Investing in Ukraine: overview of key instruments and considerations
The investors operating in Ukraine are confronted with a range of formidable obstacles. These can be broadly divided into two types: those that require immediate attention as part of daily business operations, and those related to the post-war reconstruction phase, which pose significant challenges, especially in the context of long-term project engagement.
Nevertheless, in order to encourage more direct investment, Ukraine has introduced specific investment regimes, such as state incentives for industrial parks and a special legal regime called “Diia City”. Alongside these comprehensive investment support programs, Ukraine also offers various investment incentives for priority sectors of the economy. Some of them were introduced before the war, and some after.
In IT sector, the Law of Ukraine “On Stimulating the Development of the Digital Economy in Ukraine” introduced the concept of a virtual economic zone known as Diia.City.
The “Diia.City” virtual economic zone offers various incentives to its residents, including a special corporate income tax regime where they can choose to pay a 9% withdrawal capital tax instead of the 18% corporate income tax applicable to all. Residents are also eligible for a 0% tax on dividends accrued by a resident company, provided that they are paid once in a 2-year term. The zone also provides tax rebates on investments in Ukrainian start-ups and allows for a new form of cooperation between residents and IT specialists via “gig-contracts,” where specialists pay a 5% personal income tax and can include provisions such as non-disclosure obligations, non-competition, and remuneration in foreign currency. Diia.City also provides venture investment tools such as the right to increase the charter capital of a limited liability company via convertible loans mechanism, mechanisms of the employee stock ownership plan, warranties, indemnities regulations, liquidated damages provisions, etc.
In the field of industrial parks there is the Law of Ukraine “On Industrial Parks” and associated regulations that provide a range of measures to support the development of industrial parks in Ukraine. The legislation outlines requirements for initiating, managing, and operating industrial parks. There are several incentives available to managing companies, initiators, and participants of industrial parks. Among them are compensation for interest rates on loans used for establishing or conducting economic activities within the park, non-refundable financing for the park’s development and related infrastructure, a 10-year corporate income tax exemption if the money is reinvested, VAT exemption on the importing of equipment for park participants, favourable land tax rates, etc. State incentives are available to processing industries, waste recycling, R&D, IT, and telecommunications activities. However, the park cannot engage in certain economic activities such as producing excise goods, organizing lotteries, gambling, mediating in employment abroad, industrial catch of aquatic bioresources outside Ukraine’s jurisdiction, and household waste disposal.
The examples of practical implementation of industrial parks are following. In Zakarpattia, industrial parks are now registered in Solomonov (auto industry) and Solotvyno (the Maramuresh park – wood and furniture industry). Also, in Kamiansky the industrial park plans to deal with logistics and processing of agricultural products and it is already in the final stage of creation. In Uzhgorod, an industrial park is in the final stage of creation. It will produce building materials and industrial housing with perlite heaters.
In agricultural and agri-processing sectors Ukraine has established a state program known as “Affordable Loans 5-7-9%”. The program is valid for five years and offers partial interest rate compensation for loans for agricultural producers. Its objectives include promoting entrepreneurship, business development, increased production, export and import substitution, energy efficiency, innovation, job creation, and encouraging labor migrants to return to Ukraine.
Additionally, the program offers debt refinancing for business entities (excluding large ones).
A famous large-scale initiative to attract investment to Ukraine was envisaged by the Law of Ukraine “On State Support for Investment Projects with Significant Investments” or simply so-called “investment nannies”, which has been adopted in January 2021. The idea was to provide investors with tax and customs privileges to encourage them to invest significant funds in Ukraine. Namely, the minimum amount of investment should exceed the hryvnia equivalent of 20 million euros at the NBU exchange rate.
In order to receive state preferences, a project has to meet certain criteria. Firstly, it must be implemented in the areas of processing industry, mining, waste management, transport, warehousing, postal and courier activities, logistics, education, scientific and technical activities, healthcare, art, culture, sports, tourism and resort and recreational activities (some of the above areas have their exceptions). Secondly, the investment project must provide for the construction, modernisation, technical and/or technological upgrading of the investment object. Thirdly, the project must create sufficient number of jobs for people, namely not less than 80, and the average salary of the employees must be at least 15% higher than the average salary for this type of activity in the region. And, lastly, the project implementation period should not exceed 5 years.
It’s been more than 2 years since the “investment nannies” initiative was introduced, but it has not achieved any success yet. The beginning of the war may be an explanation for this. For example, 3 out of 5 applicants were submitted to the Ministry of Economy in late 2021, and the process has stalled because of the war. Currently, companies are updating calculations and waiting for the end of the active phase of the war, explained Zheleznyak. Also, he said that two applications were received during the war, namely, in late December 2022 – early January 2023, from ski resorts Bukovel LLC and Slavsky LLC.
Although it is too early to predict the activity of “investment nannies”, the benefit of using this tool for the post-war reconstruction and development of Ukraine is obvious. Of course, in order to gain the trust of business in this mechanism, it is necessary to set up comprehensive and transparent legal by-laws and practices, as well as to rectify the existing deficiencies and inconsistencies in law.
There also several areas that apparently need some improvement to enhance post-war investment attractiveness.
First of all, it seems to be crucial to increase transparency in public procurement. Businesses need to know that public procurement processes are fair, and that they comply with international best practices. It entails further increase of transparency, prohibition of discriminatory tenders’ terms, and enhancement of appeal mechanism. Businesses need to feel that they have recourse if they believe that a public procurement process is unfair or biased. Without the aforesaid it will be hard to involve big international companies into the reconstruction tenders held by Ukrainian state institutions or state or municipally owned companies.
Proper balance should be sought between time-efficient procurement and securing a right to appeal. For instance, on 19 October 2022 resolution No. 1178 of the Cabinet of Ministers of Ukraine dated 12 October 2022[1] determining the peculiarities of public procurement during the martial law in Ukraine (“Peculiarities”) entered into force. The Peculiarities, in addition to certain simplifications in the procurement process, also established shortened procurement terms. For instance, in open tenders with peculiarities, almost all terms are shorter than in open tenders in accordance with the Law of Ukraine “On Public Procurement”. On the other hand, the Peculiarities limited a right to appeal against decisions of a tender committee. Although acceleration of the public procurements during martial law is important, respective procedures should be reconsidered after the end of the war.
Another thing worth paying attention to is improving public-private partnerships. The government should ensure that public-private partnerships are structured in a way that is beneficial to both sides. This will help to build trust and confidence among businesses and increase the attractiveness of investment opportunities in the country. First of all, it looks reasonable that a private partner should retain a title to a newly established or reconstructed object by the end of the partnership agreement, and the law should be changed to allow this.
In additional to the above, certain general rules applicable to private investors shouldn’t be forgotten.
Investors looking to invest in Ukraine need to consider several important factors to ensure proper investment structuring and protection. First of all, in order to smoothly complete a planned transaction, it is crucial to conduct investment due diligence. Quite many Ukrainian businesses have historical risks, which should be cured pre-closing or otherwise addressed in the transaction documents.
Another sensitive area is establishing joint ventures, as it often turns out that business practices and expectation of partners may differ. Proper regulation of legal relations between partners is essential for any investor. This includes having well-elaborated legal documentation in place, such as a Shareholders’ Agreement (SHA), options mechanisms, security tools (UBO surety and other, etc., as well as business plans and other operational documents. Apart from SHA and other transactional documentation, it’s also important for investors to have proper operational control over their investment and the company’s activity. This can include appointing one of the directors / board members to oversee the investment, having access to bank accounts and financial records etc. Having operational control helps investors to stay informed about how their investment is performing and to ensure that it is being managed in accordance with their wishes.
Last but not the least, the choice of a right jurisdiction is of great importance in terms of risk mitigation while investing in Ukraine. Many investors choose to use a holding company registered in a foreign jurisdiction for the purposes of investment protection. Foreign jurisdictions have a range of international conventions in place to safeguard investments, and the provisions of these conventions can be invoked if the state violates the investor’s rights. The Washington Convention on the Settlement of Investment Disputes provides an opportunity to apply to the International Center for Settlement of Investment Disputes in the event if investor is deprived of its investment either by a respective state directly or due to the state’s gross negligence or investor does not enjoy other benefits under the respective treaty.
And finally, eventual reformation of the judiciary system, efficient corruption elimination, prevention of abusive practices of state authorities against business, and predictable governmental policy and stable legal environment is a key pre-requisite for success in attracting investments into Ukraine.
[1] Resolution No. 1178 of the Cabinet of Ministers of Ukraine dated 12 October 2022 “Peculiarities of public procurement of goods, works and services for customers under the Law of Ukraine “On Public Procurement” during the martial law in Ukraine and within 90 days from the date of its termination or cancellation” https://zakon.rada.gov.ua/laws/show/1178-2022-%D0%BF#n16
Sergiy Benedusiuk, Partner at LCF, for zn.ua
