Investor considerations
- Ukraine remains a challenging place to do business.
- Many investment opportunities exist, but Ukraine is still developing the legal and institutional frameworks required to fully support international business.
- There is extensive interest in the real estate market.
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2.1 Business climate
Since becoming independent in 1991, Ukraine has struggled to shift from a centrally planned economy to a market environment.
Since 2000, Ukraine has implemented significant positive economic and legal reforms. The economy grew at an annual rate exceeding 7% over the period to 2006, including 12% growth in 2004. The growth was fuelled by strong domestic demand, low inflation, and solid consumer and investor confidence.
Ukraine generally encourages foreign trade and investment, and laws allow foreigners to purchase businesses and property (but not agricultural land), repatriate revenue and profits, and receive compensation if property is nationalized. Much reform is still needed, as complex laws and regulations and weak enforcement of contracts by the courts still hinder foreign direct investment.
There has been a lot of interest recently in Mergers & Acquisitions (M&A). The 2006 PwC M&A Survey noted that the M&A market increased in size from USD 2.3 billion in 2005 to USD 3.4 billion in 2006, with an average deal value of USD 45 million. The deal volume rocketed from 85 in 2005 to 171 in 2006 - up 101%, making Ukraine the fastest growing M&A market in Central and Eastern Europe (CEE). The hot industries are manufacturing, financial services and food & beverages. The average deal size in 2005-06 was USD 114 million in financial services, USD 14 million in manufacturing, USD 11 million in retail & wholesale.
Superficially, taxes appear quite low - 25% for corporations, 15% for individuals while value-added tax (VAT) is 20%. There are many underlying issues:
- Restrictions on deductions mean the effective corporate tax rate is close to 30%.
- Social security contributions can be significant. For 2007, employer contributions to various funds will exceed 36% for employees earning less than USD 1,560 per month (see Section 7.3 for further information).
- VAT refund constraints, as well as restricted rules for zero-rating sales of services to non-residents, mean that VAT can become a significant cost to business.
Although Ukraine has extensive human capital, natural resources, and industrial potential, it is clear that the country still faces significant challenges.
The 2006 World Bank Doing Business study ranked Ukraine as the second most difficult country in which to pay taxes out of 185 countries surveyed. This has more to do with the level of tax accounting required than intrinsic difficulties in following legislation. Nonetheless, there is clear room for improvement.
Despite political uncertainty over the past two years, the economy has grown steadily and investment has increased.
2.2 Economic development plans
Following the 2004 Presidential elections, the President's team has focused on improving transparency. Tax privileges for economic zones were removed entirely in early 2005. Privatisation sales have been made more transparent. Some headway has been made in bringing a large hidden economy into the open.
Unfortunately, the government has not developed a clear strategy for reform. The removal of incentives and attempts to unwind questionable privatisations sent disconcerting signals to investors about the stability and predictability of the investment framework.
The transition into a parliamentary system is also likely to present some challenges, so it may be some time before a clear economic blueprint is developed.
2.3 Free trade zones
There are currently no free trade zones in Ukraine, although there is some uncertainty about what will happen in the future. Parliament supported a draft resolution to the Cabinet of Ministers in August 2006, recommending that special tax regimes in free economic zones and tax incentives for technology parks be restored. There is no certainty that the draft resolution will be implemented.
2.4 European Union, NATO
In 2005, President Viktor Yushchenko stated that membership in the EU was a strategic goal of his foreign policy. In practice, Ukraine maintains especially close ties with Russia (including energy dependence) and balancing this relationship affects the speed with which Ukraine can move toward integration. The EU is expected to deepen economic and political ties with Ukraine, but is yet to formally indicate that Ukraine has prospects of future EU membership.
Ukraine has a close relationship with the North Atlantic Treaty Organisation (NATO), particularly with respect to emergency situations, technical cooperation, scientific studies and military and defence reforms.
2.5 International agreements
Ukraine has established diplomatic relations with approximately 170 countries.
Ukraine is a member of the United Nations, the International Monetary Fund (IMF), the World Bank, the European Bank for Reconstruction and Development (EBRD), the Council of Europe, as well as a number of other international organisations. Ukraine also cooperates with the Organisation for Economic Cooperation and Development (OECD), but is not a member.
Ukraine is currently in the final stages in its application for membership of the World Trade Organization (WTO), and is expected to become a member by 2007 year end.
In addition, Ukraine has concluded a number of bilateral agreements concerning trade, avoidance of double taxation, and mutual guarantees of investments. It also has a free trade agreement with Russia, as well as countries of the Commonwealth of Independent States (CIS).
2.6 Legal environment
The Ukrainian judicial system underwent significant reforms in 2002. Senior judges are now nominated by Parliament and appointed by presidential decree for five years, after which Ukraine's Supreme Council confirms them for life.
Although the system has improved significantly, there are still many problems. The Supreme Court is regarded as being an independent and impartial body, but the same cannot yet be said for the lower courts. Courts also remain under-funded, meaning they are often understaffed while judges may not have sufficient background to resolve adequately some modern issues in corporate law, taxation, bankruptcy, and intellectual property. Poor enforcement of court decisions is also a significant problem.
A legal framework exists and courts are always there as an option for resolving disputes, but issues may best be resolved outside of the judicial system. It is worth considering arbitration as an alternative dispute resolution mechanism when drafting contracts, although it needs to be recognised that the Ukrainian alternative disputes resolution mechanism is still developing and there is still a shortage of skilled arbiters in the country.
2.7 Property market
Foreign citizens and legal entities have the right to own apartments, houses, and other facilities. Ownership of non-agricultural land is also possible, although legal and regulatory restrictions and red tape can significantly complicate the process.
There is extensive interest in the real estate market, but a lack of investment grade buildings in Ukraine limits the opportunities for property investors. This creates a lot of opportunity for foreign developers, if they are prepared to navigate the legal and regulatory hurdles that currently exist.
Class A buildings are currently leasing at USD 40 to USD 55 per square metre, and providing yields of around 10% to 13%.
2.8 Foreign investor associations
There are a number of foreign business chambers in Ukraine, including the American Chamber (www.amcham.kiev.ua) and the European Business Association (www.eba.com.ua). Both chambers have active committees on various issues affecting business and investors in Ukraine. Contact details are provided in useful sources of information.
As part of its ongoing efforts to present suggestions to the Ukrainian authorities for improving the investment climate, the European Business Association publishes a report entitled Barriers to Investment in Ukraine. The latest publication (2006) may be downloaded from their website.
