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Setting up and operating a joint venture in Ukraine

Structure 

Are there any particular drivers in your jurisdiction that will determine how a joint venture is structured? 

Typical drivers for joint venture structures are industry practice, regulatory framework and taxation. 

For instance, Ukraine has a long-standing practice of joint venture agreements for cooperation in the oil and gas industries, owing to certain tax considerations. Certain regulated business activities can only be conducted by legal entities that are registered in the designated form (eg, banks can only operate as a public joint-stock company). Owing to possible double taxation, joint venture parties sometimes prefer to cooperate as an unincorporated business in the initial stages before proceeding to a joint corporate entity. 

Since February 2022, IT businesses that comply with certain criteria can apply for registration as so-called ‘Diya City residents’ and enjoy a number of statutory preferences, including a special taxation regime, flexibility hiring IT specialists and governing their engagement, the possibility to conclude non-competition agreements, and implement debt-to-equity swaps, etc. 

Tax considerations 

When establishing a joint venture, what tax considerations arise for the joint venture parties and the joint venture entity? How can tax charges be lawfully mitigated? 

An incorporated joint venture is a taxpayer under the general rules (regarding corporate profit tax, value added tax (VAT), real estate and other taxes). Since February? 2022, IT joint ventures eligible for registration as so-called ‘Diya City residents’ can, instead of the general system of taxation with corporate profit tax (at 18 per cent), opt to pay capital withdrawal tax at the rate of 9 per cent. Small undertakings whose annual income does not exceed certain thresholds (approximately 7.5 million hryvnias in 2022) may enjoy preferential taxation regimes. 

In the wake of the Russia-Ukraine war, which started on 24 February 2022, the Ukrainian government introduced an alternative system of taxation for joint ventures earning not more than 10 billion hryvnia annually: for the duration of martial law, such businesses can choose to pay 2 per cent turnover tax instead of 18 per cent corporate profit tax. 

Temporary VAT and corporate profit tax exemptions exist in the cinematography industry, and in the space and aircraft industries. After 24 February 2022 and for the duration of martial law in Ukraine, most imports for defence purposes and humanitarian aid are released from import VAT and customs duties. 

An unincorporated joint venture is subject to separate taxation, for which special tax accounting regulations apply. The joint venture agreement shall define a (resident) participant responsible for the venture’s tax accounting and payment; this participant and the agreement are registered by the tax office. 

In-kind contributions (as opposed to cash contributions) of founders or participants into the (both incorporated and unincorporated) joint venture trigger Ukrainian VAT, subject to further tax credit and refund. 

Asset contribution restriction 

Are there any restrictions on the contribution of assets to a joint venture entity? 

The parties can agree on the contribution of any assets into an unincorporated joint venture. Importantly, the investments of the parties are deemed of equal value if the parties do not state otherwise in their joint venture agreement. 

There are restrictions on the contribution of certain assets to the capital of a separate corporate entity. The following cannot be used for the formation of registered capital: 

     – budget and loaned funds; 
     – bills (promissory notes); 
     – state (municipal) property that cannot be privatised; and 
     – state property that is under the operational management of a state-financed institution. 

Interaction between constitution and agreement 

What is the interaction between the constitution of the joint venture entity and the agreement between the joint venture parties? 

For unincorporated joint ventures, the joint venture agreement shall be registered with the local tax office for VAT purposes if the total volume of VAT transactions in the last 12 calendar months exceeds 1?million hryvnias. Additionally, the joint venture partner responsible for tax accounting is subject to a separate registration with the tax office. 

In incorporated joint ventures, the parties can enter into a corporate (shareholder) agreement determining certain aspects of their cooperation as shareholders. Such agreement is not subject to registration and may not contradict the joint venture’s constituent documents (charter). In case of a conflict, the constituent documents shall prevail. 

As of 2021, non-Ukrainian law may be chosen for a corporate agreement if at least one of the shareholders of the joint venture is a non-resident party. 

Party interaction 

How may the joint venture parties interact with the joint venture entity? Are there any restrictions? 

In an incorporated joint venture entity, the shareholders can participate and vote at general shareholders’ meetings and, therefore, interact with the joint venture by governing it on the most important issues. The shareholders only have access to a limited amount of information regarding the entity. 

Exercising control 

How may the joint venture parties exercise control over the joint venture entity’s decision-making? 

In an unincorporated joint venture, the parties may agree that all affairs are to be carried out jointly by all shareholders. In such a case, the consent of all shareholders must be obtained to execute each transaction. 

In incorporated joint ventures, the shareholders may exercise their will through participating in general shareholders’ meetings. 

In joint-stock companies, most issues on the agenda of the general shareholders’ meetings are resolved by a simple majority vote of all participating shareholders. However, in a private joint-stock company, the shareholders can agree to a bigger quorum (eg, unanimous consent of all present shareholders) for any issues except: 

     – the pre-term termination of the powers of the company’s bodies’ officials; 
     – the commencement of a claim against the company’s officials regarding the reimbursement of damages incurred by the company; and 
     – the commencement of a claim regarding non-compliance with the law in the case of a significant transaction. 

Therefore, a minority investor can have more power and control over a private joint-stock company. 

In a joint-stock company, a qualified majority (more than 75 per cent of the present shareholders) is required to adopt the following decisions: 

     – an amendment of the company’s charter; 
     – a cancellation of the bought-out shares; 
     – changing the type of the company; 
     – regarding the placement of shares; 
     – changing the registered capital; 
     – the issue of securities that may be converted into shares; and 
     – the termination of the company. 

In a limited liability company (LLC), as a general rule, all issues are decided by an absolute majority of votes. However, issues of changing the charter and registered capital, reorganisation or liquidation of the company require a qualified majority (at least 75 per cent of the total number of votes of participants of the company). Unless the company charter sets a lower number of votes (but no less than a majority), unanimous decisions of all participants are required for: 

     – the approval of the monetary assessment of a non-pecuniary contribution of a participant; 
     – the redistribution of the participants’ shares; 
     – the establishment of other corporate bodies; and 
     – the purchase of a participant’s share by the company. 

The minority investors are also entitled to demand internal and external audits. For instance, minority shareholders that hold over 10 per cent of a joint-stock company may request a special review by an internal auditing committee or a proper inspection of financial accounts by an independent auditing firm. 

Governance issues 

What are the most common governance issues that arise in connection with joint ventures? How are these dealt with? 

In an unincorporated joint venture, the parties are free to establish special procedures relating to adopting decisions and running the business in a practical manner, according to the terms and conditions of a joint venture agreement. 

The two most common governance issues that arise for joint venture corporate entities are the presence of a quorum and adopting decisions on specific issues. 

In the case of corporate disputes, the parties may resolve them in the courts or through arbitration tribunals. Shareholders have more freedom and flexibility to handle governance issues through shareholder agreements. 

Nominee directors 

With an incorporated joint venture, what controls exist in your jurisdiction in relation to nominee directors? How should a nominee director balance the potentially conflicting interests of the joint venture company and the appointing shareholder? 

In Ukraine, a majority shareholder (participant) usually nominates a director, but the former must act in the best interests of the joint venture company. 

In LLCs, supervision over the board of directors can be exercised by a supervisory board (if foreseen by the charter) or another corporate body appointed by the general shareholders’ meeting, or both. The general shareholders’ meeting may delegate certain powers to the supervisory board, including the appointment and dismissal or suspension of the board of directors. Moreover, shareholders that hold at least 10 per cent of the charter capital may initiate a financial audit of the company by an independent auditor. The board of directors is obliged to provide documents regarding the company at the request of the auditor. 

In a joint-stock company, the executive body is accountable to the general shareholders’ meeting and supervisory board (including its standing auditing committee). The general shareholders’ meeting can elect an auditing commission as a separate corporate body as well. In public joint-stock companies, an annual audit by an independent and certified auditor is obligatory. The board of directors is obliged to provide documents regarding the company at the request of the audit commission or an auditor. 

Competition law 

What competition law considerations are engaged by the formation and operation of the joint venture? Is approval needed? 

Assuming the turnover thresholds are met, the creation and operation of the joint venture may trigger the need to obtain certain approvals. Depending on whether a joint venture will be full-function or not, there may be a need for clearance of: 
     – merger: in the case of a joint venture’s creation, if operating permanently, all the functions of an autonomous economic entity (full-function joint venture) and such a creation will not lead to coordination of competitive behaviour between the parent companies of the joint venture themselves, or between the joint venture and its parent companies; or 

     – concerted actions: if a joint venture is established with an objective of, or results in the coordination of, competitive behaviour between the parent companies of the joint venture themselves or between the joint venture and its parent companies. 

Provision of services 

What are the key considerations in your jurisdiction in structuring the provision of services to the joint venture entity by joint venture parties? 

In an unincorporated joint venture, in the case of a simple partnership, the approval of all parties is needed for the execution of every transaction unless stated otherwise in the simple partnership agreement. 

In a joint-stock company, provision of services to the joint venture entity by joint venture parties (ie, its shareholders) may be recognised as an interested-party transaction if the transaction value exceeds 1 per cent of the company’s asset value, unless the company charter sets a lower value. The party interested in the transaction may be a shareholder (or shareholders or their affiliated persons) who alone or jointly owns 25 per cent or more of the company’s shares. Interested-party transactions with a value of up to 10 per cent of the company’s asset value require the approval of the company’s supervisory board and transactions with a value of more than 10 per cent of the company’s asset value require the approval of a general shareholders’ meeting. During the voting process, the shareholders interested in the transaction do not have the right to vote and a decision on this matter is made by a majority of votes of the non-interested shareholders present at the meeting. 

In an LLC, a transaction is considered an interested-party transaction if the other party is, inter alia, a shareholder (or shareholders or their affiliated persons) who alone or jointly owns 20 per cent or more of the company’s shares. However, it is entirely up to the shareholders to provide in the company charter for regulations concerning the need for pre-approval for interested-party transactions. All shareholders shall approve the relevant charter provisions unanimously. If the charter does not contain such provisions, no restrictions regarding interested-party transactions apply, except that such transactions shall be at arm’s length. 

Employment rights 

What impact do statutory employment rights have in joint ventures? 

Employees are entitled to all available statutory employment rights in joint ventures. Transferring the business will result in the automatic transfer of its employees to the new employer. At the same time, the mere fact of the business transfer may not serve as a reason for dismissal. In the case of transferring foreign employees, the employer must obtain a work permit prior to commencing the foreign party’s employment with a Ukrainian company. Under general labour laws, a transfer to another job in the same company and a transfer to another company, or other area or location, requires the consent of the employee concerned. However, in the context of the Russia-Ukraine war, after 24 February 2022 and during the validity of martial law, no employee consent is required in some instances (related to the liquidation of consequences of such aggression). 

In the case of non-incorporated joint ventures, employees will be employed directly by the joint venture parties. 

Intellectual property rights 

How are intellectual property rights generally dealt with on the creation, operation and termination of a joint venture in your jurisdiction? 

The parties of a non-incorporated joint venture can regulate issues of ownership and use of their intellectual property (IP) rights either in their joint venture agreement or in a separate agreement such as a licence agreement. The same applies to an incorporated joint venture. 

Economic (proprietary) IP rights may be transferred or assigned for ownership or use (eg, under a licence agreement) to an incorporated joint venture. On the termination of the joint venture, IP rights are dealt with in the same manner as any other proprietary rights; they are either sold (transferred) to third parties to pay off debts or distributed between the shareholders of the company. 

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The Marshall Plan for Ukraine: open issues

For several weeks, the Ukrainian and world media have been discussing the plan for recovery of Ukraine, as called by journalists and economists the Marshall Plan by analogy with the well-known plan to help Europe after World War II.

It is extremely important for Ukrainian society to understand several key issues regarding this plan.

Strategic triangle

First of all, today Ukraine faces three priority tasks to be fulfilled:

  • Reconstruction: rebuilding destroyed infrastructure, housing and manufacturing to help a country recover from war.
  • European integration: acquiring the status of candidate, followed by membership of the European Union.
  • Modernization: a set of changes aimed to move the country to the next level of development.

Such three processes should be launched preferably in parallel. But the main problem is that they contradict to each other. It is not so obvious to everyone, so let us take a closer look.

Reconstruction requires for decision-making as soon as possible, preferably the cheapest ones. European integration requires for correct solutions that meet EU standards. Modernization requires for sustainable solutions, next-level solutions being expensive and slow. Such three factors cannot be implemented simultaneously; usually even two of them are inaccessible at the same time.

For example, there is a problem of destroyed housing. Reconstruction needs to give all those displaced by the war the cheapest and the simplest housing as soon as possible, in other words, housing in cardboard boxes for everyone. Such temporary solutions can define face of the Ukrainian cities for over a century, like previously Khrushchev-era apartment blocks facilitated housing for millions of people who lived in barracks, basements and dugouts. European integration does not allow such quick and simple solutions, because they may cause significant economic and social problems within a few years, starting with excessive energy consumption and environmental risks, up to ghettoization. Modernization in general needs, first of all, thinking over the demographic situation and demands of future Ukraine; therefore, it requires for making slow and balanced decisions. But if all the funds are spent on reconstruction, modernization will never happen.

Another crucial aspect of this triangle is economic freedom. Modernization requires for maximum economic freedom in order to include creative energy of millions of Ukrainian men and women, to give them an incentive either to come back or not to leave. On the other hand, economic freedom attracts foreign investments; without them a fundamental increase in labor productivity aimed to enrich the country is impossible. In turn, European integration requires for restrictions on economic freedom in order to comply with European rules and regulations, and there may be additional restrictions, because European governments will think first of all about saving jobs and programs aimed to support their own producers, especially in agriculture. Reconstruction does not take care of economic freedom at all: everything should be done as soon as possible so that everyone could have shelter, water or electricity, and if the same companies obviously win all the tenders, this is a small price to pay for recovery rate, as treated in the interests of reconstruction.

Such issues are not purely economic, they also affect other spheres, including politics. Reconstruction goes faster under authoritarian rule, but this approach makes European integration and even modernization impossible. European integration does not always mean modernization, because no one is particularly concerned in emergence of a new tiger economy. European integration without modernization will cause reaching the outskirts of Europe, while modernization without European integration will awake problems with finding markets and money; however, modernization jointly with European integration will launch an endless process without results. How to combine European integration with economic freedom, which even in its current limited version provides for Ukrainians innovative digital banking services and quality coffee, which not all the Europeans have?

Fast, cheap and high-quality: it cannot happen simultaneously. It is impossible to build a stable, open and efficient system. This is the so-called strategic triangle. But which one among three principal aspects should be sacrificed? European integration that gives us the desired access to markets, financing and stable rules? Reconstruction that promises quick overcoming devastation? Or modernization that gives us hope for a new country instead of the post-Soviet legacy?

The choice in strategic triangle will determine outlines of the processes for the next decade and format of the country for the next fifty years.

Structure of launching the plan

One more keystone is the following: who will control over the process? From one side of spectrum, there is desire of the Ukrainian authorities, which can be expressed roughly like this: we defeated Putin, you owe us, you should give us money and shall not ask for anything. One Western diplomat notes that momentary weakness of the West has passed, in other words, they have been observing us for 30 years and know the whole our structure. Another Western diplomat highlights that they will remember everything they forgave us, referring to regularly repeated deception of Western partners, when funds were allocated under promises of reforms, while in fact funds were spent and reforms were not carried out.

From the other side of spectrum, there is position of certain Western circles thinking that we will steal everything, so no one shall grant costs in our favor; therefore, we shall create a project office, with only American and European experts engaged who will sign all the receipts. Such an approach is unfavorable for Ukraine: it means that our Ukrainian vision, Ukrainian strategy and interests will be completely ignored, Ukraine will not be deemed as owner of the plan. This is an unfavorable situation that local anti-Westerners call external rule: old-timers are unable to solve their problems independently due to weak institutions. Obviously, in such case, funds will be spent for development of the donor-state economies, not our own economy. Certain representatives of the Ukrainian side even declared the following: you shall give funds to Ukraine, we will steal maximum 20%, while the remaining 80% will be used for development of the country, because if the funds are distributed on your side, 40-60% will be consumed by administrative costs, while Ukraine will get only the remaining share.

Two aforesaid extreme positions outline the spectrum, with numerous intermediate options (i.e. bad compromises) lying between them. After all, usually a compromise is a solution that does not suit either party. The solution is usually aimed not to seek a compromise between two extremes, but to reach an additional dimension, finding a solution of the next level of complexity. But one should understand that it will work more slowly.

There are more questions than answers!

The above two key questions are the most crucial and the most complex, but the problem covers not only them.

Who will be Number One in the process: the USA or the European Union? Obviously, there are different approaches and priorities. How to combine numerous international financial organizations with different rules and approaches into a single structure? How to secure balance between short-term (Ukrainian politicians always choose them because they think about the next elections) and long-term interests? How to balance three funding mechanisms: grant aid (obviously in restricted amount), loans (to be repaid later, but from which proceeds?) and investments in Ukrainian assets (now greatly undervalued, which contradicts to the Ukrainian business interests). How to combine reconstruction/European integration/modernization with solving security problems? Security problem was solved by the Western European Countries after World War II and by the Eastern European Countries after the fall of communism, both with NATO assistance. But we will have to bear our own liability for on a significant part of this task.

Special attention should be drawn to one of the most vital questions: what will be economic policy of post-war Ukraine? Can we significantly raise economic freedom, rising from the current 130th place in global rating and making the country attractive for domestic and foreign investments? Will it result in victory of supporters of increased state regulation, socialist approaches and leading role of the state in economy? That is why Ukrainian business recently declared its clear position and principles (see. Memorandum of the Coalition of Business Communities for the Modernization of Ukraine).

It is gratifying that Western policymakers, trained by Ukrainian deceptions, agree to grant funds only in exchange for actual reforms: first come – first served. These are quite optimistic news, but there are still many open questions.

Finally, who is Mr. Marshall or Ms. Marshall? Who among global leading policymakers will fix their signatures on the plan, assuming personal leadership and personal responsibility and, therefore, potential political dividends and numerous risks? The very fact that we are discussing the Marshall Plan developed by the American Secretary of State in the past, shows that there is no up-to-date leader yet.

It’s a complex puzzle!

How much money do they need? From Ukrainian part, losses incurred by the state due to Russian aggression make up $500 billion (one shall not confuse it with the current budget deficit of Ukraine amounting to ca. $5 billion per month, which also needs to be covered; in fact, this is the cost of waging war). Such a huge figure has already been repeatedly criticized as inflated, but even if the actual cost is twofold or threefold lower, there are still no such funds in the world. Recent EU Commission decisions on 9 billion euros and the US decisions on 40 billion dollars are treated as funds for current needs, not for reconstruction.

Obviously, the funds will have to be collected for a long time and in different places. Ukraine will not neglect any sources of funding – either Russian reparations (one will have to expect them for a long time until all legal formalities are settled), or funds from the sale of seized Russian assets, or direct aid to Ukrainian cities from sister cities, or special projects of friendly countries aimed to help in reconstruction of certain areas.

Major share of the required amount of funds should come in the form of investments and loans through the private sector: for that purpose, the private sector needs to exist, to feel confident, to be protected by honest courts and an effective antitrust policy, to feel that its voice is heard (see the Memorandum set above). The second matter to be required is sharing the risks of Western investors, both in the form of state guarantees provided by their governments and with by means of classical insurance mechanisms.

Here one a more crucial aspect should be noted. We are now approaching problems of such a level of complexity that no one can be sure of their correct strategy. The only way out is maximum decentralization, which will make the discussed plan and the country in whole anti-fragile (a term used by Nassim Taleb). It takes hundreds of different attempts, some of which will fail, but eventually the right way will be found.

Today, nearly a dozen different groups are writing different versions of the Marshall Plan, the most famous of them are already being actively discussed: namely the Government Plan United24 and A Blueprint for the Reconstruction of Ukraine, both signed by several famous economists. The World Bank, IMF, EBRD, etc. have their own versions of plans.

All the aforesaid issues, jointly with different versions of the plans, will soon be discussed at various international platforms, for example, at the conference organized by this week Vladyslav Rashkovan at the London School of Economics, at the Davos Forum, at the conference on Ukrainian reforms in Lugano (Switzerland) etc. No doubt, other events later will be held too. It is important that we could provide a better and more detailed reconstruction plan, event by event.

It is very important that voice of not only the Ukrainian authorities, but also the Ukrainian civil society and domestic business be heard on such platforms, because any decisions in economic policy will be implemented, first of all, by hands and funds of the Ukrainian entrepreneurs, while all benefits and failures will be felt by the Ukrainian citizens

War is incredible pain, blood, suffering, destruction. But it also gives a chance to change the society and the state. Today the biggest fear of people is that nothing will change after our victory, everything will remain the same as before outbreak of the war. We need to do all the best in order to prevent missing such historic chance.