The bill on the elimination of the independence of anti-corruption bodies was written and voted on in 5 hours. At the same time, defense companies have been waiting for the 12th year for major legislative changes to stimulate the production of Ukrainian weapons.
Attempts to address regulatory challenges in arms production have largely been limited to ad hoc legislative changes and "experimental" government decrees. Many of these have played an important role in deregulating and simplifying rules for defense companies.
But a truly comprehensive initiative that would not just remove the spokes from the wheels, but would create favorable conditions for the development of weapons production, has only now appeared.
The new legal regime was called Defence City (by analogy with the Action City for the IT industry). With it, the deputies plan to introduce tax breaks, simplified customs rules, a relocation mechanism, open access to the global market, limit the publication of sensitive data about defense companies, and exempt from liability for certain types of offenses.
As one of Defence's interlocutors at the Ministry of Defense said, the initial idea is to support "champion companies," that is, the largest weapons manufacturers, which need to be given the opportunity to realize their full potential.
The new regime is to be implemented by four draft laws No. 13420, No. 13421, No. 13422, No. 13423, which provide for changes to various codes: Tax, Customs, Budget, Criminal, and Criminal Procedure. Two of them have already passed the first reading in the Rada.
Armed associations surveyed by Oboronka unanimously support Defence City, but warn that the initiative contains shortcomings that need to be changed before the second reading so that a good idea does not drown in poor implementation.
What new things will gunsmiths get?
Residents of Defence City will get a chance to address most of the chronic problems that industry associations have been talking about for years. Among the main changes:
The first is the introduction of a special tax regime. Companies will be able to avoid paying income tax if they reinvest this money in production and refuse to pay dividends to owners (except in cases where the owner is the state). Weapons manufacturers will also be exempted from land, real estate, and environmental taxes without additional conditions.
This norm should potentially solve the problem, according to gunsmiths, of the low profitability of defense sector companies, which every year need to invest more and more money in new developments, production development, and post-flight recovery.
Residents will be able to choose a convenient tax regime for themselves at any time. For example, a company can avoid paying income tax for several years, actively invest in production development, scale up, and later switch to a standard taxation regime without investment obligations and dividend payments.
The second is the simplification of customs rules for imported components. This should speed up formal procedures when passing customs control.
Third, for the first time since 2022, defense companies will have a clear mechanism for selling weapons and technologies abroad. The weapons manufacturer will need to obtain a special export license and pay a certain amount of fee. Thus, the Ukrainian army will also benefit from exports.
And to export production technologies, it is necessary that the recipient of the technology abroad is the exporter's company. At the same time, the country to which the technology is exported must have a corresponding agreement with the Ministry of Defense.
Fourth, partial closure of public company data. Defense associations complain that anyone can access YouControl and obtain revenue data and estimate the growth of production of any defense company, or obtain data on its owners. The publication of certain sensitive data on Defense City residents will be suspended.
Fifth - a mechanism for relocation to safer regions of Ukraine. This will be done by distributing part of the taxes from the salaries of company employees to the budget of the community that will host the enterprise and build infrastructure for it.
Conceptually, such a set of benefits should remove a significant part of the "stoppers" for the Ukrainian defense industry. But the devil is in the details.
Rules for everyone or a "club of the chosen ones"?
They want to make the legal regime available only to companies that will be manually included in the list of the Ministry of Defence. And they will be included in this list according to special criteria. 90% of the company's income must come from the sale or maintenance of weapons for the Defense Forces. It must also not have overdue contracts for more than 60 days and be a resident of other legal regimes, in particular, Diya City.
"The threshold of 90% of revenue from state customers is unrealistic in some cases. And if a defense company operates in a civilian direction, which overlaps 11% of revenue, then it ceases to be strategic? And if the company is contracted by charitable foundations for 30%, which provide a significant part of the defense order?
"The list should also include manufacturers of components for these weapons. We cannot be strategically independent with Chinese components," said Serhiy Goncharov, executive director of the NAUDI association.
The associations "Technological Forces of Ukraine" (TSU) and "Ukrainian Council of Gunsmiths" propose to reduce the percentage of required "arms" revenues and extend the criteria to manufacturers of dual-use goods, not just final products.
The issue of extending the new rules to as many defense companies as possible is one of the most pressing in the development of this reform. The gunsmiths interviewed by Defence agree that the criteria should be transparent, and the market rules should be equal for all participants, and not just for a closed "club of the chosen ones."
Another problem in the TSU is the impossibility of including companies that are already residents of Diya City in Defence City. This especially affects drone manufacturers. "It is important to preserve the opportunity for defense companies to be there and there. Otherwise, they will have to separate R&D centers and production enterprises. This is simply unnecessary bureaucracy and restrictions for the market," said the executive director of the TSU, Kateryna Mykhalko.
Oboronka's interlocutor from the Ministry of Defence explained that the norm of 90% of income is not final. Perhaps, in the final version of the bill, the figure will be changed downwards. Also, the meetings are looking for possible compromises on synchronizing Defence City with Diya City. One option is to give the company the opportunity to be in both regimes at the same time and choose the most convenient tax regime for itself.
Protection from law enforcement or amnesty for corrupt officials?
The most problematic part of Defence City turned out to be the part that provided for changes to the Criminal Code.
Residents of Defence City wanted to be freed from pressure from law enforcement agencies, who allegedly could abuse their position, disrupt production, and gain access to sensitive data during searches. Usually, in this context, the scandalous NABU searches of the manufacturer of thermal imagers Archer are mentioned.
One of the initiators of the bill, Danylo Hetmantsev, said on the "Economic Truth" podcast that the goal was also to exempt gunsmiths from liability for minor offenses, such as non-compliance with environmental standards, violation of labor legislation, violation of equipment operating rules, etc.
To implement this idea, two key innovations were proposed. First, all procedural actions against Defence City residents must be coordinated with the Prosecutor General. Second, the company's actions will not be considered violations if they were committed to strengthen the state's defense potential and did not create a threat to life or an environmental disaster.
If you carefully reread the second provision, the question immediately arises: how will the court determine that the company contributed to the defense capability by committing one or another offense? There is even a joke among gunsmiths: "I was forced to bribe an official, because otherwise I would not have received the contract and would not have been able to strengthen the defense capability of the state."
The corruption risks inherent in the bill outraged part of society, and the Ministry of Defense and deputies subsequently had to justify themselves to the ambassadors of the G7 countries at a separate meeting.
Voting for the "criminal" part of Defence City in this version could simply bury the entire initiative in the eyes of partners and society. Therefore, the deputies decided to simply postpone it for later, without even agreeing to the first reading.
Now, the initiators have registered a new bill in the Rada. It removed the scandalous provision on avoiding liability for offenses, but left the part according to which all cases against gunmakers must go through the Prosecutor General. This also raises questions among anti-corruption activists due to the possible politicization of investigations or their absence.
"For all three adopted bills, the only question is how to finalize them. But the fourth, even in its new version, is completely bad. This bill should simply be lost."
Many gunsmiths are really afraid that they will be prosecuted. However, our deputies do not want to hire good lawyers who would build the protection of these companies into various codes and clearly prescribe exceptions so that this does not lead to an imbalance in other processes and norms. This is an office of simple solutions, - said Tetyana Nikolayenko, a representative of the Public Anti-Corruption Council under the Ministry of Defence, to Defense.
In general, the idea of closing as many processes as possible to the Prosecutor General's Office fits into the general logic of the "monomajority" deputies, which we saw in the example of depriving the independence of the NABU and the SAPO. Therefore, discussions on this issue will continue.
Export with nuances
When talking about arms exports, they usually mention several risks for the state. The first is reputational, because Ukraine supposedly asks for weapons on the one hand, and sells them on the other. The second is that the state will be forced to compete for the capabilities of domestic enterprises with much richer foreigners. The third is that there will be a leak of technologies to unfriendly countries.
At least on paper, it looks like the export format proposed by Defence City should solve these problems. Reputational losses will be minimized by wrapping arms exports in the guise of "joint production with partners and mutually beneficial exchange of technologies." With the capabilities of domestic manufacturers, there will be no need to compete, because the Ministry of Defence will independently issue export licenses for products whose surplus it cannot buy up.
To prevent weapons from falling into the wrong hands, the state will be able to issue permits only to countries it deems safe. And the mandatory license fee paid by arms exporters will be directed to the needs of the Defense Forces, which will bring tangible financial benefits to the army and legitimize the idea of exports among the military.
Questions arise only about the norm that regulates the transfer of production technologies abroad. This is allowed only if the recipient of the technology is a foreign company that is 100% owned by the exporter himself. In other words, you can only transfer military technologies abroad to yourself.
The problem is that this makes it impossible to transfer technology to joint ventures that Ukrainian companies open with European partners. Some countries simply do not allow weapons manufacturers to enter their countries unless they share production with a local company. In this version, the norm significantly narrows the window of opportunity on the global market.
On the other hand, some Ukrainian defense companies are already effectively transferring their technologies abroad, which later end up in joint ventures with European companies to produce drones and armored vehicles. So it seems that a loophole for the transfer of Ukrainian technologies already exists. The only question is how legal it is.
Investment control
Residents of Defence City will have the opportunity to avoid paying income tax in exchange for waiving dividends and investing this money in the purchase, modernization, repair of machines, premises, construction of new workshops, training people, and in general everything that falls under the definition of "investment in development."
This will provide honest manufacturers with additional resources to scale and develop technologies. At the same time, it will also provide space for dishonest managers.
Here we can only hope that the state will be able to ensure control over manufacturers who will use the benefit. After all, "investments" can include, for example, the purchase of machines, services, and intellectual property objects at inflated prices with the subsequent withdrawal of funds.
Since the global defense market is very dynamic and monopolized in many segments, determining the "market prices" of certain goods and noticing anything suspicious in the declarations will be an even greater task.
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In general, defense associations surveyed by Defense characterize the discussion on Defense City as adequate. Gunsmiths, the Ministry of Defence and deputies meet from time to time, express their proposals, concerns and gradually prepare the norms for the second reading. According to the plan, it should take place in the second half of August, after the "vacation" of the Verkhovna Rada.