Labor relations between employees and residents of DiiaCity in Ukraine
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Companies that have obtained or are planning to obtain resident status in Diia City enjoy a range of benefits, including:
- Wide range of options for utilizing foreign financial management mechanisms.
- Expanded avenues for structuring employment relationships.
In this article, we will delve into relationships with employees and contractors.
Residents of Diia City have the flexibility to establish employment relationships or contract arrangements using various contract types, including:
- Employment agreement;
- Gig contract;
- Contract for services/work with an individual entrepreneur or individual.
Each of these contract types has its own set of advantages and disadvantages, which we will explore further.
Our company not only helps you understand the pros and cons of Diia City residency, but also provides expert guidance on whether it is the right fit for your specific company. If it is, we can assist in seamlessly transitioning your company and employees to Diia City residency, ensuring a smooth and efficient process.
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The Distinction Between Employment Agreements and Gig Contracts
An employment agreement is a formal agreement that outlines the relationship between an employer and an employee. When an employment agreement is signed, it establishes an employment relationship.
This includes (but is not limited to):
- Hiring the employee for a specific position
- The employee performing work within the scope of their job description and tasks assigned by the organization's management
- The employee adhering to the company's work schedule
- The employee working at the employer's designated location and using the employer's equipment
- The employee receiving salary according to the salary and rate specified in the staffing schedule (at least twice a month)
- The employee's entitlement to social benefits (such as annual paid leave of 24 calendar days, sick leave with pay, etc.)
- If the company loses its resident status in Dia City, the employment relationship is not terminated
- Regulated by the Labor Code of Ukraine.
A gig contract is a type of legal agreement that governs the relationship between an organization (a resident of Diia City) and a gig specialist.
Please note! Gig contracts are exclusively made with residents of Diia City.
Under a gig contract, the following provisions apply:
- The gig specialist (an individual who provides services or completes work) performs tasks and/or services for the customer - a resident of Diia City.
- The resident of Diia City pays compensation for the work performed by the gig specialist.
- The amount of compensation and payment terms are specified in the contract.
- The resident of Diia City provides suitable conditions for the gig specialist to carry out the work (e.g., may provide necessary equipment and tools for service provision) and social benefits (such as annual paid leave of at least 17 working days, paid sick leave, etc.).
- The gig specialist chooses the place of work, unless otherwise specified in the contract.
- The possibility of applying NDA (Non-Disclosure Agreement) and NCA (Non-Compete Agreement).
- The gig contract is considered terminated on the last day of the third month following the month in which the residency status is lost by the company.
- Regulated by the Law "On Stimulating the Development of the Digital Economy in Ukraine".
Please note! Gig contracts can be used not only for IT specialists, but also for employees who perform specific roles or functions within a company.
A civil law contract (referred to as a CLC) s a legal agreement that governs the relationship between a company and an individual or sole proprietor. It is used for specific work or service arrangements and should not have any characteristics of an employment relationship.
Please note! CLCs are commonly used for short-term or seasonal work. The contract cannot exceed a duration of 3 months or have a permanent nature. Otherwise, it may be considered an employment relationship. In other words, if you want to avoid providing social guarantees such as paid leave or sick pay, and opt for a CLC with an employee instead of an employment or gig contract (for a period longer than 3 months), there may be potential tax risks involved.
In a civil law contract (CLC), the relationship involves the following (not limited to):
- The contractor performs work and/or provides services to the customer, who is a resident of Diya City.
- The resident of Diya City pays compensation for the work performed by the contractor.
- The details of the work and the deadlines for completion are specified in the contract.
- The amount of compensation and the payment timelines are indicated in the CLC.
A sole proprietorship service agreement is a contract that outlines the relationship between a company and an individual operating as a sole proprietor. This type of contract is typically used when specific work or services are being provided, and it mustn’t resemble an employment relationship.
In a sole proprietorship service agreement, the relationship involves the following (not limited to):
- The contractor performs work and/or provides services to the customer, who is a resident of Diia City.
- The resident of Diia City pays remuneration for the work performed by the contractor.
- The details of the work and the deadlines for completion are specified in the contract, Technical Assignment, and the Act of Services Rendered/Work Performed.
- The amount of remuneration and the payment timelines are indicated in the contract.
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Documenting labor and gig relationships
When it comes to documenting employment and gig relationships, there are similarities between the two, despite some differences in the contracts.
Please note! Unlike employment contracts, there are no standardized forms for gig contracts that must be used. However, our experts recommend creating internal documents that can serve as evidence of work completed under a gig contract.
Let's go over the list of such documents at each stage of collaboration with employees/gig specialists.
Hiring a Freelancer in Diia City/Starting Work on a Gig Contract
1) For Employment Relationship:
- Employment Agreement
- Job Application
- Offer of Employment
- Employment Contract
- Notification of Employee's Acceptance of Employment (to be provided at least one day prior to the start of work)
- Notification to the Territorial Service Center of Conscription about the Hiring of a Conscripted Employee
- Job Description
- Timekeeping Record
- Payroll Register
2) For Gig Contract Relationship:
- Order for Formalizing the Gig Contract
- Gig Contract
- Notification of Commencing Collaboration with Gig Specialist (to be provided at least one day prior to the conclusion of the gig contract)
- Technical Assignment for Work Completion
- Acceptance Report for Completed Work/Services Rendered
1) For Employment Relationship:
- Vacation Schedule
- Request for Vacation
- Vacation Approval
2) For Gig Contract Relationship:
- Break Schedule for Gig Specialists
- Request for Paid Break
- Paid Break Approval
Ending Employment for a Diia City Resident/Gig Contract Termination
1) For Employment Relationship:
- Resignation Letter
- Termination Order
- Final Payroll Record (including details of the employee's final settlement)
2) For Gig Contract Relationship:
- Written Notice of Gig Contract Termination
- Final Payroll Record (including details of the gig specialist's final settlement)
- Based on the information provided, it can be concluded that a gig contract offers greater flexibility, allowing employers and specialists to document the actual terms and conditions of the work performed.
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Taxation of Payments for Employment Agreements and Gig Contracts in Diia City
In Diia City, there are unified rules for taxing payments to residents under both employment contracts and gig contracts, regardless of whether they are corporate income tax payers on general grounds or use a special tax regime.
Employees and gig specialists are subject to the following taxes:
- 5% personal income tax (PIT);
- 1.5% military tax;
- Fixed single social contribution at a rate of 22% of the minimum wage (as of January 1, 2023, the minimum single social contribution amount is 1474 UAH).
So, if an employee worked a full month at the full rate with a salary of 20,000 UAH, or a gig specialist provided services and received compensation of 20,000 UAH according to the terms of the contract, the calculation would look as follows:
1) Gross earnings/compensation under the employment agreement or gig contract - 20,000 UAH
2) Deduction of the personal income tax and military tax:
- 20,000 UAH * 5% = 1,000 UAH
- 20,000 UAH * 1.5% = 300 UAH
3) Net earnings/compensation under the employment agreement or gig contract to be paid: 20,000 UAH - 1,000 UAH - 300 UAH = 18,700 UAH.
On the other hand, Diia City non-resident employees are subject to a personal income tax rate of 18%, and the net amount payable would be 16,100 UAH.
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Reservation of Workers by Residents
Residents of Diia City have the option to apply for reserving 50% of conscripted workers with whom they have established employment relationships.
Please note! Gig specialists are not eligible for reservation.
Before submitting an application for reservation, a resident must ensure that they meet the criteria for critical business. Specifically, they must meet at least two of the following criteria:
- The amount of taxes paid during the reporting year exceeds the equivalent of 1.5 million euros;
- The amount of foreign currency receipts to the bank account (excluding loans and borrowings) exceeds the equivalent of 32 million euros;
- The company is classified as strategically important;
- The company has no arrears on the unified social contribution;
- The average monthly salary of employees (for the last quarter) under employment contracts is not less than the average monthly salary in the region.
If a resident meets 2 or more of these criteria, they have the right to apply for the reservation of workers.
Residents of Diia City can submit such applications to the Ministry of Digital Transformation of Ukraine.
Documents to be submitted along with the application:
- Copies of supporting documents that confirm compliance with the criteria (Certificate from the tax office confirming no outstanding dues on unified social contribution / Bank statement showing foreign currency receipts / Company's statement on average monthly salaries of employees, and others);
- Copy of the income tax declaration for the most recent reporting period (along with receipt of acceptance).
After processing the application, the Ministry of Digital Transformation of Ukraine will issue a decision on whether the resident of Diia City qualifies as a critical business or not.
If the company is deemed eligible, the next step is the reservation process, which includes the following stages:
- Formation of a list of conscripted workers who are subject to the reservation;
- Submission of the list to the Ministry of Digital Transformation of Ukraine;
- Verification of the list by the Ministry;
- Coordination of the list with the General Staff;
- Decision by the Ministry of Economy on the reservation;
- Issuance of deferment;
- Receipt of a statement from the resident confirming the granting of deferment to workers;
- Submission of notification to the territorial conscription center regarding workers' deferment.
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Restrictions on Establishing Relationships between Individual Entrepreneurs and Residents of Diia City
Using a payment scheme involving individual entrepreneurs is a common practice in the IT industry. However, when obtaining the status of a resident of Diia City, there are certain limitations on collaborating with individual entrepreneurs.
Residents of Diia City who are subject to regular corporate income tax at a rate of 18% based on their financial results, and whose annual income does not exceed 40 million UAH, can collaborate with individual entrepreneurs without any restrictions.
For other residents, payments to individual entrepreneurs should not exceed:
- 50% of total expenses from the previous year (limitation effective from 2024);
- 20% of total expenses from the previous year (limitation effective from 2025);
Note: During the year 2023, there is a transitional period in effect, and limitations on payments to individual entrepreneurs are not applicable.
What are the consequences for those who surpass the limits?
For residents who pay corporate income tax under the general system, any amounts that exceed the limit are included in their financial result, resulting in a zero balance (services received from individual entrepreneurs are simultaneously recorded as both income and expenses).
For residents who pay corporate income tax under a special tax regime, any amounts that exceed the limit are subject to a 9% tax on top of the regular income tax.
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Case Study: Financial Analysis of Pros and Cons of Transitioning to Special Tax Regime for Diia City Resident
We have received a request from a client who is planning to become a resident of Diya City and is seeking consultation on the unique aspects of taxation and financial processes for residents.
The company intends to become a Diia City resident and considers:
- Which employees to transfer to different types of contracts.
- Whether transitioning to a special tax regime would be advantageous.
The client's company currently has 3 employees under employment agreements and has signed 100 contracts with individual entrepreneurs (IEs) for IT services.
Note: The contractual cost of services provided by IEs includes a 5% unified tax payment made by IEs to the budget.
To calculate the potential financial benefits, we need to know the projected annual figures for the company:
- Plan for revenues
- Plan for expenses (including who they will be paid to: individual entrepreneurs or general taxpayers)
- Plan for payroll costs (wages and related taxes).
Unfortunately, the client does not currently employ comprehensive forecasting and planning methods. Therefore, we have conducted a financial analysis of the benefits of obtaining Diia City resident status under the special tax regime based on the previous year's data. Specifically, we have calculated how the taxes would have changed if the client had obtained Diia City resident status from 2022.
In actuality, for the year 2022, the company paid a total of 1.6 million UAH in taxes:
- 1.2 million UAH for corporate income tax
- 0.4 million UAH for payroll taxes.
For the same year, individual entrepreneurs paid a total of 9 million UAH in taxes:
- 6.9 million UAH for unified tax payment
- 2.0 million UAH for minimum social security contribution.
Overall, the total taxes paid by the company and individual entrepreneurs amounted to 10.6 million UAH.
How much would a company have paid in taxes if it had been under the special tax regime in Diia City?
Scenario: Let’s retain payments to individual entrepreneurs at 20% of the previous year's expenses, while transitioning other employees to gig contracts or employment agreements.
In 2022, the company could have paid a total of 10.4 million UAH in taxes, including:
- 0 million UAH in corporate income tax
- 10.4 million UAH in taxes on wages and gig-rewards
Similarly, the individual entrepreneurs could have paid a total of 0.6 million UAH in taxes for 2022, comprising of:
- 0.6 million UAH in unified tax
- 14,000 UAH as the minimum amount for the single social contribution
Overall, the combined tax amount for the company and the individual entrepreneurs would amount to 11.0 million UAH.
The calculations indicate that continuing to use the special tax regime would not be financially advantageous for the company, as it would result in a 400,000 UAH increase in the total tax amount.
We have advised our client to:
- Stay on the general taxation system for an additional year after obtaining resident status in Diia City.
- Implement financial planning to gain a better understanding of the company's financial health over the next six months to a year.
- Calculate the projected corporate income tax, taking into account the financial planning, two months before the end of the year.
Please note! This is just one example, and the financial benefits may vary for each business and need to be calculated on a case-by-case basis.
If you are interested in knowing the financial benefits of transitioning to Diia City for your specific business, please don't hesitate to contact us!
You can find the cost of our services here.
We provide assistance with registering as a resident in Diia City and managing the process of establishing new relationships with your employees.