Diia City is likely to arrive this year. On 15 July, the Parliament passed bill 4303 which establishes a special legal framework for the IT industry. Although the President has yet to sign the law, and the Parliament – to amend the Tax Code, I’m sure the new regime is just around the corner.
Diia City has potent PR and the President’s support on its side. For the first time, the powers that be are determined to streamline the IT sector and gain more control over it. For the first time, they’ve engaged the IT community in an open and fair dialogue, actually heeding their comments – albeit not all of them.
So what does the new legislation has to offer to Ukrainian IT entrepreneurs? What are gig contracts for and what will they change? How to work with sole professorships now? Also, what about migration issues, taxation, risks and benefits of Diia City? Let’s tackle the big question – should you join or not?
What has changed compared to the law’s previous versions
The bill on Diia City passed by the Parliament differs from the previous versions, which have been so widely discussed. To bring you up to date, let’s take a quick look at the key changes.
1. The law’s “guarantee period” has been extended. Diia City is being introduced for an unlimited period, in any case for at least 25 years after the appearance of the first resident. What this means is, the state guarantees that the rules of the game aren’t going to change during this time. Or, more precisely, there might be changes, but only changes that are convenient for business (to be fair, the law doesn’t specify how to gauge the level of convenience for business).
Of course, considering that each new government in our country tends to ignore the undertakings started by their predecessors, which is why none of the reforms have been completed, there are certain doubts as to the feasibility of that promise. But – time will tell.
2. Forcing people to join Diia City is prohibited. The law has a separate provision that expressly prohibits coercing legal entities into becoming residents of Diia City, either directly or indirectly.
3. Now there are clear conditions for joining and leaving Diia City.
Conditions for obtaining the status of a Diia City resident:
– the company must meet the requirements established by the law on Diia City.
– the company must submit an application to the authorized body.
The conditions for losing the Diia City resident’s status have also been defined, including the tax implications of appealing such a decision.
4. Another way added for appealing decisions on resident’s expulsion from Diia City.
There used to be only one way to do this – through court. Now there’s also the administrative option: a resident company that has been expelled can fight this by turning to an appeals commission of the Ministry of Digital Transformation.
Thus, the commission will include employees of the same ministry that made the decision to expel. It will also have representatives of the public (50%), but it’s unclear what sort of public.
The law does not provide a procedure for establishing this commission, or the rules for its work and decision making, and such omissions can lead to all sorts of machinations and abuse. We can only hope it won’t come to that.
5. There’s no longer a requirement for Diia City residents to form a self-regulating organization.
Previous versions even had membership fees of $14 to $21 in these organizations for each employee or gig worker. A lot about how it would work and why it was even needed was also unclear.
Now it’s simply stated that such organizations may exist, but joining them is not mandatory.
6. Average monthly salary/remuneration for each employee/gig worker changed from $1,400 to €1,200.
It’s calculated by dividing the amount of all payments to employees and gig workers in the corresponding calendar month by the number of employees and gig workers who received these payments.
7. Easing requirements for startups.
For one, they are no longer required to present a business plan before they can join Diia City. Secondly, they don’t need to have an audit firm’s report confirming the accuracy of information they submitted to join Diia City (like other residents). However, the audit report will still be required if the authorized body spots discrepancies between the provided information and the actual state of affairs. The law fails to specify what discrepancies these could be exactly.
These aren’t all of the changes. See more on that below.
What about sole proprietorships?
In the previous versions of the Diia City law, it was assumed that Diia City residents wouldn’t be able to work with sole proprietors. It was, however, changed following an outcry of the IT community, so now it is possible, albeit under certain conditions:
Until 31 December 2023 — Diia City residents can work with sole proprietorships without restrictions.
After 1 January 2024 — the amount of payments to sole proprietorships free of taxes may not exceed 50% of the company’s total expenses. Anything more than that is subject to the tax on withdrawn capital in the amount of 9%.
After 1 January 2025 — the threshold of payments to sole proprietorships free of the tax on withdrawn capital will be reduced from 50% to 20%.
This means that Diia City residents will have to rely more and more on hired employees and gig workers.
Gig workers – what’s that and what’s it for?
Gig work is a new form of employment for our country, introduced specifically for the IT industry.
We used to have:
● employees working under the Labor Code,
● sole proprietorships running their own businesses.
Now there are also:
● gig workers (or gig contractors) that will be working with Diia City residents on the basis of a gig contract (they are neither employees nor sole proprietors).
The Parliament’s Main Legal Department in its comments on the bill on promoting the development of digital economy in Ukraine called gig contracts a “legal Frankenstein”. Very aptly, if you ask me.
By creating this somewhat artificial device, the authors of the Diia City bill, on one hand, chose to provide sole proprietors that are essentially employees with some degree of social security, while on the other hand, this way the government is trying to mitigate the effects the Labor Code’s inability to satisfy the needs of business.
But did they succeed? Let’s try to figure it out.
How gig contracts are going to change the life of IT workers
Right now it’s almost as if someone’s been trying to hide from us any changes for the better that the introduction of gig contracts is going to bring. Thus, under the new law, Diia City residents:
– can’t fire a female gig contractor while she’s on maternity leave (but not until the child reaches the age of 3, as it is for employees),
– must provide gig workers with social insurance in connection with temporary disability – i.e. sick leave, in accordance with the Law of Ukraine “On Compulsory State Social Insurance”.
At the same time, they:
– can terminate the contract with a gig worker if he/she has been unable to work for more than a month,
– can introduce irregular working hours for gig workers (as is already the case with sole proprietors these days),
– can terminate a gig contract without giving any reason, provided that the gig worker is notified of this 30 days in advance,
– have the right to monitor the gig worker’s performance using video surveillance.
Gig workers are also fully liable for any damage to the property of a Diia City resident – unlike employees, who, in a situation like this, only risk their average monthly salary.
As we can see, a gig contract does not expand a gig worker’s rights all that much compared to sole proprietorships, and next to a full employee this status does not seem attractive at all. All it does is add extra hassle.
Picture this: a company manager at your place of work announces once day, “From now on you all work under gig contracts – we are joining Diia City!”, while you are registered as a sole proprietor, which your company is no longer going to service – so what do you do then? You’d have to hire your own accountant, submit tax reports … No, it’s easier to just shut it down.
So you take the time to close your sole proprietorship, only to get a job offer a year later from a company that’s not a Diia City resident which asks you to open a sole proprietorship. Or, you have enough downtime to take on some projects for another company, one that’s not a resident of Diia City – but you’ve already closed your sole proprietorship. So, do you go and open it again?
This shows that the proposed gig contract system not just fails to make life simpler for the IT crowd, but makes it even harder.
Benefits of gig contracts for Diia City resident companies
For IT companies, the main advantage of working with gig contractors is not having to adhere to all the requirements stipulated by the Labor Code.
This is indeed very important for many businesses, since our country’s labor legislation simply fails to reflect the actual needs of business and entrepreneurs – it even lacks the very concept of “entrepreneurship”. Not that it’s a huge surprise that the requirements for social protection of workers in a totalitarian state with a command economy were quite different from those needed for the development of the high-tech IT market of today.
At the same time, gig workers have to contend with a greater tax burden than employees. Why then would you want to sign a gig contract?
For IT companies that like to bring in foreign workers, employment through gig contracts can make the process of legalizing their stay in Ukraine easier and cheaper than it normally is.
Previously, a foreign national had to obtain a work permit and only then – a residence permit. Now a gig contractor can get a 1-year residence permit even without a work permit.
At the same time, gig workers are still able to make use of the regular legalization procedure and get a work permit, which then makes the residence permit valid for 3 years.
I think we’ve been slightly fooled
When joining Diia City, the company has to meet certain eligibility criteria. First it is checked against state registers. Then, after 6 months, the company has to submit an independent auditor’s report (and subsequently re-submit it annually) confirming that it meets the criteria for Diia City residency.
Hardly a problem – at first sight. It’s not like you’re being asked to conduct a full audit, right? And yet, under Ukraine’s legislation on audits, you can only get the report you need after a full audit of your business activities!
This means that six months after joining Diia City, resident companies are expected to tell the government everything: under what contracts they work, how and how much money they are making, who their clients are, how much they are spending and on what, etc.
The government does not bring it up publicly, or even claims that nothing like that will be required. However, an auditing firm simply can’t give you a report other than that which follows a full and exhaustive audit.
I think this is very dangerous detail. After all, who knows where your information is going to end up? No one is going to guarantee that after another change of government, some department won’t start harassing you for bribes. Or, even under the current government, how can you be sure that some public servant won’t pass on your most intimate data to your competitors or even criminals?
In a civilized country, I’d have no issues with this. In Ukraine, however, getting a report like this is a very risky step.
Taxes in Diia City
As was mentioned above, Tax Code amendments have not been adopted yet, but it’s already known how they are going to affect Diia City.
Diia City residents will be able to pick which tax to pay: 9% on withdrawn capital or 18% income tax. Moreover, companies will be able to choose the taxation system right away when joining Diia City, so there’s no need to visit the Tax Office twice. This is a definite plus.
As for employment taxes for Diia City, they are going to look as follows:
1. For employees:
– 5% personal income tax (instead of 18%),
– 1.5% military tax,
– minimum single social tax – as of July 2021 this is UAH 1,320 (instead of 22% on the entire amount of wages and other payments).
2. For gig workers:
– 5% personal income tax,
– 1.5% military tax,
– 22% single social tax on the entire amount of remuneration (no lower than the minimum or greater than the maximum single social tax rate).
Thus, for an employee of a Diia City resident with a salary of UAH 100 thousand, the company’s tax expenses will be:
UAH 7,820 (5% personal income tax + 1.5% military tax + minimum single social tax).
If it’s a gig worker with the same salary of UAH 100 thousand, then the company’s tax expenses will be:
UAH 26,300 (5% personal income tax + 1.5% military tax + 22% single social tax on 15 minimum wages – that is, on UAH 90,000) – calculation based on the official text of the law.
Once again I’m struggling to come up with any reason for an IT company to pick a gig worker over of an employee. Who in their right mind would want to pay significantly more taxes for a gig worker if they can simply have them as an employee?
Diia City – is it a voluntary or compulsory thing?
Government officials keep stating that Diia City is a voluntary alternative, not a replacement for existing frameworks.
However, despite all the promises, few still believe that the state won’t be in any way forcing people to join Diia City.
Indeed, even before Diia City, representatives of the Servants of the People faction registered a bill that concerns hidden labor relations, causing some tension in IT circles. What if this law was conceived specially for those who decides not to join? Furthermore, even though the faction’s head publicly promised to withdraw the bill more than a month ago, so far it hasn’t been done.
In addition, those who’ve studied the bill on hidden labor relations carefully noticed that work under a gig contract (as described in the law on Diia City) matches such relations on three counts! How is this even possible, especially given the fact that both bills were developed by the Servants of the People faction?
So should you join Diia City or not?
Depends on who’s asking.
Diia City for large IT companies
If we’re talking about large IT companies (with more than 1,000 employees), a lot of them will find this an interesting opportunity. After all, say want you want about the sole proprietorship framework (that it’s legal and breaks no laws), it’s still in the gray area, and it’s getting increasingly more difficult for the big market players to hide behind it.
At the same time, if they make all sole proprietorships employees just like that, their profits will plummet. Taxes will go up from 5% to 42%, and for IT companies, remuneration is about 80% of their total budgets.
The elephant in the room is, large IT companies today live in constant fear of inspections and fines by the Tax and the State Labor Service. They have long been waiting for certainty and peace of mind, and that’s something that Diia City can give them.
Diia City for small and midsize business
On the other hand, midsize and small IT businesses (with less than 1,000 employees) do have something to worry about. There’s still a high probability that the government will try to strongarm them into joining Diia City.
For these companies, the transition will mean more taxes – which they probably won’t be able to handle – and no silver lining.
However, if joining Diia City is indeed going be a voluntary thing, they will have some room for maneuver: work as usual (sole proprietorships, unregistered employees, freelance, etc.), or choose the safer and more profitable option of a coworking space.
With this way of conducting joint business (one person creates a coworking space while others rent spaces from him as sole proprietors):
– the State Labor Service will not take issue with you on account of hidden labor relations,
– tax authorities will not be able to accuse you of tax evasion.
And although reorganizing a company into a coworking space will require certain resources, currently this is by far the most profitable course of action for IT SMB in Ukraine. It will allow you to continue working without having to pay more taxes and suffering never-ending inspections.
For Diia City and the state
If Diia City is indeed an honest attempt by the government to regulate relations with the IT community, to build mutually beneficial and transparent cooperation, then it’s probably a good idea. However, many are skeptical about it, and with good reason, as you can see for yourself.If you would like to consult a lawyer to weigh all the risks of the new framework for your company, don’t hesitate to contact us here.