Ukraine - The current status of the foreign investment regime
With a few exceptions, foreign investors can undertake investments on a par with Ukrainian domestic investors. Like in many countries, it is now an almost level playing field. The Law "On Investment Activity," which was adopted in September 1991, established the general principles of investment, irrespective of the nationality of the investor. These relate to the types of investments, the available investment vehicles, and the investment targets.
Certain exceptions are regulated by the Law "On the Regime of Foreign Investment", which was adopted in March 1996. Under this Law, the term "foreign investment" refers to all forms of “… value invested by foreign investors into objects of investment activity for the purpose of obtaining profit or achieving social effect....”Pursuant to this Law, any Ukrainian company will qualify as an "enterprise with foreign investment" if the foreign investments into its charter fund are not less than 10% of the total.
This Law extends certain privileges to "enterprises with foreign investment." These include exemption from paying import VAT and customs duties on in-kind contributions of assets by the foreign investors into an enterprise’s charter fund, with the exception of goods for sale or goods provided for the enterprise’s own consumption. They are also entitled to certain state guarantees. In addition, the Ukrainian legislation provides for the establishment of free economic zones that may grant investors additional benefits and privileges. Nevertheless, foreign investment incentives have been reduced somewhat, for example, since July 1997, all enterprises with foreign investment are taxed on their profits in the same way as other Ukrainian domestic enterprises. This caused a few ruffled feathers when the law was enacted, but, in reality, it is a much more realistic system.
There are also certain general restrictions on investment activities, which apply to both foreign and domestic investors. For example, certain types of business activity may only be pursued by state-owned enterprises, such as defense contracting and military technology. Certain other restrictions apply only to foreign investors and represent legally established thresholds for the maximum permissible percentages of foreign investments in the charter funds of Ukrainian enterprises doing business in a specified limited number of industries. This is a very complex subject, however, and one that requires specific advice.
As far as progress goes, the steps are now becoming logical and progressive. Ukraine inherited Soviet law and, in the early years, the Verkhovna Rada wanted to proclaim independence through the establishment of new ‘Ukrainian’ legislation. With hindsight and experience, many of these laws proven to be not up to the task of a modern nation and, thus, changes are in process. The newer legislation, particularly in the investment sphere, is much more in line with European standards and this now appears to be the trend.
Investment vehicles preferable for foreign investors
That’s a good question. The legislation provides for a large variety of potential investment and business vehicles, all of which can be grouped into two categories: corporate or contractual.
Companies, as a distinct group of corporate enterprises, have proved to be the most convenient and popular form of business legal entities, as they are in most countries. The principal laws governing the establishment, maintenance, and liquidation of business legal entities are the Laws “On Enterprises in Ukraine” (“Enterprise Law”), dated 27 March 1991, and the Law “On Companies” (“Company Law”), dated 19 September 1991.
The limited liability company and the joint stock company have proven to be the most popular and convenient types of companies among investors. As in many western countries, shareholders in joint stock companies and participants in limited liability companies are only liable for their companies’ obligations to the extent of their capital contributions.
Modern “post-Soviet” laws regulating joint stock companies and limited liability companies have yet to be enacted by Ukraine’s Parliament, albeit that draft laws have been circulating for several years. The establishment, operation, and liquidation of companies is somewhat regulated by the new Civil Code of Ukraine, which will enter into force on 1 January 2004; however, modern laws specifically regulating joint stock companies and limited liability companies are urgently needed. In certain regions of Ukraine, local governors are testing certain models that greatly simplify the system; nevertheless this is still at an ”experimental” stage, and it has yet to be incorporated into law.
Investment vehicles in contractual form include; joint activity agreements, joint cooperation agreements, and agreements of a similar nature, all of which are available to both domestic and foreign investors. Such contractual joint ventures, like companies, are required to maintain separate accounting records and to establish separate bank accounts, and are taxed as separate legal entities.
Alternatively, the Law “On Institutes of Mutual Investment (Contractual and Corporate Investment Funds)”, dated 15 March 2001, provides a legal vehicle designed specifically for the purpose of carrying out portfolio investment activity. These investment vehicles may be established in both contractual and corporate forms, with the latter being permitted only in the form of an open joint stock company. In practice, this model of investment fund has yet to be tested in Ukraine.
In addition to the foregoing, foreign investors may choose to carry out marketing, promotional, and liaison activities through a representative office (i.e., a branch) in Ukraine. The relevant Ukrainian corporate tax legislation and foreign currency regulations, as well as the recent administrative and court practice, allow foreign companies to carry out commercial activities in Ukraine through their representative offices, including the execution of contracts, the import and export of goods and services, and other transactions.
The current status of the Ukrainian tax legislation
The tax system is one of the more challenging aspects of doing business in Ukraine; however, recent changes in attitude towards the collection system, coupled with forthcoming positive legislation, are sure to improve the situation. Without getting into the details of the various taxes, it is safe to say that Ukraine’s tax legislation is headed in the right direction from the point of view of the country’s economic growth and the improvement of its investment climate. Generally speaking, the Ukrainian tax system and the types of taxes and duties that may be levied in Ukraine are defined in the Law “On the Taxation System”, dated 25 June1991.
Personal income taxation is principally regulated by the Decree of the Cabinet of Ministers “On the Personal Income Tax”, adopted on 26 December 1992, as amended (“Personal Income Tax Decree”). Moreover, on 1 January 2004, the Law “On the Taxation of Incomes of Physical Persons (Individuals)”, dated 22 May 2003 (the “Income Tax Law”), is scheduled to come into effect. Instead of the current rigid progressive system with a maximum tax rate of 40%, it will introduce a more favorable flat tax rate of 13% as of 1 January 2004, and 15% as of 1 January 2007. This is very similar to the Russian system and will be a great incentive not only to encourage tax payment, but also to assist business development. For the foreign investor, this new legislation makes Ukraine an even more attractive proposition, since the cost / quality ratio of labour is now one of the best in Europe
The Law “On the Taxation of Profits of Enterprises” (“Corporate Profits Tax Law”) of 22 May 1997, as amended, governs the income tax liabilities of corporate taxpayers in Ukraine. On 22 January 2002, amendments of the Corporate Profits Tax Law were officially published and significantly clarified a number of points concerning the taxation of corporate taxpayers in Ukraine, which either had remained unresolved or were subject to ambiguous interpretations by the tax authorities. The good news is that the corporate tax rate of 30% will be reduced to 25% as of 1 January 2004, and this again is an additional incentive for investors.
Finally, there is VAT. The principal law governing Value-Added Tax is the Law “On Value-Added Tax” (“VAT Law”), as amended on 3 April 1997. Under this Law, every legal entity is required to pay VAT of 20%, if that entity: (a) has sold goods or provided works or services subject to VAT within Ukraine; (b) has imported goods into the customs territory of Ukraine; or (c) is the recipient of works or services from a non-resident entity and such works or services are provided for consumption within the country. A 0% tax rate is provided for the export of goods and the provision of services consumed outside Ukraine. Moreover, the Verkhovna Rada is currently considering a new draft law proposing a reduction of VAT to 15% by 2004, with an increase to 17% by 2006.
Overall, Ukraine does not have the most liberal tax laws in the world. Nevertheless, while the recent legislation and proposed tax rates are positive for Ukraine’s economic growth and for improving the investment climate, there is still a great need for a comprehensive Tax Code. The current situation is viewed as an unnecessary complication for foreign investors. Therefore, if I could make one plea to the Ukrainian government, it would be to make the new Tax Code a real priority.
Regulating of land ownership
Land issues in Ukraine are regulated by the Land Code of Ukraine, which entered into effect being on 1 January 2002 ("Land Code"). The Land Code applies to all types of land, and governs the legal relations of Ukrainian and foreign individuals, legal entities, state-owned companies, state and municipal authorities, foreign states, and international organizations in the ownership, use, and disposition of land in Ukraine. Under the Land Code, five types of land rights exist: (a) ownership; (b) perpetual/indefinite use; (c) short-term lease; (d) long-term lease; and (e) servitudes (easements).
The previous version of the Land Code provided only a very limited concept of private land ownership by Ukrainian individuals and collective farms only. The new Land Code expressly states that there are now three types of ownership: private land, municipal land, and state land. Foreign individuals, legal entities, and foreign states are allowed to own, use, and dispose of certain non-agricultural land in Ukraine, but are currently prohibited from owning agricultural land. As the result of a recent amendment, Ukrainian companies with foreign investment are entitled to own non-agricultural land in Ukraine, provided that such Ukrainian companies are constituted as “joint ventures”. Since there is no real clarity as to the intended results of this amendment, serious lobbying efforts by foreign investors are currently underway to rectify this situation.
Regulating of foreign currency
The principal legislation in Ukraine on currency regulation is the Decree of the Cabinet of Ministers “On the System of Currency Regulation and Currency Control”, dated 19 February 1993 (“Currency Decree”). In its implementation of the Currency Decree, the National Bank of Ukraine (“NBU”) has adopted a large number of systems, regulations, and instructions. This Currency Decree was implemented to prevent the wholesale flight of foreign currency in the years of hyperinflation, and has been used since as an effective, albeit cumbersome, control system.
The Currency Decree requires, with certain exceptions, the obtaining of an individual license from the NBU for the use of foreign currency in Ukraine as a means of payment or as an object of pledge. An NBU license is also required for any transfer abroad of foreign currency from Ukraine, subject to an exhaustive list of exemptions provided within the Currency Decree. In addition, the receipt by a Ukrainian resident of a foreign currency loan from a non-resident is, except in certain specified cases, subject to the registration of the loan with the NBU.
A Ukrainian corporate or private resident’s proceeds in foreign currency under an export contract must be received in the resident’s own bank account within 90 days from the date of the customs clearance of the exported goods. Similarly, goods paid for by a Ukrainian corporate or private resident, pursuant to an import contract concluded with a non-resident, must be imported and cleared through Ukrainian customs within 90 days of the resident’s payment. This is an important decree, as many companies get caught up in masses of red tape if goods are delivered and customs cleared outside this time allowance.
On 12 February 2003, the NBU adopted Resolution No. 58 "On the Remittance of Funds in National and Foreign Currency as Payment for Works and Services Rendered by Non-Residents". This Resolution is aimed at restricting the remittance from Ukraine of funds exceeding EURO50,000 as payment for works and/or services rendered by non-residents on "commercially unreasonable" terms. The Services Remittance Resolution does not apply to licensed banking, insurance (reinsurance), transport, and communications services rendered by a non-resident service provider. To a potential foreign investor, this may seem to be a strange law, but it was primarily introduced to curb capital flight though bogus contracting.
The Verkhovna Rada and the NBU have taken numerous measures to combat “money laundering” in Ukraine. However, by and large, Ukraine’s existing foreign currency controls, while understandable due to the need to curb currency flight, serve as a significant impediment not only to direct foreign investments, but also to the normal conduct of international trade and business generally. It is hoped that Ukraine will be able to liberalize its currency controls in the nearest future.
The status of foreign employers in Ukraine
A potential foreign investor entering the Ukrainian market will, at some point, face the need to investigate the Ukrainian labor legislation, so that it will not get lost in the vast array of strict statutory requirements and numerous regulations inherited from the Soviet Era. In addition to the aged 1973 Labour Code of Ukraine, employment relations in Ukraine are governed by the Law “On the Employment of People”, the Law “On Vacations”, the Law “On the Remuneration of Labour”, and other voluminous legislative acts, which regulate separate matters relating to employment.
The applicable labour legislation requires an employer to conclude a collective agreement with its employees. An employee must generally be employed on an indefinite term basis, since employment for only a fixed term of specific duration is permitted in only very limited circumstances. The employer must properly and carefully record and support by all of the appropriate documents any and every decision taken with respect to its employees. Most importantly, the employer must exercise extreme caution whenever it wants to unilaterally dismiss any of its employees.
Foreign investors should note that Ukrainian and foreign citizens working for them in Ukraine are protected under the aegis of the "pro-employee" nature of the labour legislation in Ukraine. The core principle of this legislation is that any employment arrangement between an employer and its employee is unenforceable and null and void, to the extent that it is less favorable for the employee as compared with the provisions of the Ukrainian labour legislation. It is also important to note that the Ukrainian labour legislation does not provide investors with any privileges or exemptions from the general employment rules.
These “alignment of forces” in favor of employees and the statutory burden on the employer may be smoothed with the adoption of a modern Labour Code in Ukraine, drafts of which have been discussed already for a very long time. It is now expected that the Ministry of Labour will submit the most recent draft Labour Code for consideration by the Ukrainian Parliament during the course of September 2003.
The current legislative position for potential investors
Investors should note that the overall legislation of Ukraine was designed for a country in transition from the Soviet command economy to a free market. The older financial control legislation in particular was a product of the state of the nation at the time when it was enacted. Nobody likes paying taxes and, in the relative chaos of the birth, - or should I say rebirth - of the Ukrainian State, drastic methods had to be adopted to prevent the implosion of the system. While criticism can be levelled at the speed of change, we should also understand that, at present, the legislature is passing approximately 300 new laws a year, which is no mean feat. In many cases, necessity has taken priority over fine points of implementation. Today, the entire situation is much calmer and more considered, with the contradictions of the early legislation being substantially reduced. In the past year there have been great strides toward streamlining Ukrainian legislation toward European standards. I can see no reason why this should not continue. It is projected that Ukraine will join the EU in some ten years time. If this is the case, then Ukraine should be one of the few countries of the region, which will have parallel legislation in place prior to its accession.