How to set up IT Outsourcing to Ukraine

Over the past decade, IT has become one of Ukraine’s most promising sectors — above all, its export-oriented outsourcing segment. Many Ukrainian IT companies and freelance developers work on projects for foreign clients, who then release the resulting software under their own brand.

The case below looks at foreign companies that decide to work with freelance developers in Ukraine, and it examines in detail the issues that can arise when performing such cooperation contracts.

Which option to choose: work with sole proprietors or register a company in Ukraine

Option 1 is to set up a local IT company and employ staff. This is the best choice if you plan to bid for large tenders and already have major clients.

It also suits a well-established business with a large office and a sizeable team (more than 10 people), each with their own workstation.

There are, however, significant drawbacks. First, you face stricter requirements for HR record-keeping and management, along with the need for full accounting and financial reporting. You should also bear in mind that once your headcount reaches 8 employees, you must set up a workplace for one person with a disability. If you fail to meet this quota, you face a fine that can equal your company’s average annual wage for each disability workplace you have not created. All of this adds to the cost of running the business.

Option 2 is for the foreign company to engage freelance IT specialists directly, under a freelance contract with each of them. This works best when you work with no more than 10 freelancers who are registered as sole proprietors (FOP) on the single-tax system (Group 3). While your business is still developing, this form of cooperation is ideal.

The main risk of working with sole proprietors concerns the extent of personal liability: a sole proprietor is liable before the law and answers for their obligations with all of their property.

An LLC (limited liability company) therefore appears more trustworthy to clients, but working with sole proprietors on the single-tax system is the better fit if you are just starting out.

The cost of a product or service you contract from freelance developers

Whichever of the above options a foreign company chooses, it needs to be aware of the costs involved in each.

With an LLC, when the company officially employs freelancers it incurs additional costs of more than 40% in taxes on salaries, namely:

• 18% personal income tax (withheld from the employee’s salary)
• 1.5% military levy (withheld from the employee’s salary)
• 22% unified social contribution (paid by the employer, on top of salaries).

In most cases, companies reduce these costs by employing some staff officially while also working with freelancers. This structure, however, calls for careful tax and legal planning so as not to break the law or run into trouble with the tax authorities. In addition to salary costs, a local LLC pays 18% corporate income tax (18% of the income it receives).

Working with sole proprietors involves a few points to consider. To work freelance in Ukraine, individuals can register as sole proprietors under the simplified taxation system. This system offers a very advantageous, simplified single-tax rate of 5%. Sole proprietors must also pay the unified social contribution quarterly, even if they earn nothing. It is charged monthly at 22% of the minimum wage in force for the month the payment covers.

From January to November 2021 the minimum wage was UAH 6,000; since December it has been UAH 6,500.

The tax on employees’ salaries in an LLC therefore far exceeds the tax paid by sole proprietors, even taking the unified social contribution into account.

How to transfer money to freelancers for the services they provide

There are several possible ways:

1. Transfer foreign currency to a sole proprietor’s foreign-currency account.

   This option lets the freelancer legally conduct international business in Ukraine and work with foreign clients. To use it, you must conclude a foreign trade agreement in line with Ukrainian law, as required by the bank processing the incoming foreign-currency transfer. Payments under the contract should also be confirmed by the sole proprietor with invoices, if the bank asks for them. The tax is 5% single tax plus the 22% unified social contribution — 22% of the minimum wage in Ukraine.
   The main advantage of this option is that it is entirely legal.

2. Transfer to an individual’s foreign-currency card account at a bank in Ukraine.

   This option suits irregular, one-off transfers. As a rule, for such payments the bank asks the freelancer to sign a statement that “this transfer is not related to business activity.” In terms of taxes, the personal income tax rate is 18%, plus a 1.5% military levy. Technically this option is much simpler and involves no paperwork or accounting, but with regular transfers to the account you may be accused of concealing business activity and evading a sole proprietor’s income tax. There are a few other ways to transfer earnings if you choose this option, namely:

• transfer to an individual’s card account at a foreign bank
• MoneyBookers, Payoneer Debit Card
• WebMoney, Limonex, etc.
• Western Union.

Transfers to an individual’s foreign-currency account, as well as via payment systems, make cash withdrawals more complicated, which is why IT specialists prefer the first option.

Bank commission on money transfers

When processing foreign-currency transactions, banks charge a commission on the money due to arrive in the sole proprietor’s account. In particular, when carrying out foreign economic activity (FEA) operations under FEA agreements, the correspondent banks may charge a commission for payment and cash services out of the sum the freelancer-sole proprietor is due to receive from the foreign company for the work and services provided.

Under Ukrainian law, if the bank deducts a commission for payment-processing services from the proceeds when handling payments for work and services, the sole proprietor’s income comprises the total proceeds plus the commission the bank charged. In effect, you will have to pay an extra 5% tax on the commission charged.

How to organize freelance work: remote work (mainly from home) or coworking

Setting up a workspace for freelancers involves additional costs that a foreign company must be prepared for. If a company engages one person for the project, that specialist can obviously work from home, and no spending on workspace is needed. It is quite different for a large project handled by a big team.

On the one hand, having a freelancer work from home suits the company because it reduces costs. On the other hand, remote work is not always as efficient as needed: there are distractions to consider — children, pets, or other family members who also have to work from home, and so on. This is why coworking hubs are becoming increasingly popular.

Both individual specialists (copywriters, designers, developers) and whole teams work in coworking spaces. Some companies rent entire coworking centers and place their staff there. This can minimize the cost of rent and of arranging amenities: tea, coffee, snacks, equipment, Wi-Fi. Coworking is convenient because you can rent fixed workstations for the list of staff the company approves. For employees who do not need to come in every day, “flexible” desks or spaces without fixed workstations can be rented.

There are several ways to pay for sole proprietors’ coworking:

• the first is to transfer the rent to the individual’s account as payment for the service, after which the sole proprietors pay the rent themselves.
• the other is to sign a contract with the coworking center and pay the rent directly. With the first option, bear in mind the 5% single tax on the transferred amount, since the transfer counts as the sole proprietor’s income. With the second option, you pay the bank commission on the transfer. When drawing up the contract, specify who pays the commission — this simplifies settlements and saves you from unnecessary disputes.

Accounting and financial record-keeping for sole proprietors in Ukraine

Another important issue is the maintenance of accounting and financial records for sole proprietors in Ukraine. It covers a set of tasks, namely:

1. registering the sole proprietor;
2. annual and quarterly financial statements;
3. preparing payment documents to pay taxes;
4. monitoring tax payments and the absence of tax debt;
5. keeping the income ledger;
6. preparing documents for foreign economic activity (FEA).

As a rule, IT specialists do not keep their own accounting and financial records, either because they are too busy or because they lack sufficient knowledge of accounting and the law. Late submission of reports and late tax payments are subject to penalties. Every financial transaction must be documented, and you need to keep all the paperwork required to confirm your income — here, that means FEA agreements, invoices, and certificates of the services provided for each transfer.

To avoid problems with the tax office, a foreign company takes on responsibility for its IT specialists’ accounting and financial record-keeping by hiring an accountant or an outsourcing firm. This approach simplifies everything from preparing FEA documents to filing annual and quarterly reports, and it also gives you the chance to seek advice on tax-optimization matters at any time.

Did you know? “Olha Petrukhina Law Firm” provides comprehensive legal support to companies wishing to set up IT outsourcing to Ukraine.