Diia City During the Wartime

Tetiana Yashchenko, PhD, partner at Expatpro, analysed the legal regime of Diia City in the present-day reality

The legal regime of Diia City is an experiment to an extent. The rules that should be applied to Diia City residents are uncommon for the vast majority of businesses in Ukraine. Moreover, it would be quite helpful to see how well the requirement to apply the exit capital tax in Ukraine works, as it has been considered for many years to be an alternative to the corporate income tax in Ukraine. The experiment is being conducted under rather extreme conditions, which will undoubtedly affect the outcome.

Diia City 2022 in Figures

The Diia City data system was launched on 08 February 2022. The first residents were registered on 15 February. By the end of 2022, the number of registered businesses had already reached 428. This means that the absolute majority of registrations happened during the period of martial law in Ukraine.

Decisions on the acquisition and loss of the Diia City resident status are public and posted on the official website. No explanations on the decision (motivational part) are publicly disclosed.

Notably, the Desnianskyi District State Tax Inspectorate of the Head Office of the State Fiscal Service in Kyiv city was denied the residency status of Diia City.

Selection Criteria and Control

The Law of Ukraine “On Stimulating the Development of the Digital Economy in Ukraine” clearly defines the resident’s obligation to meet the criteria applicable to residents throughout the entire period. The only exception is non-compliance with the criteria (namely, the requirements for the average number of employees and gig workers, the amount of average monthly remuneration to employees and gig workers) for newly established business entities (registered less than 24 calendar months prior to applying for residency status with income not exceeding the income limit for Group 3 of the simplified taxation system). They have a conditional “grace” period to meet the following criteria: the calendar year in which the resident status was obtained and the following calendar year. The applicant must indicate that special conditions apply to them in the application for status (a start-up mark is required).

Residents are required to submit their first reports no later than 6 calendar months after the date of obtaining resident status. These are compliance reports or an audit report, depending on the grounds for obtaining resident status. In the event of discrepancies between the initial data and the information provided in the report, an independent opinion may be demanded.

Residents have to file an annual report (by 1 June) for the previous calendar year (annual compliance report), which must be accompanied by an independent auditor’s opinion.

Since the regime is new, the control over compliance with the rules and achievement of compliance criteria is rather lenient and essentially allows for a “margin for error”. Violation of the reporting deadlines is not an unconditional basis for a decision to lose the status, although repeated violations will result in a negative decision.

The operating conditions during martial law tend to provide for the possibility to refer to force majeure to justify the non-application of penalties or sanctions. It is essential, though, to confirm the impact of such conditions on the impossibility of timely (or full) fulfilment of obligations, similar to the position of the Ukrainian tax authorities. No specific notifications or decisions have been made on this issue.

Loss of Diia City Resident Status

The main reason for losing the resident status is non-compliance with the requirements. At the same time, the wording of the Law suggests that the administrative procedure creates opportunities for a resident to eliminate “minor discrepancies” (such as repayment of tax debt, bringing the ownership structure into compliance) without actually losing the status.

So far, there have been a few decisions on the loss of Diia City resident status. Although, based on the analysis of the decisions, such processes were initiated by the applicants themselves (decisions were made based on their applications). The Ministry of Digital Transformation has not yet issued any decisions on the loss of Diia City resident status due to non-compliance with the criteria.

No statistics on the performance of Diia City have been publicly released, and the first more or less complete annual reports with auditors’ opinions are due by 01 June 2023. They are likely to serve as performance indicators.

The war in Ukraine had an impact on the functioning of this regime, as some investors suspended their activities and postponed the launch of new projects in Ukraine. Therefore, 2022 can hardly be considered the “ideal” year for conducting such an experiment and for an objective assessment of its results.

To summarise, the IT industry has so far proved to be one of the most resilient in Ukraine during the war, and the data from the Register also confirms this. We are expecting the Ministry of Digital Transformation to consider the annual reports and the decisions that will be made based on the results of the annual reporting.