Ukrainian taxation regulations in the field of IT service
IT Ukraine Research
16 February 2016
Taxation when purchasing IT services from Ukrainian entities or freelancers
The following applies only to the purchase of IT services from a Ukraine-registered legal entity or individual freelancer – not to cases when the Ukrainian service provider operates via an entity registered in another country, with work subcontracted to a Ukrainian entity or Ukrainian freelancers.
• IT services purchased directly from a Ukrainian entity
If the client is a non-resident entity, IT services are generally not subject to Ukrainian VAT, since under Ukrainian law the place of supply is not in Ukraine but where client is located. In particular this applies to R&D services, software testing, data processing, consulting on informatization, and related functions.
• IT services purchased from Ukrainian independent contractors (freelancers)
These services are also not subject to Ukrainian VAT. Ukrainian freelancers are mostly registered under the “unified tax regime” and thus liable for the “unified tax,” with a rate ranging from 2% to 4% of their earnings.
Foreign clients may face tax issues, however, due to the lack of flexibility of payment methods. For example, it is still not possible to use PayPal to send money to a Ukrainian resident. (This restriction is expected to be lifted in 2016.)
Taxation of resident entities
As companies established in Ukraine, subsidiaries of foreign companies involved in IT software development will be liable to certain Ukrainian taxes.
Generally, salary outlay is the most significant expense for Ukrainian IT companies (up to 60% of a company’s total expenditures). Salary taxes comprise a unified social security contribution (USCC) of up to 40% (mostly on top of net salary) and personal income tax (PIT) up to 20%. Pursuant to the high tax rates, the tax base is capped at approx. 23,000 hryvnias (approx. $1,000 as of November 2015) for the USCC. The lower rate of PIT is applied to salaries below 12,000 hryvnias (approx. $500 as of November 2015). Salaries above this threshold are taxed at 20% PIT. As a temporary measure, all salaries are also subject to a military assessment of 1.5%, which is applied to the gross amount without the cap.
Many companies want to reduce these costs by hiring freelancers as opposed to full-time staff. In this case, the salary tax burden could be reduced to approx. 4% -5%. However, such a structuration requires careful tax and legal analysis.
Most of the services provided by the subsidiary to its mother company will not be subject to Ukrainian VAT, as the place of their supply is not in Ukraine.
Furthermore, software development services within the territory of Ukraine are exempt from VAT. This special incentive is valid through 1 January 2023. Therefore, IT companies enjoy a favorable VAT rate on most services. VAT may only affect such related costs as office rent, etc.
The corporate income tax rate is 18%. Usually these types of businesses operate on a cost-plus model, so the margin that an IT company will earn will be taxed at 18%.
In addition to the above, Ukrainian companies are liable to anti-avoidance regulations, namely currency control and transfer pricing (TP) rules:
- Currency control: 75% of foreign currency income must be converted into Ukrainian currency.
- TP rules: If a company’s transactions fall under TP control , the company must submit a TP report and provide TP documentation upon request from the tax authorities.
If the annual earnings of an IT company (or any other company) do not exceed 20 million hryvnias (approx. $865,000 as of November 2015), the company can be registered as a unified taxpayer. Unified taxpayers pay the unified tax at the rate of 2% or 4% (depending on the VAT regime) instead of the corporate income tax. TP rules are not applicable to unified taxpayers. Moreover, the salary taxes paid by the employer are significantly lower than the standard rates.
Potential changes in tax regimes
Current discussions of tax reform may lead to significant changes in Ukrainian tax legislation. In particular, lowering the annual earnings limit to benefit from the unified tax regime is being considered, with the aim of stimulating the development of small businesses. On the other hand, some lawmakers are considering putting an end to the VAT exemption for IT companies.
Moreover, a draft bill inspired by the Estonian tax legislation might lead to significant changes in the corporate income tax regime in Ukraine. Under this proposed variant, corporate income tax would apply only to distributed profit, such as dividends and ‘quasi dividends.’ Profit reinvested in the company would be exempt from taxation.
1 Software development services include the development of operating systems, entertainment and/or educational computer programs or their components, websites and other online services as well as cryptographic means of information security.
2 The company’s transactions with related parties fall under TP control if the following conditions are met:
- the taxpayer’s annual income exceeds 50 mln hryvnias.
- the volume of transactions with this counterparty exceeds 5 mln hryvnias.