From the "club of the chosen" to an entire industry: The Aerospace Association has prepared proposals for changes to Defence City

The Aerospace Association of Ukraine has prepared its proposals for amendments to the legislation regulating the functioning of the special tax and customs regime Defence City. This involves a comprehensive revision of the norms required for obtaining resident status, tax incentives, and mechanisms of state support for the defense-industrial complex. The Association directly states: without correction of the current rules, this instrument risks remaining declarative and in practice will not be able to become a driver for the development of the industry, writes UNN. 

The proposals of the Aerospace Association of Ukraine, which we are submitting for consideration to the relevant committee of the Verkhovna Rada and people's deputies, cover several key blocks at once – from company selection criteria to the logic of tax incentives and administration of the regime itself. Our main goal is to make Defence City more inclusive for the market, while not losing state control

According to him, the Association has gathered wishes from market players and developed proposals for amendments to the legislation. 

One of the most controversial points is the requirement regarding the share of defense revenue. The current model, in our opinion, provides for an excessively high participation threshold, which, according to our estimates, cuts off a significant part of enterprises operating in segments adjacent to the defense-industrial complex or being component suppliers. The Aerospace Association proposes to significantly reduce this indicator – from 90% to 50%

According to him, this approach allows integrating into the system not only weapons manufacturers but also a wider pool of companies that form value chains in the defense sector. 

Taking our proposals into account will allow changing the approach of Defence City, which is currently: from a narrow "club of the chosen" to an industrial ecosystem where both large manufacturers and medium-sized businesses can operate. This is especially relevant in wartime conditions, when the speed of scaling production often depends on the flexibility of cooperation

The second important block, according to the head of the legal committee of the Aerospace Association of Ukraine, concerns the simplification of procedures for acquiring resident status. In the current version of the legislation, this process requires companies to go through a bureaucratic procedure via the Ministry of Defense. The Association proposes introducing a more automated model: if an enterprise is included in the list of defense-industrial complex enterprises, it automatically receives the status of a Defence City resident. According to Ruslan Melnychenko, this approach will reduce the administrative burden and significantly shorten the time for obtaining resident status.

Separately, it is proposed to expand the grounds for including enterprises in such a list. It is proposed to consider companies' participation in international defense contracts or interagency agreements as a sufficient basis for obtaining status. This directly corresponds to the task of integrating the Ukrainian defense-industrial complex into global markets and production chains, the Association believes.

We place significant emphasis on the tax part. We propose not only to preserve but also to detail the mechanism of exemption from income tax for defense-industrial complex enterprises with a clear condition of reinvesting funds. This involves directing resources to modernize production, purchase equipment, develop technologies, intellectual property, and improve personnel qualifications. Thus, tax benefits will be tied to the development of the production base, not just a reduction in the fiscal burden

Another block of proposals concerns the criteria for refusing to include an enterprise in Defence City. In the current version, they are formulated quite strictly and, according to the association's assessment, do not always correspond to the realities of the Ukrainian economy. 

We propose to soften the approach to the existence of tax debt: allow enterprises to obtain status subject to its gradual repayment over a defined period. This is an important signal for companies operating in difficult financial conditions but having potential for the development of defense production. The association also proposes to review some restrictions that essentially duplicate other state control mechanisms or create excessive barriers for business. In this context, it is about a balance between security requirements and economic feasibility.

It also concerns the regulation of the use of released funds. The proposed changes stipulate that such resources should be directed to specific production and innovation goals, including support for defense forces.

In addition, the proposals provide for a more flexible approach to the relocation of defense industry enterprises, which is critically important in the context of a full-scale war and constant enemy shelling. In particular, the timelines and mechanisms for changing the location of enterprises are being clarified while preserving their status and access to Defence City incentives.

As noted by the head of the legal department of the Aerospace Association of Ukraine, Ruslan Melnychenko, the proposed package of amendments is the result of an analysis of the practical application of current legislation and feedback from defense industry and related enterprises.

We proceeded from the fact that Defence City should become a truly working tool, not a formal regime with excessive restrictions. Today, some requirements effectively make it impossible for a significant number of enterprises that are already working for defense or can quickly join it to participate.

According to him, it is critically important to ensure flexibility of rules and predictability of the regulatory environment. "The defense-industrial complex is an industry with long investment cycles and high risks. If the rules of the game are not adapted to realities, business will not be able to scale production as quickly as the state requires," Ruslan Melnychenko believes.

The Aerospace Association plans to submit its proposals to the Verkhovna Rada of Ukraine in the near future and expects that their proposals will become the basis for refining legislation and will be taken into account during further changes to the Tax Code and relevant laws.

Let us recall 

Earlier, the head of the Verkhovna Rada Committee on Finance, Tax and Customs Policy, Danylo Hetmantsev, stated the need to soften requirements for potential residents of Defence City. This will expand the circle of participants and stimulate the industry.

UNN previously wrote that the Aerospace Association of Ukraine is collecting proposals from companies operating in the defense industry sector and aircraft manufacturing enterprises regarding changes to legislation that provides for the functioning of the tax and customs special regime Defence City. Based on the results of this work, the association plans to submit the developed proposals to representatives of the VR Committee on National Security, Defense and Intelligence and to join the further refinement of the regulatory framework of Defence City in dialogue with the government and parliament.

Let us add

Today it is becoming clear that the special regime Defence City, which provides customs and tax preferences for enterprises from the defense industry and related sectors, is not very popular among businesses. Market representatives in comments to UNN explain that this is due to some legislative gaps that create barriers for potential residents of the special regime.

Among the main deterrent factors are, in particular, unclear requirements for turnover, which effectively limit access for small and medium-sized businesses to Defence City, as well as unclear requirements for auditing companies that seek to join the special regime. In addition, experts point to the lack of symmetrical tax conditions. This refers to the fact that companies are forced to pay VAT on domestically produced parts, while this tax has been abolished for imported components. The Verkhovna Rada Committee on National Security, Defense, and Intelligence also already understands the need to refine the relevant legislation and awaits  proposals from the market.

Another barrier experts consider is an overly strict norm regarding criminal proceedings. A potential resident of Defence City must not be involved in any way in criminal cases. This norm even applies to factual cases without suspicions, indictments, or verdicts. Lawyers interviewed by UNN point to a violation of the presumption of innocence.