Date of publication: 10 October 2025
Ivan Maryniuk, Head of Tax Law Practice
Source: Liga:Zakon
A special legal regime called Defence City will soon be launched in Ukraine. It primarily concerns companies in the defence industry that manufacture weapons, military equipment, components and dual-use technologies.
What is Defence City?
Defence City is a regime created by the state specifically for defence industry enterprises. The special regime is designed to create favourable conditions for scaling up the production of weapons and equipment, attracting investment, reducing the tax burden and facilitating access to international markets and partnerships.
The regime will remain in force until 1 January 2036 or until Ukraine joins the EU.
What are the Benefits for Defence City Residents?
Tax aspects
- exemption from income tax (provided that the profit is reinvested in production or R&D);
- exemption from land tax, property tax and environmental tax;
- these exemptions may supplement existing VAT exemptions for participants in defence operations.
Customs formalities
- simplified customs procedures for the import and export of defence products;
- simplified export control regime for military goods.
Improved confidentiality
- the Ministry of Defence will maintain the Defence City Residents Register;
- sensitive information about residents will be hidden in public registers (a mechanism has already been introduced to restrict access to information about enterprises, institutions and organisations in the defence industry sector, regardless of whether they have Defence City resident status).
Who Can Become a Defence City Resident?
The following entities are eligible for this status:
- domestic enterprises that are income tax payers, with at least 75% (50% for aircraft manufacturing) of their income generated from transactions involving defence goods.
- enterprises with no tax debts or pending legal claims in the field of defence procurement.
- enterprises with an impeccable business/financial reputation (with a transparent ownership structure, stable financial position, no bankruptcy proceedings, no ties to the aggressor country and no sanctions);
- enterprises that are not residents of Diia.City.
Possible Tax Risks of the Defence City Regime
Tax incentives are indeed important for business development and can create an additional financial impetus for scaling up. However, there are certain nuances that require attention.
The non-reinvested portion of profits, income of controlled foreign companies, and results of controlled transactions of Defence City residents are subject to taxation on a general basis. In addition, if a company is found to have failed to meet the residency requirements in Defence City in the past, it must submit revised tax returns for all previous periods, as well as accrue liabilities and pay penalties. If this is done by force, a fine will also be imposed. At the same time, the general limitation periods do not apply to taxes for which tax benefits are provided to residents.
Secondly, Defence City is not for everyone. Unlike the Diia.City regime, young companies/start-ups will not be able to be immediately included in the list of residents and enjoy the benefits of the latter. At a minimum, they must undergo a year-long trial period and develop qualifying indicators. This may slow down the development of the defence industry and contradict the main idea behind the new law.
Greater confidence in joining Defence City could be provided by state guarantees of protection against possible abuse by law enforcement agencies. For example, cases of arrest and seizure of property (products, equipment, raw materials) in the context of insufficiently substantiated criminal proceedings may affect the execution of defence contracts and, in fact, residency status. Failure to comply with the terms of a defence contract, the imposition of penalties (which are always imposed by the state) and non-payment of the latter may result in the loss of Defence City resident status.
The law regulates the relocation of residents’ businesses to safer areas, but it is not entirely clear whether relocation is mandatory for obtaining resident status. At the same time, as the experience of three years of war shows, there are no safe places in Ukraine, and any relocation involves additional costs of resources, time, production delays, and a potential negative impact on employee’ families, as not everyone is ready to move and break social ties.
The introduction of a tax on withdrawn capital for Defence City (as for Diia.City) could stimulate more investment, including foreign investment, in the development of Ukraine’s defence industry. After all, the ‘transparent’ opportunity to earn income from investments is a significant prospect for any business.
Conclusions
Defence City is not only a set of incentives, but also a new model of interaction between business and the state, in which both sides are interested in each other’s stability and development.
Defence City could be a big boost for Ukraine’s defence sector, but for businesses, the new regime isn’t an ‘oasis in the desert.’ It could be a tool that only works if the rules are clear, flexible, and minimise risks and abuse on both sides.
