adopt additional regulations for the operation of the law (instructions, rules), and amendments to the Tax Code are currently being considered for the process of Diia City under Bill No.5376.

About what

The bill declares a “special legal regime” for its participants, who have additional options and conditions for doing business in the IT field. The regime implements several special measures on acquiring a resident, taxation, relations with IT specialists.

New concepts and conditions are introduced, such as a gig-contract, a gig-specialist, the provisions of the NCA (Non-Compete Agreement) are enshrined in law, but a “new regulator” also appears.

We offer to understand these concepts in more detail and get acquainted with some principles of the work of Diia City.

The body that will regulate the activities of residents

The Ministry of Digital Transformation of Ukraine (Ministry of Finance) will be the authorized body responsible for the functioning of the Diia City regime and decides on the acquisition and deprivation of the status of a resident (participant).

Status of the participant (resident) Diia City

The bill declares voluntary acquisition of the status of a participant in the Diia City regime. For this purpose, it is necessary to apply to the authorized body (Ministry of Finance).

The draft does not oblige others to acquire the status of a participant in the relevant legal regime or to comply with its provisions. Accordingly, IT companies may determine whether this model is suitable for their business, whether the company intends to take advantage of alternative opportunities and assume additional responsibilities as a resident of Diia City.

A resident will be considered a legal entity registered in the Register of Diia City. That will allow using of unique opportunities for preferential tax treatment, the conclusion of agreements (gig-contracts), etc.

The law stipulates that only companies (enterprises) registered in Ukraine will acquire the status of a Diia City resident. Individual entrepreneurs will not be able to become participants. Still, individual entrepreneurs are not prohibited from concluding contracts with Diia City residents.

Another question is whether there will be additional complications for the activities of “non-residents of Diia City,” such as extra attention to the operations of private individuals and audits by the tax authorities.

Mandatory criteria for companies that grant the right to acquire resident status:

  • carrying out activities in the field of IT (computer programming, publishing computer games, website management, web portals, testing, software configuration, etc.), which must be specified in the company’s charter and/or in the Unified Register of Legal Entities (i.e., have the relevant classification of economic activities). The complete list of activities is comprehensive and enshrined in Part 4 of Article 5 of the Law;
  • the average monthly salary (fee) of specialists of a resident of Diia City cannot be less than the equivalent of € 1200. Given the wording of the article of the law, “the amount of the average monthly remuneration to employees and gig-specialists … is not less than the equivalent of 1200 euros …”, whether this amount is the average for the company and applies to all positions or only “IT positions” – this question is open;
  • the number of involved IT specialists may not be less than 9 people;
  • the share of revenue (from carrying out activities related to IT) must be at least 90% of the total revenue for the calendar year. An independent audit submitted to the regulator by a resident of Diia City during the reporting period should determine relevant financial indicators.

In addition, there are restrictions for companies that cannot become residents (25% of the share capital belongs to the state, the presence of tax debt, restrictions on some ultimate beneficial owners of non-residents, etc.). The complete list of restrictions is enshrined in Article 2, Part 2 of the Law.

Note that the initial acquisition of resident status is primarily formal. Since Art. 6 of the Law stipulates that the applicant indicates that he meets all the criteria. In turn, the Ministry of Finance should check the information in the registers. Decisions on residency are made within 10 working days without a decision to refuse or return the application within this period.

As a general rule, a resident submits the first “report” within 6 months, which should contain information on compliance with all requirements for residents. Each year, no later than June 1 of the year following the reporting year, submit annual reports. We see a system in which participants in some way “declare” compliance with the criteria and confirm in the established periods of reports.

The issue of losing the status of a resident of Diia City and the consequences: tax, financial, reputational, remains problematic and debatable. In particular:

  • Lack of practice of deciding on deprivation of resident status, for example, due to non-compliance with the Law or improper reporting. We hope that this procedure will be spelled out in more detail in some provisions of the Cabinet of Ministers.
  • Composition, work, and procedure for consideration of complaints by the appeal commission. We pay special attention to Part 5 of Art. 10 of the Law: “If within the period provided for in this part the Appeals Commission has not decided to revoke or change the decision on loss of resident status of Diia City, it is considered that the Appeals Commission has decided to leave the decision on loss of resident status of Diia City.” That is, if the applicant did everything possible and the appeal commission “did not have time” to consider the appeal, the decision remains unchanged. And the responsibility of the appeal committee is not provided by the Law. In our opinion, in case of violation of the terms of the decision, it should be in favor of the applicant, restoring the status of a resident of Diia City.
  • Terms, practice, and procedure of judicial appeal. We consider the abolition of the status of a resident of Diia City in the register to be a problematic issue, even during a court appeal. Exceptions, i.e., when the status of a resident is kept in the register during a court appeal, are given in Part 3 of Art. 11 of the Law, including the simultaneous observance of the following criteria: the presence of resident status for three years, the timeliness of reporting, no change of beneficiaries over the past three years and more. It is probably worth providing for transitional provisions for the first 3-5 years of the Law so that residents have the opportunity to comply with the requirements and not lose their resident status during a court appeal.

Implementation period

According to the draft approved in the second reading, the Diia City regime is implemented for an unlimited period, but not less than 25 years (the first reading draft set a deadline of 15 years) from the date of first registration.

This means that the state guarantees the stability of the conditions of the legal regime of Diia City for the participating company for 25 years, which can be changed only in the direction of mitigation. In addition, it is noted that the conditions and benefits provided by law may not be abolished or replaced by stricter ones.

The question remains how long it will take to harmonize the legislation and whether they will do so at all. Because specific reforms, such as creating a specialized court on intellectual property, which should also “promote investment, development of the sphere, etc.,” have not yet been implemented.

Tax regime

It should be noted that the issue has not been fully resolved, as the parliament registered Bill 5376, “On Amendments to the Tax Code of Ukraine to Stimulate the Development of the Digital Economy in Ukraine,” which was adopted in the first reading to date.

Under the project, Diia City residents will be able to choose a special tax regime, which is as follows:

1. The rate of 9% tax on certain types of transactions (certain types of dividends, interest payments, royalties, return of the founder’s contribution, etc. – a complete list is in paragraph 141.9.2. of the project No.5376);

The draft establishes the entry into force of its provisions from January 1, 2022, and some items from 2024.

An interesting point of the draft amendments to the Tax Code is paragraph 54, which states that “in 2024, income taxpayers – residents of Diia City do not include in the taxable transactions for the purchase of goods, works, and services from the single taxpayer (* including private entrepreneurs on the simplified), during the reporting year, such transactions in an amount not exceeding 50% of the sum of expenses from any activity according to the Statement of financial performance for the previous annual reporting (tax) period.”

The purchase of services from the “simplified” can not exceed 50% of the company’s costs for its financial results. It is unclear why these restrictions will apply in 2024.

2. A rate of 5% (instead of 18%) for personal revenue tax will be deducted from employees’ salaries and/or gig-specialist remuneration and 1.5% military tax.

3. Single social contribution:

  • for employees, it is the amount of the minimum insurance premium, which is calculated in the amount of 22% of the minimum wage (currently is 1320 UAH);
  • for gig specialists, it is 22% of the remuneration under the gig-contract, which must be not less and not more than the minimum and maximum amounts of the single social contributions established by the legislation of Ukraine. The minimum insurance premium is 22% of the minimum wage and currently amounts to UAH 1,320 (22% of UAH 6,000). The maximum is calculated from 15 times the minimum wage and presently amounts to UAH 19,800 (22% of UAH 15 × 6,000).

For example, if the remuneration under the gig contract is UAH 50,000, then the single social contribution will be 22% of this amount – UAH 11,000. If the fee is UAH 150,000, 22% of the single social contribution should be UAH 33,000, but the maximum allowable rate will be UAH 19,800.

Please note that the minimum wage may change during the year, and from 01.12.2021 will be UAH 6,500. Respectively, the fees of the single social contribution will increase.

In our opinion, to increase the attractiveness of gig contracts, the single social contribution rate should be applied for employees, i.e., in the amount of the minimum contribution (22% of the minimum wage). To reach conclusions on taxation issues, it is necessary to wait for the signing of the bill and amendments to the Tax Code.

Forms of cooperation with IT specialists

The central aspect that directly follows the adopted law is determining the forms of cooperation with IT specialists. In particular, the resident can choose one of three ways:

1. Concluding an employment contract with an IT specialist. Such an employee is subject to the general conditions, rights, and obligations provided by labor legislation (the right to leave, working time requirements, compliance with the rules of internal labor regulations, etc., under the Labor Code).

2. Concluding an ordinary contract for the performance of works and/or provision of services. Such agreements are often used by companies and entrepreneurs today. For example, they are service agreements, contracts for software development, design, etc. They are regulated by civil and commercial law.

3. Concluding a gig-contract with an IT specialist. This is a new form of agreement. The law stipulates that a “gig-contract” is a civil contract under which a gig specialist (IT specialist) undertakes to perform work and/or provide services following the tasks of a resident of Diia City as a customer and a resident of Diia City It is necessary to pay them and give the gig-specialist appropriate conditions for the performance of tasks, as well as social guarantees.

The gig contract combines the features of an employment contract and an ordinary civil contract (for the provision of services, contracting, etc.). The fundamental labor rights of the employee are provided, for instance, leave and sick leave, minimum wage, days off, working days, social guarantees, etc. In this case, the gig contract is not an employment contract, and the gig specialist is not considered an employee of the company. In addition, the gig contract can be fixed and “non-employment” conditions: additional remuneration, fines, telework or office work, and so on.

It is possible to prescribe a relationship with a specialist within the gig-contract “as it is,” avoiding the risks of recognizing the relationship as employment or violating the guarantees of the Labor Code. In our opinion, this form of contract is relevant for the IT sector.

Additional agreements between residents and employees (or gig-specialists)

Diia City introduces the ability to sign non-compete agreements (NCAs) and non-disclosure agreements (NDAs) between residents and IT professionals.

Relevant contracts are on the market, and almost every IT professional has signed NDAs and service contracts, often containing regulations and NCAs.

Non-Competition Agreement (NCA)

The draft law stipulates that the NCA is obliged by an IT specialist to refrain from carrying out activities similar to the employer’s actions because it may compete with him in the market.

The definition states that it is forbidden to engage in similar activities. We assume that the interpretation of whether one or another action is identical to another will later be provided by case law or additional provisions to the law. So far, this definition can be interpreted differently. For example, if an IT professional was developing a specific video game for a resident, would he be prohibited from developing video games at all or only, for example, “shooters” for smartphones.

For now, we can only recommend reading the NCA contracts before signing and require that you specify which activities will be subject to restrictions.

The main conditions of the NCA are:

  • the term specified in the contract during which the IT specialist cannot be engaged in similar activity. However, this restriction operates no more than 12 months;
  • states to which the ban applies;
  • specific activities that are prohibited, as well as accompanying prohibitions;
  • monetary reward or other material benefits that the resident provides in retaliation to the IT specialist for refraining from competitive activities.

Thus, for specific compensation, the employer may deprive the IT specialist of the right to work and entrepreneurial activity in a particular field.

Please note that the NCA is voluntary, so signing requires the will of both the resident and the IT specialist.

Despite the introduction of the NCA in the future, there is a risk that such agreements may be declared invalid in court. These reservations are based on the fact that the purpose of such contracts does not fully comply with the provisions of the Constitution, the Commercial Code of Ukraine on equal opportunities in choosing a profession and type of employment, freedom of entrepreneurial activity, which can be prohibited only by law and not by contract.

Non-Disclosure Agreement (NDA)

In practice, the relevant contracts are signed by almost all IT specialists, or their provisions are in the arrangements for the provided services. Now this concept is still enshrined in the bill on Diia City.

The NDA is the responsibility of the IT professional not to disclose trade secrets and/or confidential information of the Diia City resident/employer. The NDA determines the information that is prohibited from revealing, and in case of non-compliance with such prohibition, it may be fined in the amount specified in the contract.

Analyzing the case law, we note that the NDA already operates in Ukraine, the courts rule on the violation of its terms. Therefore, there is nothing significantly new in the approved draft NDA.

In addition to the NCA and the NDA, the non-seizure agreement was planned to be implemented, but the legislators rejected this idea and removed the norm.

Intellectual property

The law implements the Association Agreement between Ukraine and the EU and stipulates that the intellectual property rights to an object created by a gig specialist in connection with the execution of a gig contract belong to a resident of Diia City. The relevant rights are automatically transferred at the time of the creation of the object unless otherwise specified in the contract. Despite the “automatic” transfer of rights, we recommend identifying each employee’s work, outcome, and/or contribution. We wrote more about IT contracts and transfer of rights in the article “What to check in the employment contract before accepting the offer.”

What’s next

Upon entry into force of the law, the government should establish the form, procedure for submitting and reviewing an application for resident status, determine the procedure for forming and maintaining the Diia City register, and develop the structure, strategy for submitting and reviewing the Diia City resident compliance report.

The law provides six months (from the date of entry into force) for the government to adopt the necessary documents to implement the provisions of the law.

Undoubtedly, one can find certain advantages of the bill: declaring the voluntary nature of accession, the provisions of gig-contracts on the combination of labor and civil norms, such as vacation, telecommuting, insurance, fines, different tax regimes, and others.

At the same time, a separate regulator of the sphere is created, some of the norms need to be improved and good application practices, such as acquisition and termination of resident status, reporting, taxation, the validity of NCA agreements, and more.

The question arises why it would not have been started ‘the help” for the sphere step by step:

  • introduce particular types of business taxation;
  • to reduce the tax of wages of employees to reduce the relationship of private individuals;
    introduce gig contracts as a specific type of civil employment contract.

If the President signs the bill and it enters into force, we propose not to stand aside from the process and actively participate in implementing the law’s fundamental tools and applicable provisions that will help the sphere. Because the final look of the Diia City mode will be only after all the tools are implemented to implement the adopted law. Accordingly, only in practice can it be possible to assess the work of the Diia City.

As the bills are pretty voluminous, not all items and provisions have been described in the article. If you have any questions or need to clarify additional conditions, we encourage discussion in the comments.

 

The material is prepared for https://dou.ua.

Link to the article

Authors of the material are:

Serhiy Barbashin – the IT-attorney, managing partner at Trustme Law Firm

Oleg Chip –  the senior intellectual property lawyer