Independent Contractors vs. Full Time Employees – Trends in the Ukrainian IT Industry

Admittedly, Ukrainian labor legislation is cumbersome, archaic and highly bureaucratic, but it does allow for several labor law options in setting up a business structure. For example, a legal entity can hire an individual as a full time employee (and pay significantly high taxes, face potential problems with termination, etc.) or as a private entrepreneur (independent contractor, without the above issues). Of course, most prospective employers prefer the latter option, but it comes with certain risks.

Documenting relations between a legal entity and private entrepreneurs under service agreements always carries the risk of potential accusation of avoidance of salary-related taxes that are considered due by Ukrainian law. In the past, such risk was insignificant, as minimal sanctions were established by law for when factual labor relations were uncovered between business entities and private entrepreneurs. As we describe below, today Ukrainian legislation applies much higher penalties for employers when independent contractors are retroactively recognized as actual employees and, therefore, the controlling authorities have more incentive to conduct unplanned examinations of employer/employee and customer/private entrepreneur relations.

The Ukrainian government has instilled high penalties to appease their obligations of EU integration, as well as to flush out hidden labor relations within the enormous shadow economy, to bring more transparency into the Ukrainian labor market, and to find new sources of financing for the state budget.

The below discussion describes how to minimize the risks of recognition of actual labor relations with Ukrainian consultants – private entrepreneurs (independent contractors), using careful approaches and document drafting.

I. General Observations

As a general observation, the currently employed structural models for using the services of private entrepreneurs in the IT sector often fall within the so-called "legally grey" areas of the economy. This simply means that such models are not considered as 100% "safe" for private IT specialists and companies that contract for their services, although they are commonly accepted practices in Ukraine.

Private entrepreneurs must be hired on the basis of civil, rather than labor, agreements. Nevertheless, many companies and private IT specialists often reflect in their agreements relations that more commonly fall under labor relations (monthly salary amounts, certain benefits, private insurance policies, car and telephone allowances, paid vacations, etc.). In fact, most private IT specialists, due to misunderstanding of the nuances of labor law, view their relations with any company as "labor" relations, which poses the risk that the local authorities will deem that they should be hired, paid and treated as "employees" rather than private entrepreneurs/contractors. Of course, this would mean higher tax consequences for the hiring business entity, especially if they have registered entities in Ukraine.

The risk entails that the State Tax Service (STS) or State Labor Inspection (SLI) may attempt to "re-qualify" relations with private entrepreneurs upon their respective inspections. These state bodies may issue decisions, stating that relations with, for example, IT companies' contractors/employees and private IT specialists are actually labor relations and not civil/commercial relations. The SLI issues such decisions via labor safety inspections, while the STS does so to ensure that the proper labor-related taxes (which are significantly higher than taxes under civil/commercial contracts) are being withheld and sent to the state budget. Thus, there is a constant risk that these controlling bodies will attempt to re-qualify commercial relations into labor relations with private entrepreneurs.

Understandably, today's negative consequence is that the number of tax audits and tax disputes against IT companies has correspondingly increased. Currently, there is an unwritten rule on the IT market: the more successful the business, the more frequently such business is inspected by the tax authorities. However, with the implementation of "Diia City" (specialized IT community for Ukraine) for 2022, we should see more clearly defined and reduced tax rates for those who are eligible for residency in Diia City and, coincidentally, protection against aggressive audits and disputes from the tax authorities for eligible residents.

Diia City's ambitious implementation for 2022 notwithstanding, the most frequent complaints from the side of the controlling authorities are:

(i) the understatement by IT companies of income tax obligations of individuals; and

(ii) the avoidance of salary payments (as opposed to payments for services, for example) in order to avoid payment of social insurance contributions for individuals.

The tax authorities commonly argue that civil/commercial relations are fictitious (i.e., for the purpose of tax avoidance) and attempt to establish labor relations in order to subject local IT companies to significantly higher salary-related taxes (personal income tax and social insurance contributions). The grounds for unscheduled tax inspections in such cases are found in Article 78.1.13 of the Tax Code of Ukraine, which provides that such inspections may be conducted in case of the receipt of information on payroll tax evasion, including the failure to conclude labor agreements with hired staff when required by law.

In addition to tax inspections, the failure to properly execute labor relations when required can lead to penalties for labor legislation violations. The list of grounds enabling the SLI to conduct inspections is exhaustive, and such grounds are quite broad and can be interpreted differently by state labor inspectors. These grounds are as follows:

(i) complaint by a hired laborer on violation of his/her rights provided by labor legislation;

(ii) complaint by an individual on improper execution of labor relations;

(iii) decision of the SLI in case information is received on violations of labor legislation from any source (including mass media, social media or any other type of legally recognized media means);

(iv) court decision or notice from law enforcement bodies;

(v) notice from state tax or statistical authorities.

Pursuant to Article 265 of the Labor Code, an individual or entity can be fined for permitting an individual to work without the proper execution of a labor agreement and payment of salary (remuneration) and the relevant taxes and social insurance payments. The fine is 10 times the effective minimum monthly salary at the time of violation for each individual worker whose rights were violated. In 2022 through October, the fine is 10 x 6,500 = 65,000 Ukrainian hryvnias, but it is expected to increase after October.

Importantly, however, the legislation does not determine the method by which the controlling bodies (STS and SLI) are able to establish the fact of actual labor relations and the evidence required to make their conclusions and establish such relations. As a rule, the inspections by controlling bodies usually result in the highest possible penalty amounts, while the employer must defend its position in a court of law.

II. Labor Agreements vs. Civil Agreements

In considering labor disputes, the courts firstly establish the key differences between civil-legal and labor agreements.

In brief, a labor agreement provides for an employee's functions within the overall activity/production of the employer, while a civil-legal agreement requires a hired individual to perform a specific volume of works/services for a customer/client. In other words, according to applicable Ukrainian legislation, a labor agreement does not envision the end-results of an employee's work, as it is a continual relationship on the same terms and conditions set forth in the labor agreement. Thus, after performing any specific task, labor relations do not terminate, as the employee is expected to continue performance throughout the validity of his/her employment term.

Similar to a labor agreement, a civil-legal agreement can also be concluded on a long-term basis, but the results of the private entrepreneur's work must be documented, transferred to the customer/client and paid depending on the actual volume of work performed by the service provider. Therefore, you should not see a fixed amount of remuneration each day/month/year, as the private entrepreneur only receives remuneration for time and labor actually spent during each specific order/task. Moreover, if the private entrepreneur's services are no longer required, the agreement with him/her can be easily terminated and there should be no social ties (benefits, severance, social security, pension payments, etc.) due to the private entrepreneur.

As a rule, a private entrepreneur (independent contractor) under a civil agreement should have sufficient freedom to undertake his/her tasks, should bear personal risk and liability for his/her actions, and should be solely focused on achieving the results for which he/she was hired. The private entrepreneur should not be subject to specific labor regulations and should independently plan his/her time and work organization at his/her discretion and own expense. Moreover, private entrepreneurs should not be granted any types of social or personal benefits/guarantees (health insurance, mobile phones, automobiles, etc.).

Conversely, in labor agreements, the main conditions are subordination to labor rules and regulations, performance of job duties only per the instructions of the employer and in accordance with the requirements for the individual's specific position, low level of personal liability, provision of workplace, office equipment and furniture free of charge, etc. An employee is typically not focused on the results of a single task, but on the performance of overall required labor processes (rules, regulations, work schedules, codes of behavior, etc.).

Another key difference between labor and civil-legal relations is the payment process. Under a labor agreement, salary is paid regularly, as a rule, twice per month (monthly advance and second half of monthly salary). Under a civil-legal arrangement, remuneration is paid for works/services actually rendered, the results of which are transferred to the customer, for example, upon completion or in agreed upon stages (milestones). Therefore, if a civil-legal agreement provides for a regular, strict payment schedule and mentions such payments as "salary" (especially at a fixed rate per month), then there is a high probability that such agreement will be recognized as a labor agreement.

Regardless, Ukrainian courts still do not employ a unified approach to cases on recognition of relations with private entrepreneurs under civil agreements as hidden labor relations. To date, the Supreme Court of Ukraine has not formulated a clear precedent in its judicial practice that would be applicable to all cases.

Some courts apply a legal approach where the main feature differentiating civil relations from labor relations is that a labor agreement regulates the entire process of labor activity, including its organization, while a civil agreement has the main aim of receiving certain result without regulating the process of organization of labor activity. In such cases, courts need to establish the following circumstances:

(i) whether the service provider was subject to internal labor rules and regulations of the customer;

(ii) whether the service provider was engaged under specific qualification, profession, position;

(iii) whether the service provider was informed of specific work conditions, a specific work station, hazardous or dangerous factors connected with performance of works/production, etc.

The courts also pay attention to whether the employer has positions in its payroll staff similar to work performed by the service provider, as well as whether the employer strictly monitors the service provider's working hours.

Other courts employ another approach, whereby labor relations must be confirmed by specific documents, such as a labor agreement, internal orders, labor books, etc. Thus, if a company in Ukraine maintains accounting books, records and filings for private entrepreneurs (independent contractors), this may raise questions from the controlling authorities regarding actual labor relations, which could lead to requalification of civil relations into labor relations (with all the applicable retroactive payments and penalties).

In differentiating labor agreements vs. civil-legal agreements, the state tax authorities look at such factors as: (1) civil agreements (such as agreements on the provision of certain services) do not envisage payment for the work process, but payment for the results of work, which are determined after work is completed and a transfer-acceptance act of works/services actually rendered is signed by the parties; and (2) agreements bear the signs of labor agreements if they provide for a specific period and place of work and are conditioned on the provision of services on a daily (or regular) basis and not for one-time services.

Based on the above, relations between a customer and a private entrepreneur should bear as little features as possible of labor relations (for example, lack of any vacation allowances, sick or maternity leaves, benefits such as phones and cars, bonuses, medical and other allowances, etc.). All required documents related to service/consulting agreements must be meticulously drafted and kept (such as written tasks/orders from the customer in the form of annexes to the said agreements, signed transfer-acceptance acts, lease agreements concerning leasing of workspace). Ideally, Ukrainian private entrepreneurs should register as subjects of entrepreneurial activity (independent contractors) and organize their own accounting via separate accounting services agreements and working conditions.

III. Upcoming Changes to Ukrainian Labor Code

Since early 2021, the Ukrainian government has been in discussions to add a new provision to the Labor Code of Ukraine regarding determination of labor relations and features of their existence. The aim is to increase legal protection of employees and to identify employers, who try to conceal the actual existence of labor relations (as opposed to civil-commercial relations between parties).

Under the proposed addition, a presumption of labor relations will exist if the individual who performs work meets at least three out of seven characteristics of labor relations. In such cases, the hiring entity/individual will need to hire such individual as an employee and conclude a labor agreement with such individual, regardless of whether there are contractual relations between the parties and the type/title of such contractual relations.

The existence of labor relations would be characterized as follows:

1. An individual personally performs work within a specific qualification, profession or position pursuant to the instructions of and under control of the party in whose interests the work is performed;

2. The work is regulated, bears a permanent character and does not call for specific results over a defined period;

3. The work is performed at a specific work place agreed upon with the hiring party under internal labor regulations;

4. The work conditions are organized for the work performer; and, specifically, the work performer is provided with equipment, materials, raw materials, a designated work station, etc.;

5. The remuneration in cash or in kind is regularly (systematically) paid to the work performer;

6. The hiring party establishes lengthy work time and vacation time;

7. The hiring party compensates the cost of trips and other financial expenses connected with the performance of work.

While still under consideration, it is not possible to predict whether the proposed changes will be adopted or whether they will be adopted with further changes for 2022 and beyond. In any case, all possible changes to the Labor Code of Ukraine, especially those adopted in conjunction with EU integration, should be taken into account when hiring employees or contractors in Ukraine. We expect these changes and other significant changes (and, perhaps, even a new Labor Code) to remain in discussion as part of Ukraine's EU integration obligations.

Also "new" for 2022 is the introduction of mandatory "cash registers" for private entrepreneurs. The Ukrainian tax authorities have been trying for years to implement a cash desk or cash register system for private entrepreneurs. However, this requirement has either been met with protests or simply ignored by private entrepreneurs as an additional business burden.

Nevertheless, this requirement has come into force once again in 2022, allowing private entrepreneurs to either purchase registers or use programs on their devices to enter transactions into their business activity. While there are several exclusions in place for implementing the system right away (especially for independent professionals such as IT specialists, lawyers, consultants, journalists, etc.), we are already seeing this requirement met with protests by other groups of private entrepreneurs. The system is admittedly complex for simple businessmen and only time will tell how this will play out over the course of 2022.

IV. Current Tendencies in Ukrainian IT Sector and Suggested Changes

The current tendency of IT companies is to continue working with private entrepreneurs, as it is far more beneficial from a financial and tax minimization points of view. Moreover, many Ukrainian IT specialists prefer a simplified relationship without rigid labor regulations potentially changing their work habits (nighttime vs. daytime work, holiday work, strict work schedules, etc.).

However, the IT sector is paying closer attention to legal consequences of dealing with private entrepreneurs. Many companies are actively preparing for the introduction of changes to the Labor Code while they continue to maintain their ongoing relationships with private entrepreneurs. Such changes include the eventual introduction of the GDPR (data protection) in Ukraine, requirements for registering their foreign counterparts with the tax authorities for services rendered in Ukraine, the implementation of Diia City and its effects on the IT sector and legal documentation, etc.

Regardless of the risks mentioned in this brief article, if an employer decides to stay with its current business structure with private entrepreneurs, it is necessary to introduce certain changes in order minimize risks of recognition of "concealed" labor relations with private entrepreneurs in the future.

Independent contractors should obtain written tasks/orders from the customer in the form of annexes or instructions to existing consulting agreements, which should contain specific tasks to be performed within a defined period and the desired results of such tasks to be transferred to the customer under transfer-acceptance statements. This will help to avoid qualification of their services as "employment" of a permanent character under general conditions.

Another consideration is whether compensation in cash or in kind is to be paid on a regular basis (systematically) to the independent contractor. As a rule, private entrepreneurs do not usually receive remuneration from only one source. Accordingly, tax and labor authorities look for this sign when determining whether there are actually labor relations instead of civil contractual relations. Therefore, if a private entrepreneur has more than one source of income (i.e., more than one consulting agreement with one and the same company), then risks can be minimized.

On the other hand, if a private entrepreneur has several customers, the agreements with each customer should vary in their volume, type and values. This significantly decreases the risk of recognition of labor relations and will show their actual value as independent contractors, along with unfixed work schedules and fluctuating income from various sources.

With respect to periodical payments and transfer-acceptance statements and/or invoices, such payments should be fixed each time a specific volume of services is performed and the results of such services are transferred to the customer. This may occur on a monthly basis or after the results of specific services are received and accepted by the customer. Thus, payments to independent contractors should not be fixed on certain dates (e.g., monthly), but on various dates when they have actually performed their services to the customer's satisfaction (e.g., within 3 weeks, 5 weeks, etc.).

V. Taxation and Penalties Upon Discovery of Labor Relations

The taxation systems for both private entrepreneurs and employees in 2022 are set forth below:

Monthly taxes and mandatory payments to be paid and withheld per month from one individual using 28,000 UAH (close to 1,000 USD)


Type of tax




Unified Tax at the rate of 5% for PEs in Group 3* (most common, allowing for up to 7,585,500 million UAH in annual income with no restriction on amount of hired assistance in performing services)

28,000 UAHx 5% = 1,400 UAH



Unified Social Insurance Contribution

PE pays for one month on the basis of 1 minimum monthly salary set on January 1st of the current year (6,500 UAH in 2022) x 22% = 1,430 UAH

Employer pays on top of the monthly salary, but the tax base is capped at 97,500 UAH per month (current ceiling in 2022): e.g., 28,000 UAH x 22% = 6,160 UAH


Personal Income Tax


28,000 UAH x 18% = 5,040 UAH per month


Military (War) Tax


28,000 UAH x 1.5% = 420 UAH per month


Total disbursements of the business entity

28,000 UAH per month

28,000 + 6,160 = 34,160 UAH per month


Remainder after payment of all taxes and mandatory state payments

28,000 – 1,400 – 1,430 = 25,170 UAH per month

28,000 – 5,040 – 420 = 22,540 UAH per month

* Group 2 may also be used by Ukrainian IT specialists – please contact us for details.

As seen from the above table, after re-qualification of a civil agreement to a labor agreement, hefty tax obligations connected with personal income tax, military tax and social insurance contributions may be imposed.

If the tax authorities are able to prove in a court that the hiring entity has employees rather than private entrepreneurs, then hiring entity would be obliged to pay the unified social insurance contribution in arrears for the entire period of contractual relations with the entrepreneur and the military tax for only the last 3 years (i.e., the statute of limitations on the tax authorities is 3 years for the military tax and personal income tax) plus applicable penalties for the untimely payment of taxes.

The following penalties are currently established by law:

From January 1, 2022, according to Article 1251 of the Tax Code of Ukraine, failure to calculate, withhold and/or pay taxes, including for tax agents, in favor of another taxpayer may lead to a penalty in the amount of 25% of the tax amount subject to withholding and/or payment to the state budget. The penalty increases to 50% for repeat offenders and 75% for three or more violations within 1,095 days.

Thus, for personal income tax, following our example of 28,000 UAH, the penalty would be as follows: (i) for the first month – 5,040 x 25% = 1,260 UAH; and (ii) for the second month (or a second individual) - 5,040 UAH x 50% = 2,520 UAH, etc.

The penalty for the military (war) tax would be as follows: (i) for the first month – 420 x 25% = 105 UAH; and (ii) for the second month (or second individual) – 420 x 50% = 210 UAH, etc.

If the payment due for personal income tax and/or the military tax is not paid within the required term, then a tax debt is recorded and an additional fine will be calculated according to Article 129.1.1 of the Tax Code. This fine is defined as "120% of the annual accounting rate of the National Bank of Ukraine on the day of occurrence of the tax debt or on the day of its (or part thereof) extinguishment, depending on which rate is greater, for each calendar day of delay of payment" (Article 129.4 of the Tax Code).

In addition to the above, the failure to withhold or transfer to the state budget the amount of personal income tax on income earned by an individual upon payment of income to such individual leads to a penalty on the official of the party at fault (e.g., general director, director, chief accountant, etc.) in the amount of between 51 and 85 UAH (Article 1634 of the Administrative Violations Code of Ukraine).

With respect to unified social insurance contributions (USIC), their non-payment or untimely payment by the employer can lead to a penalty in the amount of 20% of the unpaid amount in accordance with Article 25 of the Law of Ukraine "On Unified Social Insurance Contributions". In our example, the penalty for non-payment or untimely payment of USIC for one month would be as follows: 6,160 х 20% = 1,232 UAH. Moreover, a fine may be imposed for each day of untimely payment of USIC in the amount of 0.1% of the unpaid amount or 10% of unpaid amounts during full or incomplete reporting periods (but no more than 50% of any unpaid amounts). Notably, these penalties can be avoided if the violations occurred from March 1, 2020 until the official end of the COVID quarantine in Ukraine. Ultimately, it is the tax authorities who will analyze and decide whether a penalty should be applied.

VI. Conclusion

Despite the above penalties/fines, it is still all too common for both foreign and local IT companies to minimize taxes by using private entrepreneurs while limiting the activities, which private contractors may undertake without being labelled as employees. The current trend in companies is to try to lock down only their key "players" by concluding employment agreements with them. This way, companies can avoid the loss of key employees to competitors.

At the same time, all market players should be aware of the above-described risks so that they can make their assessments in light of their own situation. Of course, we are always happy to provide legal advice and recommendations in relation to any changes that need to occur in the current structure, activity, relations with private individuals and corporate entities. Please do not hesitate to contact us with any questions or concerns.

Disclaimer: this publication is not designed to provide legal or other advice and you should not take, or refrain from taking, action based on its content.


Frishberg & Partners 2022