6 Business Entities

Investor considerations

For representation, information gathering and liaison activities, a non-commercial representative office is likely to be an acceptable vehicle.
Establishing a legal entity is recommended for commercial activities, although a commercial representative office may be effective for a limited range of activities.
For a 100% investment, a limited liability company (LLC) is usually recommended. It is cheaper and quicker to establish than a joint stock company (JSC), and is less regulated.
Unincorporated joint ventures and partnerships exist as investment vehicles, but are not widely used.
Branches of foreign entities are not explicitly recognised by law, and would prove difficult to establish.

6.1 Legal framework

Legal framework for business entities (effective from 1 January 2004)

The primary framework for establishing and operating legal entities in Ukraine is found in the Civil Code. Legal entities may be established in the form of joint stock companies, limited liability companies, additional liability companies, general partnerships or limited partnerships.

The Civil Code and the 1991 law, On Business Associations, also deal with such issues as shareholder rights and obligations, corporate governance, and minimum capital requirements.

Commercial law

The Commercial Code (also effective from 1 January 2004) governs business relationships, and was intended to regulate issues that are not dealt with in the Civil Code. In reality, parts of the two Codes overlap, including a number of provisions dealing with the establishment and operation of legal entities.

Furthermore, the two Codes do not always have consistent positions, and this creates uncertainty.

6.2 Forms of business organisation

Choice of business entity

Establishing a legal entity in Ukraine involves registering with the local state registrar, the tax authorities, the statistics office, and various pension and social funds, as well as opening a bank account and other formalities.

From a foreign investor's perspective, the choice will tend to be either a LLC, a JSC, or in limited circumstances a representative office engaged in either commercial or non-commercial activities.

For a 100% investment, using a LLC tends to be more convenient. It is easier and quicker to establish, has lower minimum capitalisation requirements (approximately USD 9,000), and is less regulated.

One potential issue with a LLC is that members may withdraw their contributions at any time by giving three month's notice. If another investor will be involved in an entity, establishing a JSC (or establishing a JV entity offshore) may be more prudent.

If an investor intends to carry out only preparatory or auxiliary activities in Ukraine, such as representation, information gathering and liaison activities, establishing a non-commercial representative office is a viable and convenient option, provided there is double tax treaty protection.

It is not possible for foreign entities to conduct full commercial activities (executing contracts, selling and accepting payments for goods, etc.) through a commercial representative office. Nonetheless, a number of law firms and other service providers have established their presence in Ukraine in this manner.

6.3 Net asset requirement

According to the law, if the value of a company's net assets at the end of the second and subsequent financial year is less than its share capital, the company must decrease its share capital and make relevant amendments to its Charter. There is no provision for a JSC to increase its capital to achieve this objective.

Furthermore, the law states that if the value of net assets falls below the statutory minimum capital, the company should be liquidated.

There is no further clarification in respect of these articles, no explanation as to who may enforce the provisions, and no major penalties for non-observance. The Securities Commission has recently indicated that JSCs (particularly banks and insurance companies) may need to follow the rules more strictly.

6.4 Limited liability companies

A limited liability company (LLC) does not have shares in a traditional sense. Instead, participants in a LLC own a percentage in the company's capital, as specified in its Charter.

Because investors' interests in a LLC are not "securities," they are not subject to registration with the State Securities and Stock Market Commission. This means that a LLC can be established more quickly than a JSC, and is easier to maintain.

There are a number of key points that investors need to be aware of before establishing a LLC:

Participants of a LLC may transfer their participation in the company's capital to third parties (non-participants) only with the consent of all other participants.
A participant may withdraw from a LLC at any time by giving three month's notice. Upon withdrawal, a participant is entitled to his proportionate share of the assets of the LLC, although this will often involve cash settlement.
A participant who systematically ignores or improperly fulfils his duties, or whose actions interfere with reaching the aims of the LLC, may be excluded from the LLC by a majority vote. The excluded participant is entitled to his proportionate share of the assets of the LLC at the time of exclusion.
A participant's personal creditors may demand to withdraw the participant's share in LLC assets to settle obligations, if the participant's other property is insufficient to satisfy the creditors' claims.
Because a participant may withdraw from the LLC, it is unclear whether contributions to such LLCs should be reported as equity or a liability from the LLC to the participant. This issue should not have any implications from a tax or legal perspective, but may impact on the LLC's ability to obtain finance from external sources, and could impact the IFRS accounting.
A LLC does not generally require a financial audit unless demanded by a participant holding greater than 10% of the capital.

If a LLC will be 100% owned by a foreign investor, these issues are likely to have little practical implication. If one of more investors will be involved, however, the issues will need to be addressed when the LLC is formed. Some issues, such as the length of notice required for withdrawal from the LLC and the method of compensation, could be addressed by including appropriate timeframes and constraints in the LLC's Charter.

Formation procedures

A LLC may be established by a single shareholder, provided that shareholder is not itself owned by a single shareholder. The governing document of a LLC is its charter. The charter determines the company's objectives and scope of activities, the size of its statutory capital, the composition and competencies of the governing bodies and the rules for decision-making.

The distribution of shares of a LLC is set out in its charter. If shares are transferred, the Charter will need to be amended to record the change.

Generally, incorporation will take three to four weeks from the day documents are filed with the registration authority.

A LLC is deemed to exist as a legal entity from the date of its state registration.

LLCs may make "check the box" elections for US tax purposes.

Capital structure

The minimum capital requirement for a LLC is the equivalent of 100 Ukrainian monthly minimum wages at the time when the LLC is formed. The minimum salary increases on a regular basis. Based on the 2007 Budget Law, the following minimum capital requirements will apply for LLCs established in 2007.

Established on or after	Minimum wage (UAH)	Minimum capital (UAH)	Est. minimum capital (USD)
1 January 2007	400	40,000	7,900
1 April 2007	420	42,000	8,300
1 July 2007	440	44,000	8,700
1 October 2007	460	46,000	9,100

At least 50% of the share capital of a LLC must be paid before the company may register. The remaining contributions must be paid within the first twelve months of the LLC's activity.

A LLC must create a reserve fund from net profits in the amount of at least 25% of its share capital. At least 5% of annual after-tax profits must be transferred to this reserve until the entire 25% fund is fully paid (this is not tax deductible).

It is possible for participants to contribute assets in kind to LLCs.

Relationship of participants, directors and officers

LLCs have two corporate bodies.

The Participants' Assembly consists of the participants of the LLC, each of whom has votes proportionally to its interest in the company capital. Quorum for a participants' assembly requires the presence of participants holding at least 60% of votes. Most resolutions are approved by a simple majority of the votes present at the Participants' Assembly, although resolutions amending the Charter and a limited number of other decisions must be approved by a majority of all participants' votes.

The Board of Directors (or Director) is the executive body of a LLC, and is responsible for managing the day-to-day activities of the LLC and representing the LLC against third persons. There is no formal requirement to appoint a company president, corporate secretary or any other office holder. The structure of the Board, its authority, and its working procedures are specified in the Charter of the LLC.

Liquidation, receivership

A LLC is liquidated if its participants agree to liquidate the LLC, its corporate term expires (if one is specified in the Charter), or it is ordered to be liquidated by the court. In a voluntary liquidation, preference in distribution is given, in order, to:

Indemnification of losses caused by disability, other health injuries or death, as well as creditors' demands secured by pledge or otherwise.
Employees' demands connected with labour relations.
Taxes and duties.
All other demands.

The preferences are slightly different for liquidation through compulsory liquidation (bankruptcy).

6.5 Joint stock companies

A joint stock company (JSC) is a legal entity whose share capital is divided into a specified number of shares of equal nominal value. The liability of shareholders in a JSC is limited to the value of their capital contribution.

A JSC may be established as an "open" or "closed" JSC. Shares in an open JSC may be offered to the public, freely transferred, and may ultimately be traded on a stock exchange. By contrast, shares in a closed JSC are distributed initially between its founding shareholders. Existing shareholders in a closed JSC also have pre-emptive purchase rights for shares offered for sale by the other shareholders.

The legal framework for JSCs is similar to that for LLCs. A brief comparative of the two vehicles is provided in Table 2.

Other points to note are:

Formation: The issued shares of JSCs (open and closed) must be registered with the State Securities and Stock Market Commission of Ukraine, which involves filing a set of documents prescribed by law. Processing of the application by the Commission may take up to two months.

Capital: The minimum capital requirement for a JSC is the equivalent of 1,250 Ukrainian monthly minimum wages at the time when the JSC is formed. Based on the 2007 Budget Law, the following minimum capital requirements apply for JSCs established in 2007.

Established on or after	Minimum wage (UAH)	Minimum capital (UAH)	Est. minimum capital (USD)
1 January 2007	400	500	99,000
1 April 2007	420	525	104,000
1 July 2007	440	550	108,900
1 October 2007	460	575	113,900

Table 2: Quick comparison of joint stock companies and limited liability companies

	Joint stock company (JSC)	Limited liability company (LLC)
Registration	As for all entrepreneurs, legal and business entities, primary registration is made with the State Registration Department. A JSC must register shares that it issues with the State Securities and Stock Market Commission.	As for all entrepreneurs, legal and business entities, primary registration is made with the State Registration Department.
Minimum capital	1,250 Ukrainian monthly minimum wages (approximately USD 110,000).	100 Ukrainian monthly minimum wages (approximately USD 9,000).
Transfer of shares	There are generally no restrictions on the transfer of shares in an open JSC. For a closed JSC, other shareholders have a pre-emptive right to buy shares before they may be transferred to third parties.	Unless the Charter says otherwise, other contributors have a first right of refusal before shares may be sold to third parties.
Supervision	Regular reporting with the State Securities and Stock Market Commission.	No regular reporting, but annual accounts must be filed.
Management requirements	Shareholders' Meeting. Supervisory Board (not required if there are fewer than 50 shareholders). Management. Audit Committee.	Participants' Assembly. Management. Audit Committee.
Statutory audits	There is an annual requirement to submit an audit report to the State Securities and Stock Market Commission.	Generally not conducted in practice.
Risks	Liquidation if negative equity at end of the second or subsequent year of existence.	Liquidation if negative equity at the end of second or subsequent year of existence. Contributors may withdraw from LLC at any stage, given three moths notice.
IFRS	Shares are treated as equity investment.	Because contributors may withdraw contributions at any time, financial reporting standards may require investment to be reported as loans.

Reporting requirements: JSCs are required to submit quarterly and annual reports to the State Commission on Securities and Stock Market. These reports include the annual audited financial reports, quarterly financial reports, reports on securities circulation, and details of any shareholders owning more than 10% of the shares. JSCs should also publish their annual report in the official media not later than 30 April of the following year.

6.6 Foreign directors

If a foreign national is appointed as a director of a Ukrainian company, local authorities will expect to see some form of contract relating to the individual. This will take the form of either an employment contract between the director and the company, or a management service contract between the company and a foreign entity.

Because of this, a foreign national that is to be appointed as a director of a Ukrainian company may need to obtain a Ukrainian Tax ID Code before the company is registered. To obtain a Ukrainian ID Code, the foreign national or his/her representative should file with the tax authority a set of documents established by the law. Obtaining an ID Code can take up to ten calendar days. The foreign national may also be required to obtain a Ukrainian work permit after the company's registration is completed.

6.7 Partnerships and joint ventures

The Civil Code allows for the establishment of general partnerships and limited partnerships as legal entities, but such vehicles are not widely used. Because partnerships are legal entities, there are no regulatory or legal advantages to conducting business through a partnership. Taxation is also imposed at two levels - at the partnership level and in the hands of the partners.

Joint ventures typically involve establishing a separate legal entity (JSC or LLC) in Ukraine. However, the Civil Code enacted in 2004 does recognise the concept of a joint venture (including simple partnerships) without the need to establish a separate legal entity. The relationship between the parties will generally be governed by the partnership agreement. Such agreements are commonly referred to as "joint activity agreements."

The use of joint activity agreements is still relatively unexplored. On the face of it such agreements may offer benefits over a LLC. There are no minimum capital requirements and capital impairment rules to contend with. A partner may still withdraw by giving three months notice, but the law contemplates that this could be treated as a breach of contract and damages paid. At the end of the day though, aggrieved partners would still be faced with having to resolve issues through the Ukrainian courts.

6.8 Branches

In Ukraine, it is not currently possible to register a branch of a foreign legal entity.

6.9 Representative offices

A representative office is not a separate legal entity and operates in Ukraine on behalf of the foreign company it represents.

From a tax perspective, local rules for representative offices are broadly in line with those found in other countries. The problem is that the broader legal framework has not been updated. This can create uncertainty when dealing with government agencies.

Nonetheless, if the foreign company intends to carry out only non-commercial activities, such as representation, information gathering and liaison activities, it should be sufficient to establish a representative office, provided there is a double tax treaty in place.

If activities are limited to services, then a commercial/taxable representative office may be a suitable option, and a number of professional services firms, for example, operate under this structure.

A representative office should be registered with the Ministry of Economics of Ukraine (currently subject to a registration fee of USD 2,500), the Statistics Department, the tax authorities, and pension and social funds. A representative office should also obtain the right to use a seal from the Police department. Once the representative office is registered with the tax authorities and obtained a permit for a seal, it may open accounts in hryvnia and foreign currency in a Ukrainian bank.

Representative offices are subject to normal corporate income tax. However, an exemption may be available if the activities of the representative office are not sufficient to establish a permanent establishment under a relevant tax treaty.

A non-commercial representative office is generally not subject to VAT. A commercial representative office must register for VAT once its taxable sales for the previous 12 calendar months exceed UAH 300,000, although it may also register voluntarily.

Lost in translation

Ukrainian law is written in Ukrainian, but professional firms typically provide advice to foreign investors in English or other languages.

There is no agreed standard for how the names of laws should be translated. For example, the Commercial Code is also referred to as the Economic Code. The law, On Company Income Tax, is also referred to as On Enterprise Tax or as On Business Tax.

Individual words within the law may also be rendered in different ways. For example, the Ukrainian word товариство in the Civil Code is equally well rendered as company, association, society or partnership.

As with investment into any other country, one cannot assume that labels used in Ukraine will mean the same as they do in the investor's home country.