Defense City: Ukraine introduces a special preferential regime for defense sector enterprises

To strengthen defense capabilities and create favorable conditions for the growth of defense industry enterprises, Ukraine has introduced several legislative changes, including:

• On 5 October 2025, the Law of Ukraine No. 4577-IX dated 21 August 2025 "On Amendments to the Tax Code of Ukraine and Other Laws of Ukraine Regarding Support for Defense Industry Enterprises" ("Law 4577-IX") entered into force.
• On 24 October 2025, the Law of Ukraine No. 4578-IX dated 21 August 2025 "On Amendments to the Customs Code of Ukraine Regarding Support for Defense Industry Enterprises, Clarification of Certain Customs Procedures, and Amendments to Article 32 of the Law of Ukraine "On Certain Issues of Importation into the Customs Territory of Ukraine and Conducting the First State Registration of Vehicles" Regarding the Extension of Environmental Compliance Requirements to Certain Vehicles" came into effect (“Law 4578-IX”)

Law 4577-IX and Law 4578-IX (jointly the "Laws") aim to support Ukraine’s defense industry enterprises by introducing special operational conditions for Defense City residents.

1. Legal Regime of Defense City

The organizational and legal framework of the Defense City regime will be defined by the Law of Ukraine "On National Security of Ukraine". The purpose of the regime is to create favorable conditions for stimulating the development of Ukraine’s defense industry, attracting investment, and ensuring the defense forces are equipped with modern weapons, equipment, and technologies.

The Ministry of Defense of Ukraine (the "Ministry of Defense") will be responsible for shaping and implementing state policy on Defense City, making decisions on residency, and monitoring residents’ compliance with established requirements.

The Defense City regime is introduced until 1 January 2036 and becomes effective from the date the first resident is entered into the Defense City register.

2. Acquiring Defense City Resident Status

Law 4577-IX provides for the creation and maintenance of the Defense City register (the "Register") by the Ministry of Defense.

A legal entity acquires Defense City resident status from the date the Ministry of Defense adopts the relevant decision and enters the record into the Register. Obtaining resident status is voluntary and based on an application submitted by the legal entity.

The Ministry of Defense grants resident status if the legal entity:

• meets the qualifying income share requirements for the previous calendar year and
• is not subject to any negative circumstances.

The qualifying income share must be:

• not less than 75% of the entity’s total income (subject to exceptions)
• not less than 50% for aircraft manufacturing entities.

The qualifying income refers to income from the sale of self-produced defense goods or from performing works and/or providing services related to defense goods.

A legal entity cannot be included in the Register if:

• it is registered under the laws of a foreign country
• it has violated requirements for disclosing beneficial ownership or ownership structure
• its shareholders/participants are affiliated with an aggressor state
• it is subject to sanctions or affiliated with a sanctioned person
• it has violated obligations under a government defense procurement contract within the past 12 months
• it is not a corporate income taxpayer or is listed in the register of non-profit institutions
• it has a tax debt exceeding 10 minimum wages
• it is located and/or operates in temporarily occupied territory of Ukraine.

A Defense City resident must maintain compliance with the qualifying income threshold and absence of disqualifying circumstances throughout the residency period.

The Laws establish a detailed procedure for acquiring and terminating Defense City resident status.

3. Monitoring of the Defense City Residents Compliance with the Established Requirements

The Ministry of Defense monitors residents’ compliance with the established requirements, including through review of compliance reports and other information to identify grounds for termination of residency.

A Defense City resident must submit an annual compliance report to the Ministry of Defense by 1 June of the year following the reporting year, covering the period from 1 January to 31 December of the previous calendar year.

The compliance report must be accompanied by annual financial statements and an auditor’s report on the results of the compliance audit.

4. Special Regime for Information about Defense City Residents

During martial law and for one year after its termination or cancellation, access to the Unified State Register of Legal Entities, Individual Entrepreneurs, and Public Organizations, as well as other public electronic registers, will be restricted in terms of information about Defense City residents.

Residents required by law to disclose financial statements must publish them in full within three months after the termination or cancellation of martial law, covering the entire period of non-disclosure, but no later than 30 days after termination or loss of resident status.

5. Tax Preferences

The Defense City regime allows for exemption of profit a Diia City resident from corporate income tax (excluding taxable objects on controlled transactions and the profit of controlled foreign companies), provided the following conditions are met simultaneously:

• the taxpayer is not a Diia City resident
• the taxpayer does not accrue or pay dividends (or equivalent payments), except when such payments are made to the state budget or when the direct or indirect holders of corporate rights are state entities
• there are no established violations of tax obligations related to the submission of reports (notifications) as required by transfer pricing (TP) rules and by regulations on controlled foreign companies (CFC).

Tax-exempt profit must be used to develop the activity of a Defense City resident no later than the following year, including:

• creation or re-equipment of material and technical base
• creation, acquisition, modernization, restoration, repair, re-equipment of fixed assets, including the construction of production and technological facilities
• implementation of cutting-edge technologies
• improvement of technological and production processes
• acquisition of intellectual property rights for the fulfillment of a state defense procurement contract
• expenses for research, production of new models of weapons and military equipment or their components
• acquisition of corporate rights of defense industry enterprises (provided that their issuer does not accrue or pay dividends (or equivalent payments) during the period of tax exemption).

The use of tax-exempt profits for other purposes is considered to be the misuse of tax-exempt profits. If the tax-exempt profit or a part of it is not used within the established timeframe, the taxpayer is obliged to calculate and pay corporate income tax on the unused portion of the tax-exempt profit.

The object of taxation for transactions that are controlled for TP purposes, as well as CFC profits, are not subject to exemption and are taxed under general rules.

In addition to the possibility to exempt profit from taxation, Defense City residents (except those who are also Diia City residents) are entitled to other tax benefits, including exemption from land tax and from real estate tax of qualifying objects, from environmental tax.

These tax preferences are valid until 1 January 2036, but no later than the year Ukraine joins the European Union.

The practicalities of applying Defense City tax exemptions remain to be seen, including the tax authorities’ clarifications on these matters (specifically, on the use of tax-exempt profit).

It is necessary to analyze in more detail the tax consequences of rescinding the regime or a company opting out of or being barred from using the regime.

Importantly, Diia City residents who simultaneously hold the Defense City residency will not be eligible for the tax preferences regarding the unified social contribution (provided in part 14-1 of Article 8 of the Law of Ukraine "On the Collection and Accounting of the Unified Social Contribution for Mandatory State Insurance") and regarding personal income tax (provided in subparagraph 170.14-1.2 of the Tax Code of Ukraine).

6. Relocation of Defense City Residents

To ensure uninterrupted production of defense goods, state and local authorities are obliged to facilitate the relocation of Defense City residents and implement measures to enhance the security of their production facilities.

The procedure for relocation and implementation of these measures will be determined by the Cabinet of Ministers of Ukraine.

7. Export of Military Goods

Entities that are developers or manufacturers of military goods and have Defense City resident status will be allowed to export such goods without obtaining the authorizations required under Article 13 of the Law of Ukraine "On State Control over International Transfers of Military and Dual-Use Goods".

8. Customs Preferences

During martial law in Ukraine and for one year after its termination/cancellation, the placement of goods by a Defense City resident under customs regimes of import (in terms of the end-use procedure), temporary import, processing in the customs territory, and processing outside the customs territory is carried out with authorization based on a customs declaration and considering the simplified procedures established by law.

9. Special Currency Regulations

The National Bank of Ukraine is recommended to establish the specifics of currency transactions and currency supervision with regard to the Defense City residents. So far, such specific regulations have not been developed yet.