Ukraine needs a strong defense industry, so the Defence City special regime requires changes

The full-scale war has changed the role of the defense-industrial complex in the Ukrainian economy. While previously the defense industry was viewed as a separate sector of state policy, today it is increasingly transforming into the foundation of economic resilience, technological development, and national security. To rapidly scale and strengthen the domestic defense industry, a special tax and customs regime called Defence City was launched in Ukraine. However, for greater efficiency, the legislation requires improvement and adaptation to modern market realities, UNN reports.

Defence City as a Tool for Economic Transformation

The special Defence City regime was created as a mechanism to stimulate defense production through tax instruments and special customs conditions for defense-industrial complex enterprises. Its main task is to leave more resources within companies for production development, equipment modernization, scientific research, and attracting engineering personnel.

In this context, Defence City can be viewed as one of the tools for increasing the production and technological capacity of the defense industry. Its potential lies in the fact that tax incentives can leave more resources within enterprises for R&D, production modernization, and attracting engineering personnel,

However, in practice, the implementation of the special regime faces a number of problems. These involve legislative gaps that complicate the process of joining Defence City for enterprises operating in the defense sector.

Among the key problems, market participants cite the lack of clear criteria regarding the audit of companies required to join the special regime, uncertainty regarding turnover requirements for enterprises—which creates barriers for small and medium-sized manufacturers—as well as excessively strict admission criteria that do not always account for the specifics of business operations in wartime conditions.

Industry representatives have repeatedly pointed out that certain norms require refinement so that the system does not turn into a tool for selecting only large players, leaving innovative small and medium-sized businesses without support.

According to Hetmantsev, it is important for the special regime to remain open to innovative teams and defense-tech startups; only then will it be an effective tool for the development of the defense industry.

At the same time, the effectiveness of Defence City will depend on whether the support is sufficiently focused and accessible to innovative teams and defense-tech startups. In many countries, it was defense research and development that became the source of dual-use technologies. Therefore, it is important for Ukraine that a portion of defense spending works not only for the current needs of the front but also for the creation of a new defense-technological ecosystem,

The Lesson of Poland and the Risk of Import Dependency

Hetmantsev draws attention to the example of Poland: after 2022, the neighboring country significantly increased defense spending—from 2.2% of GDP in 2021 to approximately 4.5% of GDP in 2025. However, about 80% of capital defense expenditures were spent on imports.

As a result, defense capability was strengthened quickly, but domestic production did not receive a proportional effect. For Ukraine, such a model can only be a temporary solution.

For Ukraine, in the short term, the import of weapons and components is often a necessity, as the priority remains the speed of supply and the needs of the front. However, in the medium term, the strategic task is to gradually increase the share of domestic production where possible. For example, in drones, repair and modernization of equipment, ammunition, electronics, communication tools, software, and related technologies,

That is why Defence City must function not just as a tax preference, but as a full-fledged industrial policy.

Recall

Earlier, Danylo Hetmantsev stated that despite the launch of the special Defence City regime, which was intended to be one of the key tools for the development of the defense-industrial complex, current legislation requires significant refinement to achieve a real effect. 

Last year, we launched the special Defence City regime. For it to start producing the expected results, we need to lower the "entry threshold" to Defence City, increase the circle of its participants, and expand incentives, which businesses are rightly pointing out,

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

Since the launch of the special regime, it has become clear that Defence City, which provides customs and tax preferences for enterprises in the defense sector and related industries, is not very popular with businesses. Market representatives explain in comments to UNN that this is due to certain legislative gaps that create barriers for potential residents of the special regime.

Among the main deterrents are unclear turnover requirements, which effectively limit access to Defence City for small and medium-sized businesses, as well as unclear requirements regarding the audit of companies applying to join the special regime. Furthermore, experts point to the lack of symmetrical tax conditions. This refers to the fact that companies are forced to pay VAT on Ukrainian-made parts, while this tax is waived for imported components. The Verkhovna Rada Committee on National Security, Defense, and Intelligence also already understands the need to refine the relevant legislation and is waiting for market proposals.