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Obstacles to investments to IT sphere in Ukraine

30.06.2016

Iryna Kuzina, attorney at law, Head of Kharkiv office of Ilyashev & Partners
Source: Yurydychna Praktyka

Nowadays search of a foreign investor by Ukrainian IT companies is carried out like this – the bravehearted go abroad (to Silicon Valley, in particular) and, if lucky and in case of having good connections, find investors. Speaking from the investor’s perspective it is considered to be safer to establish a company abroad and make investments to its accounts and Ukraine receives only a small particle of such ivestments in the form of the salaries paid to programmers and IT developers. Profits gained from sale of the final software product shall be taxed abroad. Truth be told Ukraine has not deserved to receive such taxes as soon as it has not created proper conditions for investment into the IT sphere.

Institutional matters

Ukraine now has ten valid laws in the investment sphere. Unfortunately, the quantity of laws has not transformed itself into quality and regulation of investments is mainly represented by confirmation of a possibility to make investments in general. As for the IT sphere in particular it is not even mentioned in the legislation but only not ruled out in connection with ceratin hints onto intellectual property objects as investment instrumets. That is why investmetns include all the types of proprietary/intellectual values and holdings invested into the objects of entrepreneurial and other types of activities as a result of which profits are gained or a social effect is achieved (Article 1 of the Law of Ukraine “On investment activities”):

• monetary assets, special-purpose bank deposit, participation shares, shares and other securities (except for bills of exchange);
• movable and immovable property (buildings, constructions, equipment and other material values);
• proprietary intellectual property rights;
• body of technical, technological, commercial and other types of knowledge registered in the form of technical documentation, skills and manufacturing experience required for realizartion of certain types of production but not patented (“know-how”);
• rigths to use land, water, resourses, buildings, constructions, equipment and other material righs;
• other values.

Correspondigly proprietary intellectual property rights and “know-how” can also be evaluated and invested (in particular, into the charter capital).

Investment activities are realized through:

• execution of investment projects;
• execution of operations with corporate rights and other types of material and intellectual property values (Article 2(3) of the Law).

As regards to the first way of making investments it must be stated that foreign investors do not understand the notion of “investment projects” registered according to Ukrainian laws because in order to make an investment decision they need a specific paln with substantiated economic fugures. It is even more true in regards to high-tech and science-based spheres.

As for the second way – acquisition by an investor of corporate rights in a Ukrainian legal entity is simplier from organizational point of view. However, starting from 2014 it has become more problematic considering for acquisition of economic profits for investors (see the information futher).

Investors may act as contributors, creditors, buyers as well as perform functions of any type of investment activities (Article 5(2) of the Law).

It means that the said norm supplies the lsit of investment activities with several additional ones:

• debt financing or provision of loans of other types;
• depositing activities (mainly for banking institutions);
• purchase (other acquisition) of investment objects following their creation;
• other allowed forms of investment.

Objects of investment activities may include: any property, including capital and circulating funds in all spheres of economy: securities (for bills of exchange), special-purpose monetary contributions, scientific and technical products; intellectual values, and other proprietary objects and rights (Article 4(1) of the Law).

Suchwise, at least the legislator does not forbid making investments to the IT sphere. However, this mentioning of “intellectual property values” ends all references to regulation of IT sphere. Under normal economic conditions investors do not require obtaining additional benefits. However, the legislator established spheres where investor may be treated with privilege:

1) in social sphere;
2) in technical and technological improvement of production;
3) in creation of new jobs for people requiring social protection;
4) in implementation of scientific discoveries and inventions;
5) in agro-industrial complex;
6) in realization of programs directed at liquidation of consequences of Chernobyl disaster;
7) in production of building materials;
8) in the sphere of education;
9) in the sphere of culture and protection of cultural heritage;
10) in the sphere of protection of environment and health.

I consider that paragraphs 2, 4 (and, sometimes, 3) can fairly be applied to IT companies and it would be possible to talk about benefits. However, specialists reviewing this matter believe that benefits do not represent a practical mechanism stimulating the process of making investments to Ukraine. At the same time, as the experience shows, when the temporary benefits lose their validity the economic the economic effect gets ruined.

Monetary and currency exchange matters

Pursuant to Ukrainian laws (Article 5(2) of the Law) investors have the right to own, use and dispose of objects and results of investments including reinvestments and trade operations at the territory of Ukraine. However, foreign investors have bumped into problems here. The most problematic matter for investors is introduction from 2014-2015 of limitations of transfer of their profits gained from investment activities activities in Ukraine.

Nowadays valid is the Decree of the National Bank of Ukraine No. 140 as of March 03, 2016 “On regulation of the situation and the monetary, credit and foreign exchange market of Ukraine”, which introduces the following limitations:

• obligatory sale of 75% of all foreign currency proceeds with certain exceptions, including in relation to foreign investments to Ukraine;
• limitation of setoff of counter claims of the same kind expressed in foreign currencies;
• limitation of premature settlement of credits provided in foreign currency;
• transfer of monetary assets in hryvnias to the accounts in non-resident banks not earlier than on the third day;
• regulatory procedure of transfer of foreign currency abroad – require provision of a large quantity of documents, operations are carried out not earlier than on the third day exclusively upon getting confirmation from the NBU;
• prohibition of purchase of foreign currency in the process of its return of dividends to foreign investors (and all this in the process of obligatory sale of 75% of foreign currency proceeds).

From a lawyer’s point of view limitation of validity of the Law “On investment activities”, the Constitution of Ukraine (Article 41(1) – every person has the right to own, use and dispose of his own property, results of his intellectual and creative activities) and Article 1 of the Protocol of the Convention for the Protection of Human Rights and Fundamental Freedoms (the right for peaceful enjoyment of property) only by the Decree of the National Bank of Ukraine is illogical because the NBU, which does not enjoy sufficient influence onto economic subjects, although exerts certain influence onto disposal of its own property (indirectly through regulation of banking activities).

Evidently, imposing limitations onto the investors’ ability to dispose of the results of investment activities does not motivate them to making investments to our country. Moreover, they violate international obligations of our country.

In such way there are valid agreements on assistance and protection of investments by the Republic of Moldova, Republic of Albania, the Republic of Portugal, the Islamic Republic of Iran, Tajikistan, the Republic of Singapore, the Republic of Finland, the Syrian Arab Republic, Turkmenistan, the Republic of Slovenia, the Republic of Lithuania, the Federal Government of the Federal Republic of Yugoslavia, the Republic of Chile, Republic of Korea and the Federal Republic of Germany, United States of America , the French Republic, the Republic of India, Japan, the Republic of Austria, the Republic of Turkey, the State of Israel, Japan and others.

Terms of these agreements are somehow similar. For example, Article II of the Agreement between Ukraine and the United States of America on promotion and mutual protection of investments as of March 04, 1994 stipulates that each party shall allow and use such regime to the investments and activities related to them which is not less favorable as the regime which, in similar situations, is applied to investments of own citizens and national companies, or citizens and companies of any third country depending on which is considered to be more favourable upon existence of each Parties’ right to establish or reserve exceptions within the spheres and matters established in the Annex to this Agreement.

At the same time the Agreement indicates that each Party shall allow execution of all transfers related to investments freely and without delays to, as well as from its own territory (Article IV of the Agreement). Such transfers include:

• profits;
• compensation (pursuant to article III);
• payments from the investment dispute;
• payments made under the provisions of the agreement including payments in consideration for settlement of the main debt and interests accrued under the loan agreements;
• proceeds from sale or liquidation of the whole or any part of investment;
• additional contributions into the capital for support or development of investments.

So, there is a situation when a national investor has a possibility to receive dividends and use them at his own discretion and a foreign investor is deprived of such possibility. The said represents a violation of international obligations of Ukraine. Mass media mentioned that administrative limitations will be eased however until now such promises have not been fulfilled.

Matters of protection

The state guarantees stability of the terms of execution of investment activities, as well as observance of rights and lawful interests of its subjects. Terms of the agreements concluded between the subjects of investment activities save their force throughout the whole term of validity of these agreements, as well as when, following their conclusion, the legislation (except for tax, customs and foreign currency legislation, as well as legislation on the matters of licensing certain types of economic activities) establishes the terms deteriorating or limiting their rights, unless they have come to agreement on the change of the terms of the agreement (Article 18(1) of the Law). In case of upholding by the state or other authorities of the acts violating the rights of investors and subjects of investment activities the losses inflicted shall be subject to reimbursement in full by such authorities. Disputes on reimbursement of losses are resolved by the court (Article 18(2) of the Law). Investments cannot be nationalized or confiscated, as well as no measures equal to the consequences can be applied to them. The mentioned measures may only be applied on the basis of Ukrainian laws with full compensation to the investor of losses inflicted in connection with termination of investment activities.

The procedure of compensation of losses to investors is established by the mentioned laws. But are these declarations of protection of investments really valid? And is the court protection promising in this case? Let’s take, for example, the administrative case No. 2а-10972/11/2670 with participation of CJSC Casino “Premiere-Palace” foreign investments in which amounted to 79.98 % of the charter capital. The case is related to prohibition of gambling business in Ukraine, i.e. it is not related to tax, customs and foreign currency legislation or any license regulation. However, the courts failed to protect foreign investments. Failed even references to the EU-Ukraine partnership Agreement.

An example of approach used by Ukrainian courts towards protection of the investors’ declared rights for protection was created by the Constitutional Court of Ukraine – in the case on official interpretation of provisions of Article 5(1) of the Law of Ukraine “On elimination of discrimination in taxation of subjects of entrepreneurial activities established upon use of property and assets of the national origin” and of Article 19(1) of the Law of Ukraine “On investment activities” No. 1560-XII as of September 18, 1991 was provided by the Constitutional Court of Ukraine in its decision No. 1-рп/2002. The Constitutional Court of Ukraine stated that from the moment of entrance into force of the Law of Ukraine “On elimination of discrimination in taxation of subjects of entrepreneurial activities established upon use of property and assets of the national origin” provisions of special legislation and state guarantees of protection of foreign investments (which were valid as of the moment of registration of investments and were subject to be applied upon the request of foreign investors based on the guarantees of permanence of legislation) are applied within the limits stipulated by Article 3 of this Law and Article 19 of the Law of Ukraine “On investment activities” No. 1560-XII as of September 18, 1991.

Provisions of Article 5(1) of the Law of Ukraine “On elimination of discrimination in taxation of subjects of entrepreneurial activities established upon use of property and assets of the national origin” No. 1457 as of February 17, 2000, taken in conjunction with provisions of the mentioned law, represent the grounds both for dismissal and termination of earlier provided benefits in the sphere of foreign currency and customs regulation, and in the sphere of collection of taxes, duties (obligatory payments) to foreign enterprises, companies with foreign investments, their subsidiaries, subdivisions, other separate branches, including permanent representative offices of non-residents, regardless of the time of making foreign investments and their registration. Thus, the Law of Ukraine “On elimination of discrimination in taxation of subjects of entrepreneurial activities established upon use of property and assets of the national origin” No. 1457 as of February 17, 2000, which was passed later that the Law of Ukraine “On the foreign investment regime” No. 93/96-ВР as of March 19, 1996, cancelled the benefits provided to the companies with foreign investments. In other words the Constitution Court of Ukraine allowed retroactive validity of the law, furthermore in the prejudice to the interests of the investors. It was made clear to foreign investors that any business planning of business in our country is useless. The hope may be laid only to the international arbitration institutuins.

Under the international law investment disputes may be resolved by the following bodies:

1. The International Centre for Settlement of Investment Disputes established by the Convention on settlement of investment disputes between the states and citizens of other states signed in Washington on March 18, 1965 (“Convention ICSID“, ratified by the Laew of Ukraine № 1547-III as of March 16, 2000);
2. Additional Service of this Center if the Center itself is unavailable;
3. According to the Arbitration Rusles of the United Nations Commission on International Trade Law (UNCITRAL);
4. Any other arbitration institution or accroding to any other arbitration rules which may be jointly coordinated by the parties to the dispute. In case of violation of the human rights in some cases it will be possible to engage assistance of the European court of human rights or other conventional institutions according to the acts of the United Nations Organisation.

Investors also must be aware that based on the law No. 2402-XII as of June 03, 1992 Ukraine joined the Multilateral Investment Guarantee Agency (MIGA) ensuring protection of direct investments and loans from non-commercial risks (war, social unrests, expropriation of the invested capital, impossibility to transfer profits abroad etc.).

I would like to repeat the words of my colleague from Switzerland Mr Stefan Greiner from Mindspace GmbH: “Western business is very analuytical and disciplined and they all want to know everything in advance”.

Now Ukraine is doing its best for the western investor not be able to build and secure a business plan. But it does not work so (Stefan Greiner).

 
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