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Diia City: would gig contracts protect from State Labor inspections and does it forbid working with FOPs?

Diia City: would gig contracts protect from State Labor inspections and does it forbid working with FOPs?

Oksana Dankevych, Attorney-at-law, partner in Dexis Partners in a co-authorship with Diana Dutchak, lawyer in Dexis Partners

 

Ukrainian IT companies are able to apply for resident status under new legal regime, known as Diia City. “Flexible forms of cooperation with IT specialists – GIG-contracts that combine the benefits of freelance and social guarantees” – this is how the Ministry of Digital Transformation of Ukraine marks this legal know-how, which operates only under the Diia City regime. Sounds at least interesting, isn’t it? However, some questions arise: 1) whether the resident will be still able to continue working with private entrepreneurs (known as “FOPs” in Ukraine); 2) whether a Diia City resident status will help to protect an IT company from the State Labor Service inspections; 3) what awaits the already concluded gig contracts in case of loss of the Diia City resident status and whether the company will be able to return to cooperation with FOPs?

 

Let’s start with the simplest: restrictions on working with FOPs

Information, that Diia City residents will no longer be able to work with FOPs is spreading all over the global network. This is true, and this is false as well. First of all, in cooperation between IT companies and FOPs nothing will change up to the end of 2023. The tax burden and the legal basis for cooperation at the level of the service agreement remain stable, as well as the IT company’s ability to allocate the relevant amounts to expanses.

As of the year 2024, everything will depend on the chosen model of taxation. Residents of Diia City, who remain on the general tax system, with an annual turnover of up to UAH 40 million, can continue to order services from contractors and charge these amounts to expanses in full.

If the amount of income is higher, the company will be required to include in the financial result all the expanses on FOPs, which exceed 20% of total costs. For example: if the company’s expenses for office maintenance, employees’ salaries and advertising amount for UAH 80 million per year, and the expanses to cover FOP services equals to UAH 40 million per year, it will be possible to exclude no more than 80 million “other” costs plus 20 million expanses on FOPs from the financial result. It is important that this limit applies not only to IT FOPs, but also to other contractors, including landlords on the simplified tax system, clearing FOPs, food supply FOPs etc.

To companies, which choose “income tax on special conditions”, or in other words, the tax on withdrawn capital, different rules will be applied. Beginning from 2024, the expanses on FOPs should not exceed 50% of the total company costs, and from the year 2025 – these expenses cannot be calculated at more than 20%. The amount, which exceeds the permitted 20%, will be taxed at a rate of 9%. In fact, the mentioned amount will be assimilated into the withdrawal of capital.

As you can see, there is no ban on working with FOPs. Although, it is not always possible to reduce the financial result by the number of such costs. This, actually, calls into question the economic feasibility of such cooperation.

 

As to the State Labor

“The risks that gig contracts could be reclassified into employment relationships have been eliminated,” that’s how the official position of the Ministry of Digital Transformation of Ukraine sounds.

Signing a gig contract provides an opportunity to fix in the contract such things as the annual paid leave, the work mode: office \ remote \ mixed; length of working day and week; sick leaves and maternity benefits. The elements of the typical employment contract are more than enough: a ban on collecting more than 20 % of the monthly fee from a “gig specialist” for one month in case of losses, providing technical facilities and equipment to perform tasks and also the possibility to control the working process.

So can, eventually, the State Labor Services reclassify such a contract as an employment contract on the basis of, e.g. the statement of the troubled FOP, who was “misled about the nature of the contract.”? Yes, it can. Besides, companies are not immune against inspections by the State Labor Services on the labor protection matter and protection of workers’ rights if such employees are actually in staff.

However, such a scenario is very, very unlikely given the political support for the Diia City project.

 

Last but not least: the risks of losing of the Diia City resident status

It should be noted that the grounds and procedure for losing the status are spelled out quite clearly. Possibilities of administrative and judicial appeal are also provided. Therefore, we do not see the risk of “blackmail by expulsion from Diia City” on the public authorities side (although you never know).

Gig contracts will be valid for another three months after the loss of resident status – in fact, even more: until the last day of the third month following the month in which the status is terminated. But what to do if the company was did excluded from Diia City, that is the appeal did not work, but the need to continue working still exists?

The most obvious thing is to re-profile the gig specialist into FOP. However, there is one “but.” If the person, who used to work as a gig specialist and enjoyed a full package of labor and social guarantees, is now providing relevant services as a FOP, couldn’t we assume that such a scheme is elaborated to hide the employment relationship? It’s just a model of a purely hypothetical position that the State Labor Services can take. On the other hand, the possibility to register a new company and start a relationship with a FOP from scratch always exists.

 

As we can see, there are both fears and high hopes around the idea of Diia City. Acting ahead, the lawmakers added to Section VII of the Transitional Provisions of the Tax Code a ban on direct or indirect coercion of IT companies to change the form of cooperation with IT professionals. Still, it is difficult to make unambiguous predictions in a country where judicial reform has not yet come into effect.

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