Defence City offers advantages to defense industry enterprises but requires more flexible access conditions - expert

The special legal regime of Defence City opens up a number of significant advantages for enterprises of the defense-industrial complex, but in its current form, it is not a universal solution for all market players. Bohdan Dolintse, an economist and aviation expert, manager of the aviation sector, told UNN about this in a comment.

Defence City or Diia.City

According to the expert, one of the key features is that a defense industry enterprise cannot actually be simultaneously in two special regimes. This refers to Diia.City and Defence City.

"This special regime – Defence City – in principle, provides many significant advantages for enterprises of the defense-industrial complex. But some companies still do not consider it for transition due to the fact that it does not allow a company to actually be in both regimes, that is, in the Diia.City and Defence City regimes. Therefore, each company proceeds from its priorities and makes a decision regarding one or another regime," Dolintse explained.

In addition to tax and customs incentives, Defence City provides for the possibility of restricting access to information about the enterprise in public registers. This, according to Dolintse, on the one hand, increases the security of manufacturers in wartime conditions, making them less visible to the enemy. But on the other hand, it creates risks of potential use of the special regime by companies that are not directly related to the security and defense sector.

According to the expert, there are already companies that have evaluated Defence City and decided to remain in other tax regimes. "Therefore, it is probably impossible to say that the Defence City regime directly affects the company's ability to produce or develop these or other products. That is, companies in different regimes can carry out this activity, firstly. Secondly, this will only affect incentives, and in some cases, there is a possibility that the Defence City regime may even be less favorable for the company's development than other regimes," he explained.

Lack of incentives for production localization

Dolintse added that currently, Defence City lacks some tools that could make it truly attractive for scaling up production.

"When we talk about the Defence City regime, it is necessary to understand that, unfortunately, many stimulating tools that could make this regime truly very attractive for defense enterprises are not yet provided for in it. Perhaps they will appear in the future. This is primarily related, for example, to certain tools for stimulating defense enterprises," the expert noted.

In particular, this refers to tax incentives for the import of components and equipment for weapons and machinery used by the Armed Forces of Ukraine. Currently, according to Dolintse, VAT is not applied to imported components for defense equipment, while a Ukrainian manufacturer that produces similar components domestically is forced to include this tax in the cost of its products.

"This, in fact, makes conditions for Ukrainian manufacturers less attractive than, for example, when they buy these components outside of Ukraine. This does not stimulate the development or localization of certain technologies and components," Dolintse believes. 

Formal barriers for potential residents

The aviation expert notes that Defence City is a new initiative that is not yet perfectly configured. In his opinion, the legislator should take into account the realities of the Ukrainian market and adapt the criteria for enterprises' access to this special regime.

For example, changes are needed in the part of the norm regarding the absence of criminal proceedings in which a potential resident is involved.

"If we talk about the transparency of access, it is necessary to understand that despite the additional means or regimes and incentives offered by Defence City, they must also take into account the relevant realities, including those of the manufacturers themselves. For example, if a company does not have confirmed violations by a court, it would be logical not to take into account any suspicions or even proceedings that have not been proven or closed when making decisions or reviewing documents. But here the question is more for the legislator, how the conditions of the regime were defined, and perhaps it would be worth reviewing them," Dolintse noted.

What needs to be changed

According to Bohdan Dolintse, for Defence City to become a real driver of the development of defense and aviation technologies, it is necessary, in particular, to expand tax incentives for production localization.

In addition, fiscal barriers for the purchase of production and research equipment should be reduced. "Perhaps, either abolish VAT on such equipment and duties altogether, or significantly postpone the period when they actually have to pay for them. This would allow the released funds to be invested in the development of new products, first of all, and not in the payment of certain duties," the expert believes.

It is also necessary to review the criteria for admitting potential residents, in particular regarding the automatic consideration of open criminal proceedings in which the enterprise is involved.

According to the expert, it is also worth ensuring a balance between the security and transparency of the regime.

"When we talk about the Defence City regime, we must understand that it is primarily about stimulating companies in the defense industry sector to develop their products, firstly, and secondly, it is actually about strengthening the country's Security and Defense Forces. This means that it would be worth providing or expanding in the relevant regime precisely those components that lead to such stimulation," Dolintse noted.

Thus, Defence City remains a promising, but not yet fully developed tool. Further adaptation of its conditions to market realities can determine whether the special regime will indeed become a systemic mechanism for scaling the Ukrainian defense-industrial complex in wartime conditions.

Recall

The special regime Defence City has started operating in Ukraine. This is an element of systemic state policy in the field of security and defense. This legal regime is intended to create favorable conditions for scaling up defense production, attracting investments, and developing the Ukrainian defense industry. 

Defence City residents receive a complex of economic and operational incentives that should reduce the fiscal burden and accelerate production development. This includes exemption from corporate income tax, provided that defense industry enterprises reinvest funds in their development, as well as exemption from land, property, and environmental taxes.

In addition, simplified customs procedures will apply to residents; special guarantees for the protection of information and confidentiality of enterprise data during the regime; state support for relocation and increased security of production facilities if necessary.

An enterprise can obtain the status of a Defence City resident if the legal entity meets the requirements for the share of qualified income (income from the sale of self-produced defense goods or the performance of work and/or provision of services related to defense goods) for the previous calendar year, and there are no circumstances for disqualification of such a person.

The share of qualified income must be at least 75% of the legal entity's total income (with exceptions) and at least 50% of the total income for aircraft manufacturing entities.

A company registered under the laws of a foreign state or that has violated the requirements for disclosing information about the ownership structure or ultimate beneficiaries cannot be a resident.

An enterprise cannot be included in the register if its shareholders/participants include persons associated with the aggressor state, or against whom sanctions have been applied, or who are associated with a person against whom sanctions have been applied.

Legal entities against whom a violation of obligations under a state defense procurement contract has been established within the last 12 months; who are not corporate income taxpayers or are included in the register of non-profit institutions and organizations cannot enter Defence City. 

An enterprise cannot become a resident if it has tax debt exceeding 10 minimum wages; if it is located and operates in the temporarily occupied territory of Ukraine, and is also involved in criminal proceedings.

The Ministry of Defense announced that the first company received resident status.