Defence City operates in Ukraine: first resident, tax benefits, and pitfalls

The special legal regime Defence City, created to scale up defense production, attract investment, and develop Ukraine's defense-industrial complex, has officially launched in Ukraine. The first enterprise has already received resident status. UNN investigated what preferences Defence City resident status provides and what the pitfalls are.

What is Defence City and who became a resident

According to the Ministry of Defense of Ukraine, in early January, the first enterprise received Defence City resident status – a manufacturer of drones, including "Vampire" and "Shrike" drones, and interceptors for "Shaheds" that Russia uses for massive strikes on Ukrainian territory. 

Defence City 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 investment, and developing the Ukrainian defense-industrial complex. 

The government has been working on launching Defence City since the summer of 2025. Specifically, on August 21, 2025, the Verkhovna Rada adopted in the second reading and in general two key draft laws that create the legal basis for launching Defence City – a special regime to support the defense-industrial complex (DIC), namely draft laws No. 13420 and No. 13421.  On December 17, the Cabinet of Ministers, by resolution No. 1745, approved all key by-laws: the Procedure for maintaining the Defence City register; the Procedure for submitting and reviewing an application for granting Defence City resident status; the Procedure for monitoring the use of tax-exempt profit of a Defence City resident for the development of its activities; the Methodology for calculating qualified income ("defense income"); the Procedure for restricting access to public electronic registers regarding information (data) about Defence City residents; and the Procedure for submitting and reviewing a report on the compliance of a Defence City resident.

What benefits do Defence City residents receive?

Defence City residents receive a complex of economic and operational incentives designed to reduce the fiscal burden and accelerate production development.

Among the tax incentives are 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, Defence City residents will benefit from simplified customs procedures; special guarantees for information protection and confidentiality of enterprise data during the regime's operation; state support for relocation and increased protection of production facilities if necessary.

For a medium-sized defense enterprise with a turnover of €5-10 million, the total savings can reach €500K-1 million annually. The key condition is the reinvestment of released funds into development. Control is exercised by the tax service, which informs the Ministry of Defense about violations. The regime is valid until January 1, 2036, or until Ukraine joins the EU – meaning with high probability 3-7 years, not ten

To obtain resident status, a defense industry enterprise must submit a corresponding application and a package of documents to the Ministry of Defense. This includes compliance with legal requirements; financial and audit reports, as well as information on participation in the execution of state defense contracts.

Based on the review, a decision is made to grant status, refuse, or return the application without consideration. In case of a positive decision, the company is entered into the official Defence City register.

Pitfalls: Expert Warnings

Dmytro Mykhailenko, President of the Association of Tax Consultants, points out that despite the obvious advantages of the regime, Defence City has a number of risks that businesses should consider from the outset.

The tax authorities will check the targeted use of the released funds. Formally, the money should go to production expansion, R&D, and equipment purchases. Withdrawal into dividends or non-core assets = loss of benefits + penalties for the entire period of use

In addition, according to him, the methodology for determining "defense income" has not yet undergone practical testing. 

The first residents will effectively become system testers. The risk is unpredictable interpretations by the tax authorities

According to the expert, it should also be taken into account that after Ukraine's accession to the EU, the Defence City regime will have to be adapted to EU state aid rules, which may significantly change its conditions.

Defence City is created for "enterprises of strategic importance," but the criteria for this importance remain vague. Whether medium-sized companies with a turnover of €1-2 million will be able to obtain status, or whether the regime will become a privilege for selected top players in the industry – the coming months will show

Partial support for aircraft manufacturing enterprises

Among those who can claim Defence City residency are aircraft manufacturing enterprises. Often, in addition to servicing and repairing aircraft for the military, these companies also engage in drone manufacturing. 

As UNN previously wrote, aviation proposals were partially taken into account in the legislation. Along with the main opportunities that Defence City opens up for all participants in the initiative, the aviation industry insisted on including aircraft manufacturing entities that fall under the Law "On the Development of the Aircraft Manufacturing Industry" and were designated by the Cabinet of Ministers as critically important for the economy among the residents. These enterprises, in particular, specialize in the production of engines, components, and technologies that are simultaneously used in military and civil aviation.  The full list of these enterprises was not included, but residency was allowed for those whose share of income from the defense sector would be at least 50%. 

At the same time, aviation managed to achieve the removal of a norm that could have become a "hidden bomb" for the entire defense industry: previously, it was proposed to oblige companies, in case of losing Defence City resident status, to reimburse all taxes and penalties for previous years. After discussions in parliament, retrospective sanctions were removed.

Separately, a proposal was considered to exclude restrictions on tax arrears and overdue defense contracts. This involved the possibility of including enterprises with tax arrears in the List, provided they are repaid within three years, taking into account security risks, shelling, relocation, supply disruptions, and other factors beyond the manufacturer's control. In the final text, this criterion was not fully taken into account, but its requirements were partially softened.

Despite progress, a number of proposals from the aviation community were not included in the final text of the law. In particular, initiatives to expand the grounds for including enterprises in the List of residents were not taken into account – it was proposed to consider not only Ministry of Defense contracts, but also international agreements in the field of defense and dual-use. The proposal to add financing of research and development work on aircraft manufacturing to the areas of use of tax-exempt profit was also rejected. The idea of establishing a separate procedure for the use of released funds by aircraft manufacturing entities by decision of the Cabinet of Ministers of Ukraine (by analogy with CMU Resolution No. 476 of 07.06.2017, which was valid until 01.01.2025) was not supported either. In addition, the norm regarding the absence of open criminal proceedings against companies was not softened. 

"Baptism of fire" and the need for refinements

The launch of Defence City undoubtedly became an important signal for the development of the defense industry, however, the first months of the regime's operation show that the process of acquiring residency is moving significantly slower than the market expected. Despite the availability of all by-laws and the declared readiness of the state to support the defense industry, as of early 2026, only one enterprise has received resident status. 

This is clearly not about a lack of interest from businesses, but about the excessive complexity of the procedure itself and overly strict selection criteria. For example, according to the law "On National Security of Ukraine," an application for Defence City resident status must include a report on the compliance of a Defence City resident, not a candidate for Defence City resident status, for the period from January 1 to December 31 of the corresponding calendar year, which is impossible.

In fact, Defence City is only beginning to undergo its "baptism of fire" in practice. However, it is already clear that for many medium-sized manufacturers, including those in the aviation industry, the barriers remain a deterrent, even despite the obvious financial benefits.

A separate problem remains that a significant part of the proposals from industry communities, including the aircraft manufacturing industry, were only partially taken into account or completely rejected in the final version of the legislation, which may significantly narrow the circle of potential residents. Thus, there is a risk that Defence City may turn into a regime for selected large players and will not become a mass tool for the development of the defense industry.

It is obvious that the Defence City legislation needs refinement. This is not about changing the concept, but about targeted simplification of procedures, clearer residency criteria, greater flexibility regarding financial and formal requirements, and reducing regulatory uncertainty. Without this, the pace of new resident accession and the real effect for the industry may remain very low.