AUSTRIA IN UKRAINE

INVESTING IN UKRAINE: Insights for investors considering Ukraine market entry

CMS experts offer analysis for international investors looking to explore Ukrainian market opportunities

INVESTING IN UKRAINE: Insights for investors considering Ukraine market entry
About the authors: Anna Pogrebna is a Partner at the Kyiv office of CMS Reich-Rohrwig Hainz. Maria Orlyk is a Partner at the Kyiv office of CMS Reich-Rohrwig Hainz
Anna Pogrebna and Maria Orlyk
Saturday, 14 October 2017 16:28

Ukraine’s rich land, generous resources, advantageous geographical position and industrious people make it a naturally attractive investment destination. For many years, the country benefited from this attractiveness. However, the international business and investment communities have responded cautiously to the period of political instability and economic recession following Ukraine’s 2014 Revolution of Dignity and the subsequent tragic developments in Crimea and the eastern regions of the country. Many foreign businesses have chosen to press the “pause” button or limit their investments into the country. A limited number of market exits have also taken place.

Nevertheless, in the past two years the Ukrainian reform process has given cause for guarded optimism. Despite numerous controversies and the slow pace of some reforms, this optimistic mood continues to gain momentum in business circles. Multiple international ratings and surveys reflect the growing consensus opinion that post-Maidan Ukraine is making progress. Ukraine moved up three places to occupy eightieth position in the latest version of the World Bank’s annual Doing Business survey, building on gains from the previous year. This positive result is largely attributable to improvements in the quality and level of investor protections.

According to a recently published survey conducted by the European Business Association, in the first half of 2017 Ukraine saw its investment attractiveness reach a six-year peak. Meanwhile, at the end of August 2017, research group Institutional Investor placed Ukraine at the top of the EMEA list for potential investment based on the results of a survey carried out among more than 150 investment companies. Ukraine also ranked as 2018’s number one destination among investment industry professionals seeking new investment opportunities. In line with these positive trends, Ukraine also recently climbed four positions in the World Economic Forum’s Global Competitiveness Index.

This mounting international recognition indicates that Ukraine remains very much on the radar for foreign investors. It also highlights the fact that the business environment continues to demonstrate high levels of adaptability in response to the challenging and fast-changing economic and social environment in the country. These changes include a range of government initiatives to improve the business climate and remove various barriers to doing business in Ukraine. While many of these barriers regrettably remain in place, the fast-developing business environment makes it crucial for potential investors to constantly monitor the situation and keep abreast of new opportunities. The following brief analysis aims to provide international investors with insights into the current situation as they consider starting business operations in Ukraine.

 

Entering the Ukrainian Market

Before entering the Ukrainian market, most foreign investors typically face the question of which legal form of business presence to choose. The two most common options for a foreign company looking to establish a business in Ukraine are a separate legal entity in the form of a limited liability company (“LLC”) or a representative office (“RepOffice”).

When it comes to choosing between an LLC and a RepOffice in Ukraine, there are a number of considerations to take into account. A RepOffice is usually established to carry out marketing, promotional, and other auxiliary functions on behalf of the foreign parent company. It is less clear whether a foreign parent company may also conduct trade or business through a representative office. However, “commercial” representative offices that serve as the equivalent of “branches” in most other countries are quite common in Ukraine.

If a RepOffice acquires “commercial” status, its activities become taxable in Ukraine on a general basis, including financing received from the parent company. Moreover, a “commercial” RepOffice is recognized as a permanent establishment of the parent company for taxation purposes in Ukraine, and is therefore not eligible for any tax incentives or tax holidays envisaged by Ukrainian legislation. Additionally, a RepOffice does not enjoy the status of legal entity in Ukraine and may therefore face difficulties when obtaining the required licenses or permits for some types of business activities.

There are also important differences between the two options in terms of liability. The parent company is fully liable for the RepOffice’s activities and commitments, while shareholders of an LLC are only liable for the LLC’s commitments to the extent of their capital contributions to its charter capital.

In terms of costs and timeframes, registration of a RepOffice is more expensive and time-consuming compared to registration of an LLC. An LLC is usually registered within 24 hours and becomes fully operational within a couple of weeks following submission of all the required documents. Meanwhile, the minimum statutory term for the registration of a RepOffice is 60 business days. In practice, it usually takes about three months for a RepOffice to become fully operational. Making the right choice from the very beginning is crucial as changing status further down the line can be problematic. A RepOffice cannot be “transformed” (re-registered) into an LLC or vice versa once registration is complete.

 

Financing a Ukrainian Subsidiary

In our experience, most investors chose to establish a subsidiary in the form of an LLC. While there is no minimum capitalization requirement for an LLC, contributions to the charter capital are commonly used to finance the subsidiary’s activities during the initial stages of its operation. However, in light of the existing restrictions on the withdrawal of capital from Ukraine, investors are typically alert to the risk of not being able to repatriate their investments. In response to these restrictions, they look for an alternative way of financing their subsidiaries.

Additional available options to finance an LLC include intercompany or third party loans. All loan agreements between Ukrainian borrowers and foreign lenders are subject to mandatory registration with the National Bank of Ukraine prior to the disbursement of funds, and fall under limitations in terms of maximum applicable interest rates. In light of these requirements, any investor should carefully consider the time required for such registration, as well as the loan repayment terms and schedules, before opting for a shareholder loan scenario. Debt-to-equity swaps are not yet available to Ukrainian LLCs. This makes the immediate conversion of a shareholder loan into equity impossible. However, draft laws designed to allow debt-to-equity swaps for LLCs have already been registered with the Ukrainian parliament. Their adoption is expected in the foreseeable future.

 

Work Permits for Foreign Nationals

Except for individuals possessing permanent resident status in Ukraine, all foreign nationals seeking employment with Ukrainian companies must acquire a valid work permit. Furthermore, it is practically impossible to employ a foreign director at the initial stage of incorporation of a company in Ukraine. The most common solution to this obstacle is the appointment of a Ukrainian national as company’s interim director until the foreign director is able to obtain a work permit.

 

Managing a Ukrainian Subsidiary

Irrespective of whether the company manager is a Ukrainian or a foreign citizen, shareholders will be naturally concerned with vesting the management of the company with specific, and often limited, powers. Achieving the appropriate limitation of powers for local management is something a shareholder should seriously consider as a sensible precaution. This may relate to issues like pre-authorization of certain transactions and expenditures or the conclusion of contracts. Establishing limits is possible through proper wording of the company charter and management contracts.

 

Incentives for Foreign Investment

As part of efforts to attract more investment to the country, the Ukrainian government has introduced a range of different incentivizing tools and measures designed to make Ukraine more appealing as an FDI destination. For example, until 2021 newly established taxpayers can benefit from “tax holidays” as long as they have an annual income of UAH 3 million or less and meet a series of additional requirements. These include a payroll featuring at least two statutory minimum wages per employee (currently UAH 6400) and involvement in a priority area of the economy that the Ukrainian government is looking to incentivize such as the export of IT products and services. Meanwhile, the import of any assets as an in-kind charter capital contribution by a foreign investor is currently exempt from customs duty in Ukraine. However, if these assets are then subject to resale within a three-year period after import, the company is obliged to pay the exempted amount of import duties plus additional VAT.

 

Contracts with Ukrainian Companies

When contracting in Ukraine, one should remember that contracts with Ukrainian counterparts should always be in the Ukrainian language, while bilingual contracts have also become an increasingly common practice. Although most of the agreements are executed in plain written form, certain types of contracts require notarization and even state registration.

In the course of ongoing reforms, Ukraine has managed to achieve great transparency in terms of accessibility to public data. Most state registers (such as the Unified State Register of Legal Entities and Individual Entrepreneurs, the State Register of Proprietary Rights to Immovable Property, State Register of Encumbrances over Movables, the Unified Register of Debtors, the Automated System of Enforcement Proceedings and others) are now available online and accessible by any interested party. This allows easy background checks on Ukrainian contractors. This precaution is highly recommended in order to avoid unpleasant surprises in future.

 

Limitations and Restrictions

Ukrainian law generally treats Ukrainian and foreign investors equally. However, potential international investors should be aware that in some industries certain limitations on foreign nationals do apply. For example, Ukrainian legislation imposes a maximum shareholding threshold of 35% for foreign investors in Ukrainian information agencies. Additionally, foreign investors domiciled in offshore jurisdictions (listed by the Cabinet of Ministers of Ukraine in special regulations) and in the Russian Federation do not have the right to establish television and radio broadcasting companies in Ukraine.

 

Always a Solution

Because of the many regulatory restrictions that are still in place, international investors continue to encounter difficulties when pursuing their business interests in Ukraine. This inevitably leads to frustration and raises questions about the practicalities of managing a successful business in what remains a relatively challenging jurisdiction. At the same time, most of the problems and difficulties investors encounter prove to be manageable and solvable. Businesses have a habit of finding legal ways to adapt to the existing limitations of the Ukrainian business environment and mitigating their negative consequences.

As the current reforms move closer to completion in a wide range of areas including corporate regulations, the judiciary, land reform, and the privatization of state property, this will further contribute to the improvement of the investment environment. Investors can look forward to increasingly simplified business operations in Ukraine and additional levels of comfort as they seek to develop a presence in this exciting and dynamic market.

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