DEFENSE CITY a new legal framework to advance Ukraine’s defense industry

On September 3, the President of Ukraine signed two key bills (No. 13420 and No. 13421) introducing a new legal regime – Defense city.

This regime is designed to stimulate the development of the defense-industrial complex by providing tax, customs, and regulatory incentives to enterprises that are residents of Defense city.

The duration of the Defense city regime is from the date of the first resident's registration in the Defense city registry until January 1, 2036.

In this material, we propose to take a closer look at what this regime entails:

• Who can obtain the status of a Defense city resident (“the Status”)
• Who cannot obtain the Status
• Procedure for acquiring the Status
• Procedure for submitting Reports
• Incentives
• Simplification of certain customs procedures
• Simplified Export
• Facilitation of relocation
• Limited access to information about the Resident
• Monitoring Compliance by Residents with the Requirements of the Defense city legal regime

Who can obtain the Status?

A legal entity registered in Ukraine that has the relevant qualifying income for the previous reporting period, namely:

• not less than 75% of the total income;
• not less than 50% of the total income for aircraft manufacturing entities subject to the provisions of Article 2 of the Law of Ukraine “On the Development of the Aircraft Manufacturing Industry”.

Attention: a legal entity acting as a co-executor (subcontractor) of a state contract includes in its qualified income the revenue from the sale of materials supplied to a resident of Defense city (hereinafter referred to as the "Resident") for the manufacture of defense products under such contract. The participation of the co-executor/subcontractor is confirmed by the state customer.

Who cannot obtain the Status?

A legal entity that meets at least one of the following criteria:

• registered outside Ukraine;
• isn’t a profit tax payer;
• has tax debt and/or overdue payments for the single social contribution, the total amount of which exceeds 10 minimum wages;
• included in the Register of Non-Profit Institutions and Organizations;
• is in the process of liquidation (excluding transformation);
• declared bankrupt or subject to bankruptcy proceedings;
• located in the temporarily occupied territory (TOT) or engaged in activities in the TOT;
• violated legislation on disclosure of beneficial ownership information and/or submitted information about its ownership structure;
• has connections with an aggressor state (states);
• against which or its participants (founders) sanctions or other restrictive measures recognized by Ukraine have been applied;
• related persons subjected to sanctions recognized by Ukraine;
• participants (founders) of the enterprise included in the list of persons involved in terrorist activities;
• on which a violation of contractual obligations has been established in the last 12 months.

More details on who cannot acquire the status of Resident are provided in part 7 of Article 37 of the Law of Ukraine "On Amendments to the Tax Code of Ukraine and Other Laws of Ukraine Regarding Support for Defense Industry Enterprises" (hereinafter – the "Law").

PROCEDURE FOR ACQUIRING STATUS

Application with a statement to the Ministry of Defense of Ukraine (MoD). Requirements for the statement, as well as the documents attached to it, are established by Article 38 of the Law.

Deadline for considering the application: 10 working days from the day of its receipt.

Decision of the MoD on granting the Resident status, and the corresponding entry in the Defense city register.

TERMINATION AND LOSS OF STATUS

• In connection with the expiration of the legal regime term of Defense city.
• Based on a Resident’s application.
• In the event of a decision by the Ministry of Defense of Ukraine to revoke the Status on grounds established by law.

CONTROL OVER RESIDENTS' COMPLIANCE WITH THE REQUIREMENTS OF THE DEFENSE CITY LEGAL REGIME

This control is carried out by the Ministry of Defense through the review of compliance reports and other information to identify any signs that may be the basis for making a decision on the loss of Status.

PROCEDURE FOR SUBMITTING REPORTS

Annually, no later than June 1 of the year following the reporting year. The report is submitted for the period from January 1 to December 31 of the previous calendar year.

Integral attachments to the report are the annual financial statements and the auditor's report. The form, procedure for submission, and review of the report are established by the Cabinet of Ministers of Ukraine.

BENEFITS

(Applied on the condition of absence of Diia City)

1. Exemption from profit tax

Subject to the Resident's compliance with the following requirements:

• Possession of Status.
• Absence of Diia City Status.
• No accrual or payment of dividends is carried out, except in cases where dividends are paid to the state.
• Absence of established facts of violations of tax obligations regarding the submission of reports and/or documents (notifications) provided for by Articles 39 and 39-2 of the Tax Code of Ukraine.

• Profit exempt from taxation is reinvested in:

  • the development of the material and technical base;
  • the acquisition, repair, and re-equipment of fixed assets, including the construction of production and technological facilities;
  • R&D;
  • the acquisition of rights to intellectual property objects for the execution of state contracts for defense procurement;
  • the manufacture of new models of weapons and military equipment or their parts;
  • the acquisition, taking into account the restrictions established by law, of corporate rights (including through the formation of the statutory capital) of business entities of the defense-industrial complex.

Attention: general rules for the payment of profit tax on controlled operations of Residents are provided if they do not meet the 'arm's length' principle. At the same time, there is one exception — if the counterparty is the sole manufacturer, supplier, or executor (including an entity of a natural monopoly), but the obligation to prove such status lies with the taxpayer.

In addition, Residents are not exempt from the general rules on taxation of adjusted profits of controlled foreign companies (CFC). A statement for exemption from income taxation may be submitted by the Resident only once during the period of their holding the Status.

2. Exemption from payment of land tax applies to:

• Plots on which production facilities used in the economic activities of Residents are located;
• Plots that are temporarily not used in the economic activities of Residents during the relocation period and are not transferred for use to third parties.

3. Exemption from property tax applies to:

• Real estate objects located in the territory of the chosen relocation settlement, provided that such real estate objects are not leased, leased out, or loaned (except to the Resident's employees) and are used in the activities of the Resident and/or for the residence of its employees.
• Buildings of industry classified under the code "Industrial and warehouse buildings" (code 125) of the NK 018:2023 Classifier of buildings and structures, which during the relocation period of the Resident are not used for their intended purpose in the Resident's economic activities and are not transferred for use.

SIMPLIFICATION OF SOME CUSTOMS PROCEDURES

• Introduction of the remote conformity assessment mechanism.
• Reduction of the list of information submitted together with the customs declaration.
• Simplification of goods authorization procedures.

SIMPLIFIED EXPORT

It is envisaged that the export of military goods will be carried out without obtaining permissions from the Cabinet of Ministers of Ukraine, as well as obtaining permits or conclusions when carrying out international transfers of goods under international treaties of Ukraine under a simplified document review procedure, which will be defined separately.

RESTRICTED ACCESS TO INFORMATION ABOUT A RESIDENT

During the period of martial law and for one year from the date of its termination or cancellation, the location of the Resident may be considered as the address through which contact with the Resident is ensured, without the mandatory linkage to the actual place of conducting economic activities.

During the period of martial law and for three months after its termination, the Resident has the right not to publish financial statements.

It is provided that access to information about the Resident in public electronic registers is restricted, in particular in the following:

• The Unified State Register of Legal Entities, Individual Entrepreneurs, and Public Organizations
• The State Register of Real Rights to Immovable Property
• The State Land Cadastre
• and other public registries.

FACILITATION OF RELOCATION

To reduce security risks for defense industry capacities, government authorities at all levels are obliged to assist Residents in relocation and in implementing measures to enhance the protection of their production facilities.

4. Exemption from the environmental tax

THE LAW HAS ENTERED INTO FORCE, WHAT’S NEXT

Within one month from the date of entry into force of the Law, and within one month from the date of publication of the Law of Ukraine "On Amendments to the Customs Code of Ukraine regarding support for enterprises of the defense-industrial complex, clarification of the procedure for certain customs procedures, and to Article 3-2 of the Law of Ukraine 'On Certain Issues of Importation into the Customs Territory of Ukraine and the First State Registration of Vehicles' regarding the extension of environmental compliance requirements to certain vehicles" (together - the "Laws"), the Cabinet of Ministers of Ukraine must:

1. Ensure the adoption of regulatory legal acts necessary for the implementation of both laws.
2. Bring their regulatory legal acts into compliance with the laws.
3. Ensure that ministries and other central executive authorities bring their regulatory legal acts into compliance with the laws.
4. Develop and approve the procedure for restricting access to public electronic registries in terms of information about Diia City residents.
5. Ensure the creation and functioning of the Defense city register.

It is implemented temporarily, until January 1, 2036, but no later than the year Ukraine joins the European Union.