Crux (#9 September 2020)

Legal Digest

On 21 July Parliament passed Draft Law No. 3760 On Government Support of Investment Projects with Sizable Investments. What exactly is included in the Draft and how attractive is it for investors?

In July 2020 Parliament began considering draft legislation aimed at improving the image of Ukraine in terms of making it more attractive for significant foreign investments. These drafts have been prepared because of the investment nanny initiative by the President of Ukraine, announced at the 2020 World Economic Forum in Davos.

Initially, the investment nanny was perceived with humor and as a sort of government plenipotentiary, or business ombudsman, for particularly large investments called to help investors get through different hurdles of Ukrainian inefficient bureaucracy and attempts at corruption. However, the draft legislation is not about it. It is about how the Ukrainian government can participate financially in helping these investments projects to proceed.

Under the draft legislation, the Ukrainian government offers qualifying investors indirect financial support of 30% in their investment. The qualifying investment, among other requirements, must be in such industries where indirect financial support may be either through financing construction of outside infrastructure, necessary for the investment project, or through tax benefits. To qualify, the investment must be in areas like processing, infrastructure, logistics, home waste treatment, tourism, health care, education and sports. The investments must be to the tune of EUR 30 million or more and they shall provide at least 150 new jobs each year for a 5-year period.

To be eligible for the benefits under the drafts, investors must firstly pass a special admission procedure, culminating in a decision adopted by the Cabinet of Ministers of Ukraine. Preparations to pass the procedure and the procedure itself, may be costly and time-consuming. Unfortunately, the functions of the investment nanny, a state authority designated to consider applications for benefits under the draft legislation, are limited to preliminary consideration of the investors submissions and not in helping investors to prepare for it or pass through it. Neither does the draft legislation deal with how the investment nanny can help investors to navigate through hurdles of inefficient Ukrainian bureaucracy and attempts at corruption once the investment project has started.

Although the ideas in the draft are very welcome it seems, nevertheless, to have very limited effect in terms of raising the attractiveness of Ukraine for investors. The draft fails to provide solutions on how to deal with the hurdles of inefficient bureaucracy and attempts at corruption.

On 21 July 2020 the Ukrainian Parliament adopted Draft Law No. 3739. How grounded are the regulations on the localization of production and what consequences can be anticipated?

Parliament passed Draft Law No. 2655 On Cloud Services in the first reading. It would introduce Suite, (Office 365); unfortunately, there are no Ukrainian alternatives to most foreign SaaS.

On 21 July 2020, the Ukrainian Parliament adopted Draft Law No. 3739 On Amendments to the Law of Ukraine On Public Procurements in the first reading.

The Draft introduces a local content requirement in public procurement for a period of 10 years starting from 1 January 2021. If adopted, the said requirement will cover such products as vehicles for the needs of energy, municipal transport, and housing and assumes that public procurement of these goods will be allowed only if localization of their production in Ukraine reaches a certain level specified in the Draft Law On Localization. The prescribed levels of localization range from 25% to 40% for the period of 2021-2024 and rises up to 60% from 2024.

In general, public procurement could be an effective tool for protection of local manufacturers and for the attainment of economic goals in Ukraine. However, the effectiveness of the proposed Draft is questionable.

The Draft may endanger the main idea of transparent public procurement, namely the supply of goods of the highest quality at the most reasonable prices. Compliance with a local content requirement may increase the prices of goods participating in public procurement and lead to additional expenses.

In addition, provisions of the Draft may create obstacles for the participation of importers in public procurement and, at the same time, create unjustified preferences for domestic producers. Adoption of such a discriminatory criterion conflicts with the international obligations of Ukraine under the WTO framework as well as under the Association Agreement between Ukraine and the EU. The Draft has been criticized by the EU Delegation to Ukraine and the American Chamber of Commerce.

Although national manufacturing industries do need state support, the means proposed by the Draft are far from the best solution. The provisions of the Draft are discriminatory and have already raised concerns from international partners and anti-monopoly authorities.

At the end of July the NBU adopted the new regulation related to financial monitoring. How do you evaluate the amendments to the order in which financial monitoring is carried out, and what are they the result of?

The regulation on financial monitoring by financial companies, which came into effect on 30 July 2020, intends to replace outdated regulations of the Financial Services Commission and implement new requirements of financial monitoring legislation. The National Bank of Ukraine adopted this regulation after taking over regulatory functions over non-bank financial companies as a result of the so-called split law.

A number of positive developments in the new financial monitoring regime are similar to those introduced earlier by the NBU for banks. In particular, the regulation promotes a risk-oriented approach to financial monitoring, which should correspond to the nature and range of activities of a specific financial company. When organizing their internal financial monitoring systems, each financial company must develop risk criteria. The NBU still leaves wide discretion for the companies in developing such criteria, given that the regulation contains only indicative lists to take into account. Similar to banks, financial companies are allowed to carry out risk assessment with respect to groups of clients (rather than individual clients) based on parameters set out in their internal regulations (e.g. social status or the total value of financial transactions).

At the same time, some of the requirements are simpler in comparison with those applicable to banks. Although financial companies must appoint an employee responsible for financial monitoring, there is no requirement for the NBU to approve that appointment. Moreover, it is not necessary (but still permissible) for financial companies to establish a separate financial monitoring structural unit. One more notable relaxation is that financial companies may verify clients based on e-passports available at DIIA (portal of state online services).

Together with the described regulation, the NBU also adopted a regulation setting out sanctions for violation by financial companies of financial monitoring legislation. These two regulations laid down the basis for the new financial monitoring regime on the non-bank financial services market.

On 4 August 2020 Parliament registered Draft Law No. 3955 On Amendments to Certain Legislative Acts of Ukraine Regarding the Management of State Unitary Enterprises and Business Entities in which the state has a 50% or more shareholding. What are the changes envisaged by the Draft Law and how will these changes influence the work of state-owned entities?

Although according to the authors of the Draft the intention is to ensure efficient governance of state-owned enterprises this piece of legislation could, in actual fact, rightfully be labeled a Trojan Horse constructed to impede corporate governance reform in Ukraines state sector. It contains a list of quite controversial provisions that will change not only the governance structure but also the entire policy of governance of state-owned enterprises. The key novelties are as follows:

1. If the Draft is adopted in its current wording, the powers of Supervisory Board members of state unitary enterprises would be automatically terminated. Moreover, the Supervisory Board of state unitary enterprises would cease to be a corporate governing body. The directors of state unitary enterprises would instead be appointed by the relevant state bodies authorized to manage these entities.

2. The new qualification criteria for the Supervisory Board members of business entities with more than 50% state ownership will be introduced. Consequently, the election of new Supervisory Board members will have to take place, while the powers of current Supervisory Board members would be terminated at the moment of such re-election.

3. Foreign nationals would be prohibited from serving as members of the Supervisory Board of business entities in which the state has a stake of 50% or more, state-owned banks, and state defence sector enterprises (i.e., State Concern Ukroboronprom). Additionally, dismissed independent foreign national members of Supervisory Boards would be required to file E-Declarations immediately upon termination of their office and one year after termination.

While it is too early to comment on the overall effect the Draft Law may trigger, it is already obvious that discussion around the document will not go unnoticed. Generally, the fact that some MPs are trying to introduce changes of such a nature demonstrates that there is still room left for debate as to whether Ukraines state sector is actually ready to follow good governance practices and to engage with top-notch experts. Needless to say, the Draft Law will test whether or not the desire of the Ukrainian government to continue reforms has firmed up.

Parliament has registered Draft Law No. 3979 On Measures to Stimulate the Development of the IT Industry in Ukraine. What are the main provisions proposed by the draft, and how relevant is the topic of taxation of the IT industry?

Draft Law No. 3979 of 11 August 2020 is one of a series of draft laws that belong to a broader discussion between the Ministry of Digital Transformation and the IT industry on the DIA City project. Originally, the DIA City project was presented as a one of a kind special regime for the IT industry that would enable the residents of this project to use English law in their contracts, establish digital currency exchanges, ignore existing labor legislation in relation to their employees, and enjoy special dispute resolution procedures, state guarantees for investments and more. Most of the concept idea was incompatible with the Ukrainian regulatory system and the countrys Constitution. Therefore, the Ministry reduced its ambition for the establishment of a special economic regime applicable to certain types of companies (residents of DIA City) in exchange for certain tax benefits, which was then reflected in the Draft Law. In short, this Draft Law is a place holder that was prepared by the Ministry and filed by MPs to save a spot in the registry of draft laws to be then amended and filled with more elaborated details, including the details of the proposed tax regime. In its current version, the Draft Law proposes to create two special tax regimes: (i) for companies residents of DIA City; and (ii) for employees of such companies. IT companies are eligible to apply for this regime in case they: (a) are registered and function as an IT company; (b) have an average salary of EUR 1,500; (c) spend 70% or more of their income on salaries; and (d) receive 70% of their income from the export of their services. The Draft Law defines the Ministry as a new IT industry regulator that would be responsible for the admission of IT companies to this special regime and corresponding tax benefits. The Draft Law restricts IT companies admitted to the regime from engaging private contractors, which is currently the most popular practice in the IT industry. In overall terms, the IT industry supports the idea of the DIA City. However, it is essential for the industry to avoid creating new regulators or increasing the tax burden, and to preserve the opportunity to engage contractors and the certainty that all IT companies would be able to continue their business as usual with or without the DIA City regime.

On 13 August Law No.768-IX, which regulates gambling, came into force. What are the differences between the adopted version of the law and previous ones, and what aspects of it should get the greatest attention?

Six years have passed since the inception of the new concept of a new gambling regulation, promised to end the encompassing gambling ban of 2009. With hundreds of draft laws and tens of thousands of proposals submitted, Parliament adopted the new gambling framework in July 2020.

The coming into force of the Gambling Law finally ended the formal gambling ban and gave a chance for the Ukrainian market to be reborn. And this did not go unseen: new regulatory environment makes Ukraine a newsmaker on the international gambling market in 2020.

Despite vibrant optimism, I would still mention several issues to consider before setting up business in Ukraine:

Lottery matters

The first drafts of the Gambling Law envisaged that lotteries were included in their scope and recognized as games of chance. The final version of the Gambling Law sticks to the idea of split regulation: lotteries are not considered as games of chance and will be governed by the current (yet outdated) State Lotteries Law.

Questions arise: will the split regulation coexist peacefully when even experts struggle to spot the difference between a lottery and a game of chance?

The Gambling Law welcomes foreign gambling operators to set up in Ukraine. But the provisions of the State Lotteries Law are worded in such a way that foreign investors are unlikely to get access to the national lottery business.

State Online Monitoring System and License Fees

The exact amounts of the license fees are also unknown at the moment. The Gambling Law states that until the launch of the State Online Monitoring System, license fees for online casino, betting and slot machines are tripled.

This system is aimed at ensuring control over the gambling market and to prevent commercial and fiscal fraud. It is planned that the system will become fully operational 2.5 years after the Gambling Law has come into force. Will it be launched by then? Thats a big, expensive question for every foreign investor.

The President of Ukraine placed a veto on the law that puts a moratorium on debt collection. What are the reasons behind this decision, and how do you evaluate the law in general?

The Draft, submitted to Parliament in June and voted on in its original version, introduced an even greater imbalance between creditors and foreign currency debtors than the moratorium law itself. Its authors not only unreasonably argued that the Bankruptcy Procedure Code did not solve the problems of debtors and the moratorium should be continued, but the wording of the amendments extended the moratorium to any debts in principle. The Presidents veto and his proposals to the law are an attempt to find a golden mean and eliminate the possibility of abuse of the moratorium by fully solvent debtors with the aim of further evading obligations and court decisions. The President also proposed to shorten the period for extending the moratorium by another six months until April 2021 (the law adopted by Parliament established it until January 2022). At the same time, the President refers to the quarantine due to COVID-19 as the reason for extending the moratorium for another six months. In so doing, he contradicts his own statements about the ability of foreign currency borrowers to restructure debts and to eventually begin to repay them, which was possible even during the quarantine. Such debtors had a whole year to do this, but the majority still decided to continue to evade the fulfillment of obligations.

Overcoming the veto and the adoption of the law in the initial version will have irreversible consequences both for the investment climate in Ukraine (which investor will invest in the economy, where does a creditor becomes a hostage of the debtor?) and for ordinary Ukrainians who will simply lose the possibility of getting a mortgage to buy a place to live, which the majority cannot do without external borrowing.

Law No. 816-IX, which reforms Intellectual Property legislation came into force. What are the arguments for such amendments, and what is your viewpoint on them?

The purpose of reform of the intellectual property legislation of Ukraine was to harmonize it with European legislation in this field. However, in practice, we obtained the Law On Protection of Rights to Inventions and Utility Models, which raises many questions.

It was surprising and inexplicable to exclude the subject matter of the inventions use from the subject matters whose legal protection is granted (Part 2 Article 6 of Law).

In p.7 art.7 of Law it is stated that new forms of the drug known from the prior art including salts, esters, ethers, compositions, combinations and other derivatives, polymorphs, metabolites, pure forms, particle sizes, isomers, if they do not differ significantly in efficiency, can be recognized as such that are obvious from the prior art. The question arises that only these subject matters are obvious from the prior art, other subject matters cannot be obvious to a person skilled in the art. This provision should not be in the Law since during the substantive examination the examiner must consider each claimed subject matter regardless of whether the subject matter is a compound, salt, device or method for its obviousness based on the prior art. Thus, the purpose of specifying this is not clear.

With regard to Article 271 of the Law (Supplementary protection of rights to inventions), it is inexplicable why only a patent owner who filed a request for registration of a drug in Ukraine within one year from the date of filing of such a request first in any country has the right to extend the validity of a patent. Such a provision of Law does not meet international rules in IP, particularly Article 220 (Supplementary protection certificate) EU-Ukraine Association Agreement ratified on 1 September 2017 and Regulations (EC) No 469/2009 of 6 May 2009.

At the same time, the Law left unresolved a number of issues that are critical. For example, filing the divisional application (Art.171 of Law), etc. In our opinion, the Law can have an adverse effect on the development of innovation in Ukraine.

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