The principal structure of legislation consists of laws adopted by Parliament (Verkhovna Rada) and international agreements of Ukraine duly ratified or acceded to by Verkhovna Rada. Laws are implemented through various normative acts, which are adopted by the relevant government bodies (i.e. the President, the Cabinet of Ministers, Ministries and State Committees).

Ukrainian legislation provides that (with some few exceptions). Foreign investors are authorized to carry out their investment activity in Ukraine on the same basis as domestic investors. This relates to types of investments, available investment vehicles, and investment targets.

The Law of Ukraine On Investment Activity, adopted on 18 September 1991, establishes the general principles of investment activity on the territory of Ukraine, irrespective of the nationality of the investor.

Certain Peculiarities of making foreign investments in Ukraine are regulated by the Law of Ukraine On the Regime of Foreign Investment (the Foreign Investment Law), adopted on March 19, 1996.

1. Setting up the business by the foreign investor in Ukraine.

To start with, the current issue of the present article, taking into account that the legal entity considered is a foreign investor I have to mention that the regime of activity of the companies with foreign investment capital and domestic companies nowadays doesn’t differ, since the major purpose of such equality - to level the playing field for all companies on the Ukrainian market, mainly without providing the incentives for a much-needed injection of foreign investment capital.

The legal analysis hereof offer the general options for the foreign non-productive investor, without the conditions precedent, such as the type of economic activity, the major goals of such activity, long duration of the investors’ business plans. Therefore the following analysis considers the general conditions for the business startup, its development, financial activity, taxation and major legislative pitfalls, the foreign investor may face while conducting the business activity in Ukraine.

1.1.1. Types of companies/business structure to commence the business, company management structure.

The basic forms of companies are established by the Ukrainian Civil Code (No. 435-IV, dated January 16, 2003, effective January 1, 2004, hereinafter – Civil Code) and Economic Code (No. 436-IV, dated January 16, 2003, effective January 1, 2004, hereinafter – Economic Code) and by the Law of Ukraine “On Economic Associations”, therefore the major analysis are made, basing and referring to the above-mentioned basic by-laws, regulating the process of foundation and organization of enterprises in Ukraine.

Civil Code and Economic Code in their most efficient combination provide various types of companies, which are also known as legal entities – organizations, which are established and registered pursuant to the procedure established by law.

The following principal types of companies, certain types among which, present a special interest for us, can be founded in Ukraine:

1. Private enterprises;
2. Collective enterprises;
3. Communal enterprises;
4. State enterprises;
5. Other enterprises, which are provided by law. This “type” of companies, leaves plenty of space to add various types of companies in the future.

Civil and Economic Code, Law of Ukraine “On Economic Associations” govern the types of companies, known as economic associations or corporate enterprises, created as a rule, by two or more founders, pursuant to their mutual agreement, acting on the basis of union of property and/or entrepreneurial or labor activity of the founders (participants), and their mutual administration of affairs on the basis of corporate rights, including via the authorities, which are created thereby, and the participation of the founders (participants) in the division of profits and risks of the enterprise.

Among those companies are:

• Stock companies (Closed Joint - Stock Companies, Open Joint-Stock Company);
• Companies with limited liability; - Companies with additional liability;
• General partnerships;
• Limited partnerships.

Notwithstanding the range of business structures, offered under Ukrainian law, foreign companies’ options in Ukraine are limited to one of the following four alternative business structures:

• representative office – which is not a legal entity, however can be either commercial, leading economic activity or non-commercial.
• Wholly-owned foreign subsidiary or enterprise - usually with limited liability, which can be provided in their statutory documents.
• “joint ventures”- companies with foreign participation – either in form of a closed joint stock company or limited liability company. Ukrainian legislation permits a foreign investor to conduct business in Ukraine without creating a legal entity by entering into a Joint Activity Agreement with a Ukrainian legal entity.
• Agreements on joint cooperation and production, which do not require registration of a separate legal entity.

One significant consideration in selecting the appropriate business structure involves Ukrainian foreign currency legislation, which categorizes the above structures as either non-residents or residents, depending on the type of activities carried out by the structure. Non-commercial representative offices are usually considered “non-residents” under currency regulations and tax legislation, while subsidiaries and joint ventures are classified as residents because they are legal entities, registered and residing in Ukraine for more than 183 days per year. While the distinction is not clearly expressed in other laws, it is significant in terms of tax consequences and the ability of foreign businessmen to effectuate transactions in foreign or local Ukrainian currency.

Both subsidiaries and joint ventures have the status of separate corporate entities, and thus, both limit and investor’s liability to its initial investment. As Ukrainian corporate entities, joint ventures and subsidiaries are considered to be “residents” under Ukrainian currency legislation, they are subject to a different financial regime, than “non-residents”. For instance, resident companies must transact business in Ukrainian currency only, which has historically shown a disturbing tendency to devaluating and revaluating, thus such instability presents a possibility of impact on the profit earning of the company.

Whereas enterprises may be created for carrying out entrepreneurial activity or non-commercial activity, we are interested in considering in more details such type of enterprises as economic associations, which are created solely for the purpose of profit-generating activity. However, sometimes for reasons of corporate strategy, foreign investors register both structures (non-resident representative office and wholly-owned resident company), to give them greater flexibility in performing transactions in foreign and Ukrainian currency. In item 1.2. hereof we are going to analyze in greater details the possibilities of financial operations.

Let’s review the general characteristics of the above-listed legal entities, as for the better understanding of their business structure, so for the possibility to choose the most convenient for establishing and profit earning.

A.) A representative office of a foreign company is not a separate legal entity, but is considered to be a “representative” of a foreign company in the other country, being not incorporated under Ukrainian law, which simply represents the interests of a foreign legal entity on Ukrainian territory. Those offices are subject to a special financial regime under tax laws. The key function of such non-resident representative offices is to service existing contracts between the non-resident company and a Ukrainian customer, but not to engage in commercial activities on its own behalf. This arrangement legally allows the non-resident company to earn foreign currency abroad while expanding its market area in Ukraine.

On one hand, one has to admit a certain advantage of the representative office of a foreign company in Ukraine, over a Ukrainian company: the ability to legally earn foreign currency and to keep it abroad. On the other hand, it has its drawbacks either: it can enter into contracts only on behalf of the parent company, cannot carry out sales in Ukrainian currency, and hire full-time employees without registration with the relevant government agency.

B.) Wholly-owned foreign subsidiaries and joint ventures are usually organized in the form of either closed joint-stock companies or limited liability companies, correspondingly depending on the particular requirements of the project.

Whereas in the conditions precedent, I didn’t receive the detailed description of the projects, for the purposes of which the current legal opinion is composed, therefore the analysis below contain the review of both business forms of wholly - owned foreign subsidiaries as both “residents” under the Ukrainian currency and tax regulations and, both having the liability of founders and shareholders being limited only to the value of their contributions to the company and therefore considered more adequate form of business structure for foreign investor.

On one hand, one has to admit a certain advantage of the representative office of a foreign company in Ukraine, over a Ukrainian company: the ability to legally earn foreign currency and to keep it abroad. On the other hand, it has its drawbacks either: it can enter into contracts only on behalf of the parent company, cannot carry out sales in Ukrainian currency, and hire full-time employees without registration with the relevant government agency. B.) Wholly-owned foreign subsidiaries and joint ventures are usually organized in the form of either closed joint-stock companies or limited liability companies, correspondingly depending on the particular requirements of the project. Whereas in the conditions precedent, I didn’t receive the detailed description of the projects, for the purposes of which the current legal opinion is composed, therefore the analysis below contain the review of both business forms of wholly - owned foreign subsidiaries as both “residents” under the Ukrainian currency and tax regulations and, both having the liability of founders and shareholders being limited only to the value of their contributions to the company and therefore considered more adequate form of business structure for foreign investor.

Several differences exist between these types of companies. For example, in a limited liability company, the founders own equity in the company (or in the statutory capital of the company, formed by the contribution of the equities by the founders or by the founder), expressed by a percentage of ownership. Joint-stock company issues a share of stock, to be purchased by the founders and consequently form the statutory capital of the company. According to the Economic Code and the Law “On Economic Associations” a stock company requires at least two founders, which may be either legal entities or individuals. However Article 154 of the Civil Code states that “a joint stock company may be created by one entity or may consist of one entity in case of the acquisition by shareholder of all shares of the company”. Limited liability company is allowed to be founded by a sole founder, however according to the Civil Code it may not have another business company as its sole participant if such company has only one participant/shareholder in its shareholding.

The management structure of a stock company and that of a limited liability company is very similar with a few minor variations. The three-part structure is headed by the “general assembly of shareholders (in limited liability company - ”general assembly of participants”), which represents the interests of the company owners. The next level, “the supervisory council” - is optional in both types of enterprises; however it is commonly organized in the stock company structures, but smaller companies tend to disregard it. And, finally, Management board (“Executive board”), performs the company’s day-to-day functions.

In practice, simple joint venture or 100% foreign-owned companies usually register in the form of Limited Liability Company. This company structure allows a relatively small number of people to avoid a complex multi-layered management structure composed of a general assemble, supervisory council and management organs and to avoid registration of shares of stock. It is particularly attractive in cases of 100% foreign-owned companies because the charter can provide for one executive organ where the founder has complete and unequivocal control.

1.1.2. Capitalization issues.

The Law “On Economic Associations” governs the formation of joint stock companies and limited liability companies, and contains no limitations on the size of statutory capital for joint stock companies, provided however that the company’s statutory capital is divided into shares of stock of equal nominal value. The Law “On the Foreign Investment Regime” only encourages large amounts of foreign investment in all shapes and sizes. Accordingly, a joint stock company may have as large a statutory capital, as it wishes.

The minimum capitalization for registration of joint stock company is 1, 250 minimum monthly salaries, while the minimum statutory capital of Limited Liability Company must be at least 100 minimum monthly salaries. By the Law of Ukraine “On making amendments to the Law of Ukraine “On the State budget for the year 2006” the minimum monthly salary from the July 1, 2006, as it is actual for the current analysis, is established on the of UAH 375. Any Ukrainian and/or foreign investor is permitted to register a company subject to these absolute minimum.

As a result of recently enacted decree of the National Bank of Ukraine, a foreign investor may make cash contributions into a Ukrainian legal entity only through special investment accounts opened by the foreign investor with a Ukrainian commercial bank (as opposed to the transferring funds from abroad directly to the bank account of its Ukrainian subsidiary as was previously the case).

Shareholders of stock companies and founders in limited liability companies must make initial pre-registration deposits towards their contributions prior to registration. According to the Law “On Economic Associations”, 50% of a shareholder’s contribution must be paid prior to registration if shares are originally distributed amongst the founders of a joint stock company (30% if shares a re distributed via an open subscription – for open joint stock companies. In limited liability companies, however, the legislation is still unsettled as the Law “On Economic Associations” calls for a 30% of a participant’s contribution to be paid by the moment of state registration of a company, while a Civil Code requires 50% of a participants contribution to be paid prior to registration. In practice, since Civil Code is higher up than laws in the hierarchy of Ukrainian legislation, I believe, that the 50% rule governs. However, changes to the Law “On Economic Associations” are widely expected in the near future. The remaining sum must be paid, in its entirety, no later than one year after registration of both types o companies. In joint stock companies, shares of stock may be given to the shareholder only after they have fully paid for such shares. Note, that the founders may not circumvent these rules in the statute by providing, for instance, that the joint stock company may hold authorized but unissued stock for more than one year.

Foreign investors have the right to invest by using the following forms:

• hard currency;
• Ukrainian currency as a re-investment into the existing or a newly established enterprise;
• any movable or immovable property and property rights connected with it;
• shares, bonds, other securities and other corporate rights;
• monetary claims and claims under contracts, valued in a hard currency and guaranteed by first rank banks;
• any intellectual property rights with confirmed estimation in hard currency according to the laws of the investor's country of residence, including copyrights, trademarks, firm names, know-how, and others;
• rights in respect of economic activities, including exploration and utilisation of natural resources valued in hard currency and conferred and valued under the laws of the investor's resident country.

Foreign investment can be executed in the form of contribution of fixed assets in return for a share in the statutory capital of a Ukrainian company. These assets shall be valued in both foreign convertible and Ukrainian currency by agreement between the parties, based on International or Ukrainian market prices and using the applicable exchange rate of the National Bank of Ukraine. Please note that under current Ukrainian legislation foreign investment in kind is exempted from VAT and import duties. However, if the goods contributed are subject to excise duties, the exemption from VAT and import duties does not apply. If the investment is disposed of within 3 years from the moment of registering a foreign investment in the books of the Ukrainian entity, all the relevant import duties will be due.

Finalizing the item 1.1. herein, there is a need to mention that certain issues, such as: state registration of the company, details in the management structure organization, special requirements to the capitalization, management structure and type of company, depending on the type of economic activity, reputed to be carried by the foreign investor, are omitted on purpose. The purpose of such omission is, whereas, the present article has generally to be focused on the issues which are of the greatest interest for the investor. Describing the issues herein, the purpose is to give an overview of the corporate legislation and current situation on business set up in Ukraine. Subsequently, certain issues, being specified by the investor, shall be reviewed in a greater detail.

1.2. Business activity

1.2.1. Taxation

Legal entities, generally described above, incorporated to and operating under the legislation of Ukraine are normally treated as tax residents and are taxable on their world wide income. Legal entities incorporated abroad and operating under the laws of another country are normally treated as foreign tax residents and are taxable on two sources of income:

• Business income received from carrying out trade or business in Ukraine, and
• Other non-business income received from Ukrainian sources.

According tot he Law of Ukraine No. 334/94 “On Taxation of Profits of Enterprises”, dated December 28, 1994 (herein the “Profit Tax Law”), the tax on companies is known as corporate income tax. Currently, this tax is calculated at a flat rate 25%. However, that separate tax rules pertain to insurance companies, operations with securities and to agricultural enterprises.

Under domestic tax accounting rules, tax items are normally recognized on the basis of the cash-accrual method (first event rule). The tax year corresponds to the calendar year. Taxpayers must submit tax returns for a calendar quarter, half year, three quarters and calendar year, and make quarterly tax payments. Quarterly tax returns must be submitted within 40 days following the last calendar day of each calendar quarter, half year and three quarters and the fourth quarter.

Resident entities are taxable on their worldwide income received or accrued within a reporting period. The amount of taxable income is determined by subtracting allowable deductible expenses and capital allowance from gross income.

Gross income is defined as any income from domestic or foreign sources received or accrued by taxpayer from any activity. Such income may be in monetary, tangible and intangible form. The “Profit Tax Law” also describes the items included in and excluded from the gross income, deductible expenses etc. Capital allowance or, in other words, depreciation of fixed assets and intangible assets, under the “Tax Profit Law” means – the gradual carrying forward of expenses for the acquisition, manufacturing or improvement of such fixed and intangible assets and for decreasing the adjusted profit of a taxpayer.

Non-business income from Ukrainian sources is normally subject to withholding tax on a gross basis, provided such income is not attributable to a non-residents permanent establishment in Ukraine. Withholding is made by a resident taxpayer when income is paid to a non-resident.