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IT-Industry: Structuring Challenges in Ukraine
It's a well known fact that Ukraine is a home country of talented software developers. However, foreign companies contemplating to penetrate the Ukrainian IT market, often experience similar difficulties when engaging Ukrainian software developers. As a matter of practice, the software developers normally get engaged through employment and/or private entrepreneur structures. The employment through a Ukrainian subsidiary is a cost-consuming structure for foreign companies, whereas the private entrepreneur vehicle allows cutting down tax expenses both for engaged software developers as well as foreign companies. Below we provide FAQs, normally arising when structuring IT business in Ukraine.
Is there any tax stimulus for IT industry in Ukraine?
Unfortunately, the Ukrainian law sets no tax exemptions for IT industry at the moment. Nonetheless, there are several draft laws intended to boost IT industry growth. The major idea of these law enforcement initiatives is to introduce special preferential tax rules for IT industry players. Under the provisions of these draft laws, the lawmakers intend to reduce corporate income tax for IT companies down to 16% (starting from 1 January 2013), whereas the personal incomes of IT companies’ employees shall be subject to tax at 5%.
What are the tax rates for IT-businesses?
Likewise other taxpayers in Ukraine, the Ukrainian IT companies are subject to general corporate profits tax of 21%. The IT companies engaging software developers as employees are required to withhold 15% or 17% (if salary exceeds certain threshold – currently USD 1,341) from their income. Also, the unified social tax (tax rate varies from 36,76% to 49,7%) applies to IT companies upon distribution of salary, whereas the withholding tax payable by the employees deviates from 2% to 6,1%. Notably, the social tax is limited to a specific level (currently, approx. USD 2,283), therefore the amounts of salary exceeding the mentioned cap will not be taxed.
Are there any specific tax regimes for small-scale companies?
Yes, the companies with small sales turnover may opt to consider a simplified tax system, implying that reduced tax rates will be available for certain categories of entrepreneurs. The Ukrainian Parliament has only recently introduced the new rules for simplified tax system. Therefore, IT businesses face a lot of controversial challenges when putting these into the practice. Without going into details, the Ukrainian law introduced four groups of private business, which may potentially enjoy simplified tax system benefits. The foreign individuals may not choose a simplified tax system, whereas the foreign companies with its Ukrainian subsidiaries may consider a simplified tax system with their Ukrainian partners. In this event, the shareholding of a foreign company within the Ukrainian company may not override 25%.
The law provides that the annual sales turnover relating to such a company may not exceed approx. USD 625,000 and the company should have no more than 50 employees. The tax rates for this category of private businesses vary from 3% (for VAT payers) to 5% (for non-VAT payers). Should however, the company deliver sales greater than USD 625,000 per annum, the tax rates would be slightly higher, ranging from 6% (for VAT payers) to 10% (for non-VAT payers).
Can you describe the most common legal structuring for IT-businesses in Ukraine?
From a practical perspective, the foreign IT businesses act through their trusted private entrepreneurs in Ukraine. In this case, the private entrepreneur arranges the necessary search and engagement of software developers (being individuals or private entrepreneurs). In its turn, the foreign companies arrange relevant financing of the software developers through the trusted private entrepreneurs. This approach allows significantly reduce the tax cost of legal presence in Ukraine. Particularly, the private entrepreneurs pay taxes at a flat rate of 3 % (for VAT payers) to 5% (for non-VAT payers).
Depending on the form of legal structuring with software developers (i.e. employment or contract facilities), the private entrepreneur might be liable for a social tax. In case of employment of software developers, the private entrepreneur should accrue and withhold the social contribution and personal income tax similar to the rules described above (rules applicable to regular salary distribution). However, as regards his personal incomes, the private entrepreneur may chose to pay either a minimal social contribution tax (currently USD 134) or provide a payment from the cap as described above (USD 2,283). In case the software developers are engaged as contractors (and registered as private entrepreneurs), the private entrepreneur will not be liable to withhold relevant taxes, as long as such a contractor has properly paid its taxes and provides services, specifically indicated in its registration certificate.
What are the key risks for foreign IT business in Ukraine?
Considering from our experience, the described options of business structuring bear certain practical risks. Particularly, the engagement of the private entrepreneurs through a service agreement may be requalified by the local tax authorities as employment relations under certain circumstances. In this event, the corporate image of the foreign IT-company may be triggered, as well as the private entrepreneur might forfeit its preferential tax status. Moreover, the private entrepreneur may be exposed to additional assessment of tax liabilities (personal income tax, social related charges) and penalties.
Can you advise on the proper way of structuring IT-business in Ukraine?
Every business case is unique and there is no one-way solution for each situation. Ukraine is a rather challenging business environment and special attention should be given to taxes. Therefore, with the view to the described curtailments and risks, the engagement of software developers through a Ukrainian subsidiary might be also considered as a viable scenario. It's especially beneficial, given the contemplated introduction of tax preferences for IT industry companies and their employees.