Imperfection of legislation hinders the scaling of Defence City - experts' position

The special regime of tax benefits and customs preferences for Defence City, which the state positions as one of the key tools for stimulating the development of the defense-industrial complex, is currently facing serious challenges at the stage of practical implementation. Despite high expectations, the number of companies that have joined the regime remains minimal. Market representatives and experts agree that the main reason lies in the imperfection of the legislation. Industry associations are already preparing their proposals for its refinement, UNN writes.

The necessary synergy between business and the state

Ihor Harbaruk, Vice President of the "Ukrainian International Institute of Recovery" and expert of the "Economic Discussion Club" Public Union, believes that the approach to creating Defence City is correct and timely. However, without proper refinement, in his opinion, there is a risk that the special regime will remain a declarative mechanism.

"For it (Defence City – ed.) to work not declaratively, it needs to be worked on. That is, in fact, both the state and arms manufacturers must be interested in this. And for this to be such a synergistic cooperation," he emphasized in a comment to UNN.

Ihor Harbaruk is convinced that Defence City should ultimately transform into a strategic economic model and become the foundation of the Ukrainian economy in the next decade.

"The defense-industrial complex must become and be the foundation of Ukraine's economy for the next 10-12 years. We will see later, but for the next 10-12 years, the defense-industrial complex must be the foundation 100%. And everything else should be formed around it," the economic expert noted.

He emphasizes the need for systemic state support for national producers, so that Ukrainian enterprises, and not foreign ones, receive state orders. In addition, an important aspect, according to him, is also the development of exports of defense industry products.

Therefore, Harbaruk is convinced that Defence City should be not only a mechanism for quickly launching the production of weapons and equipment, but also a tool for long-term improvement of product quality and competitiveness of the domestic defense industry.

Barriers for potential residents

One of the problematic aspects is the audit requirement. Market participants note that the legislation does not provide potential residents with clear answers to key questions: for what period should the audit be conducted, who has the right to conduct it, and what standards should be applied. Such uncertainty creates additional barriers for business.

Industry representatives emphasize that the lack of clear rules opens up opportunities for subjective interpretation and, as a result, risks of abuse appear. Ultimately, instead of simplifying access to the special regime, businesses receive additional regulatory uncertainty.

Another and, obviously, the most resonant norm that causes criticism from businesses is the requirement for the absence of criminal proceedings against potential residents. Experts emphasize that such a condition does not correspond to Ukrainian realities, when businesses face attempts of pressure from law enforcement officers, and can significantly limit the circle of potential participants in Defence City.

"The practice of opening criminal cases, unfortunately, often has a formal nature: proceedings are registered based on statements from competitors or within inspections, after which they can 'hang' for years without active investigative actions. Often, the criminal process can be used by some dishonest law enforcement officers as an element of pressure on business," said Ruslan Melnychenko, head of the legal committee of the Aerospace Association of Ukraine, in a comment to UNN.

In particular, industry representatives directly indicate that in the current conditions, there are practically no companies that would not be involved in criminal proceedings in one way or another. At the same time, it is often not about proven violations, but about protracted or formal cases that may not have a procedural completion for years.

"We understand that there are currently many criminal proceedings being investigated against businesses. Cases are initiated, they are registered for years, no one is charged with suspicion. Unfortunately, there are many such cases. They are not transferred to court, but, in fact, when some information (about the company – ed.) is received, the case hangs and it is clear that it was initiated against officials or the enterprise is involved in this criminal case somewhere. And, of course, this also hinders (the involvement of enterprises in Defence City – ed.)," the lawyer added.

In this context, experts also draw attention to the violation of the basic principle of presumption of innocence. After all, until there is a guilty verdict from the court, considering a subject guilty is legally incorrect. Accordingly, linking access to the special regime to the fact of criminal proceedings creates risks of manipulation and can be used as a tool to prevent companies from participating in Defence City.

No less important is the question of criteria for company turnover. Experts interviewed by UNN emphasize that the current requirements may actually limit the access of small and medium-sized manufacturers to Defence City, instead of promoting the expansion of arms production and aircraft manufacturing.

In current conditions, it is small companies that play a key role in the development of defense technologies, especially in the segment of unmanned systems and innovative solutions. Therefore, their exclusion or limited access to the special regime contradicts the very logic of stimulating the defense industry and risks turning Defence City into a special regime for the chosen few.

Separately, businesses draw attention to tax imbalances. In particular, this refers to the situation with VAT on components. The current approach seems unfair to Ukrainian manufacturers.

"When we talk about the Defense 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," noted economist and aviation expert, aviation sector manager Bohdan Dolintse in a comment to UNN.

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 products.

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

Diia.City vs Defence City

Another aspect that requires the legislator's attention is the interaction of Defence City with other special regimes, in particular Diia.City. As expert Bohdan Dolintse noted, companies working in IT but related to the defense industry are actually forced to choose between these regimes. This creates additional restrictions for businesses and does not take into account the modern specifics of war, where technological solutions and the integration of various sectors play a key role.

According to Andriy Ivaniv, a partner at Equity law firm, there is currently direct competition between Diia.City and Defence City. The latter, in his opinion, is inferior in attractiveness to other models, particularly Diia.City.

"The Diia.City regime is much more profitable in this regard. Benefits work immediately. The main issue is non-withdrawal of capital. And, accordingly, there are no radical advantages in Defense City that would motivate (enterprises - ed.) to switch to it," noted the lawyer.

The relevant committee of the Rada is awaiting proposals from businesses

The Verkhovna Rada Committee on National Security, Defense, and Intelligence is aware of the problems with companies' access to residency in Defence City and is ready to hear proposals from business representatives.

"I consider the Defence City special regime to be a correct initiative. But it is clear that, like any new mechanism, it will require additional adjustments. This will require consultations with businesses, which will point out specific barriers and deterrents, and this needs to be worked on substantively," noted Vadym Ivchenko, a member of the relevant committee of the Rada, in a comment to UNN.

He is convinced that the legislation that introduced the special regime needs to be refined after consultations with business representatives. The MP is convinced that if high-quality changes to the laws on Defence City are developed and there is a consolidated position of parliament, government, and manufacturers, they can be quickly adopted by the Verkhovna Rada.

His colleague on the committee, Hennadiy Kasai, holds a similar opinion. He is confident that the criteria for joining Defence City need to be simplified.

"I think that all this (legislation on Defence City - ed.) needs to be simplified. I know that the law has gradually started working, but there are questions... Simplify, because it is absolutely wrong to do so in terms of criminal cases (the requirement for the absence of criminal proceedings in which potential residents would be involved - ed.), because indeed, criminal proceedings are opened very easily in our country. Unfortunately, there is little responsibility. And enterprises must work today. They need to be supported," noted the member of the defense committee in a comment to UNN.

It should be noted that work on preparing proposals for changes to legislation is already underway in the relevant environment. In particular, representatives of the aerospace industry are consolidating the positions of market participants to form a comprehensive package of proposals.

"The Aerospace Association of Ukraine is currently consolidating the market's position on the functioning of Defence City and is preparing a package of proposals for changes to current legislation. We are involving representatives of aircraft manufacturing enterprises, as well as arms manufacturers and other companies related to the defense industry sector that plan to join this special regime, in this process," said Volodymyr Semenov, CEO of the Association, in a comment to UNN.

According to him, the main goal is to identify norms that prevent enterprises from joining Defence City, create excessive regulatory barriers, or do not take into account the specifics of the work of defense-industrial complex companies, and to transform this into a set of proposals for legislative changes.

Experts emphasize that the success of this special regime directly depends on the state's ability to quickly respond to feedback from the market. Otherwise, there is a risk that even a fundamentally correct initiative will not be able to realize its potential.

In the conditions of a full-scale war, Ukraine does not have the resources for long experiments, because the defense industry needs effective tools right now. If the legislator takes into account the key comments of the market and cancels discriminatory norms, ensuring legal certainty of procedures and creating equal conditions for all, Defence City can become a powerful driver of the defense industry's development, as it was planned at the stage of its creation.

Otherwise, as experts warn, there is a risk that this mechanism will remain declarative and will not be able to fulfill its key function – to ensure the rapid scaling of Ukrainian defense production in wartime conditions.