Real estate: The law of the land

Author: | Published: 1 Apr 2008
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Despite the steadfast growth of Eastern European real estate markets, such as Poland, the Czech Republic, Slovakia, Romanian and Hungary, investors are looking in the direction of Ukraine, with its profitable real estate development and efficient investment schemes. Yield compression in the already established Eastern European markets plays a large role in this interest. It is essential that foreign companies seeking to invest in Ukraine are aware of the legislation that regulates the market and the upcoming trends.

Without question there are many reasons to invest in Ukraine. The country is strategically located, connecting the Commonwealth of Independent States, Eastern Europe and the EU. In addition, the construction deficit within Ukraine has resulted in increasing residential and commercial property values. With many markets being saturated quickly, international investors are finding Ukraine to be the new investor's paradise.

The construction law of Ukraine is undergoing rapid change. There is no unified codification of state construction regulations. The state construction norms adopted at the time of the Soviet Union are still applicable. Some of them need changes to reflect development of construction technologies, know-how and materials. An important factor in the construction process is construction approval and licensing procedures. These often constitute obstacles for foreign investors.

The young and prospective Ukrainian market is developing rapidly, providing large proceeds to the investors from all over the world. It is undergoing long-awaited changes in real estate and construction legislation. It comes as no surprise that the Ukrainian Law On the State Budget of Ukraine for 2008 and changes to some legislative acts have already resonated deeply. That Law introduces a number of fundamental changes that are to be considered when investing in the real estate and construction markets of Ukraine.

Land auctions

One of the most discussed innovations is laid down in Article 82 of the Law on the State Budget. The newly adopted provision provides for a new procedure for sale and lease of community and state-owned land. Starting from January 1 2008 any land in state or communal property can be alienated or leased by a land auction only. The new procedure is not applicable to those land plots where the real estate objects belonging to prospective owners or tenants are located.

Most market insiders and players acknowledge that the existing legislation was not well-prepared for this radical alteration. The peculiarity of the issue lies in the fact that although conducting land auctions is a new type of activity subject to licensing, respective licensing requirements have not been established yet. The procedure for conducting land auctions is to be established by legislation. On February 22 2008 the Resolution of the Cabinet of Ministers of Ukraine 90 was adopted, introducing the procedure for conducting land auctions. The Draft Law on the Land Market also contains chapters setting forth auction procedures.

Still the situation is vague. It is obvious that a period of time will be needed to launch the process in a proper way.

Moratorium

The Law on the State Budget has prolonged an overdue land moratorium with regard to some types of agricultural land. Initially, the moratorium was established to prevent uncontrolled sale of agricultural land to those entities not interested in using it for farming. Since 2005 the moratorium has been extended several times. The moratorium has almost halted development of the commercial real estate market. It has increased development costs and resulted in longer time periods for completing development projects.

That issue needs to be resolved in the close future. However, pursuant to recent amendments of the Transitional Provisions of the Land Code, the moratorium was prolonged until the laws on state land cadastre and land market were adopted. The moratorium prescribes that:

  • It is prohibited to contribute land-share rights to authorised capital of commercial companies.
  • It is prohibited to sell or purchase agricultural land plots of state and/or communal property except as buy-outs for public purposes.
  • It is not permitted to sell or otherwise alienate as well as change the designation of agricultural land plots owned by citizens and legal entities for carrying out market agricultural production, for conducting individual farming, except for inheritance transfer, barter of one land plot to another land plot and for transfer of land plot for public needs.

This moratorium encompasses restrictions on alienation of agricultural land of marketable designation. The adjournment sets an uncertain timeframe. Still, the final versions of the Draft Laws on land market and state land cadastre will be submitted to the Supreme Council of Ukraine by April 1 2008. The drafts still contain many ambiguous provisions.

Land market development

The Ukraine's Draft Law On the Land Market enlarges the powers vested in privatisation and land resource agencies providing that sale and lease of land in state and communal property will be performed by the Cabinet of Ministers of Ukraine, Council of Ministers of Autonomic Republic of Crimea, local councils, local state administrations, privatisation authorities and the State Agency of Land Recources of Ukraine.

The Draft Law toughens the standards for changing designation of land plots in the following way:

  • Sale of private land is performed without changing its designation.
  • Change of state and community-owned land designation may be performed if necessary before the decision to sell or lease has been taken.
  • Change of the agricultural land designation is banned within 10 years from the date of its sale/transfer into lease.
  • In the sale of an agricultural land plot for agricultural market production (right to lease it) within five years of the date of state registration of the purchase agreement for the price exceeding the previous purchase price, the seller will be obliged to pay a certain amount of state tax.

The Draft Law lays down that the sale or lease of state and community owned agricultural land from the reserved lands where no real estate objects are located shall be conducted by the State Agency of Land Resources of Ukraine through land auction only. It stipulates that the auctions on leasehold sale are held only on availability of the worked-out land allotment documentation.

Sale of state and communal non-agricultural land from the reserved lands is conducted by the local executive authorities and councils in an amount that shall not exceed 15% of the total amount of the reserved lands in a year. In the sale of state or communal land together with the real estate subject to privatisation and real estate belonging to the purchaser of these land plots (non-agricultural land) no auction is required.

Land categories

Another Draft Law of Ukraine On Amendments to the Land Code regarding Supplementation of the Definition Categories of Land according to their designation submitted to the Parliament on February 19 2008, provides for changes of designated categories stipulated by the Land Code. The advisability of this change is disputable. The current edition does not meet today's needs, but the legislator could also have taken into account that Ukrainian legislation lacks an updated version of the classification of land designations, which the Letter of the State Committee for Land Resources of 1998 presently regulates.

Licensing in construction

Particular reformations have also occurred in licensing regulations. A number of construction works in Ukraine require licensing. The basic provisions of construction works licensing in Ukraine are specified by the Law of Ukraine On Licensing of Certain Types of Economic Activity. On May 16 2007 the Ukrainian Parliament enacted essential amendments to the Law, which came into force on January 1 2008. In accordance with these amendments the licensing of construction activity was extracted from the Law on Licensing of Certain Types of Economic Activity. It has been specified that such licensing shall be determined by the special construction laws.

The basic construction laws are the Law of Ukraine On Architectural Activity and the Law of Ukraine On Basics of Urban Development. These laws contain ground rules for the licensing of construction activity. Therefore, on December 5 2007 the Cabinet of Ministers of Ukraine passed Resolution 1396 which specifies the licensing procedure for construction works. It is significant that this Resolution has determined the State Architectural and Construction Inspection to act as a licensor from January 1 2008.

On February 27 2008 the Draft Law On Amendments to Article 17 of the Law on Architecture Activity (On Licensing of Some Types of Economic Activity in Construction) was submitted to the Parliament. The main objective of the Draft Law is to determine relations with regard to licensing of construction activity as related to the creation of architectural objects.

It is important to note that performance of the general contractor functions is expected to be subject to licensing in the near future. Because many organisations perform this type of activity, and because a new licensing procedure is absent, the innovation may cause confusion.

Pursuant to the Draft Law, the following types of construction-related activity shall be subject to licensing:

  • Exploratory activity for construction.
  • Creation of town-planning documentation.
  • Engineering architecture objects.
  • Construction/erection activity.
  • Erection of engineering networks.
  • Construction of transportation networks.
  • Engineering activity in construction, including: the function of a general developer in designing; technical inspection and estimation of buildings, constructions and engineering networks; examination of technical state of buildings, constructions and engineering networks; the function of a general contractor in construction; the function of engineering supervision in construction; geodesic control in construction; project or performance of construction works.

We expect that licensing provisions will soon change.

Foreigners real estate investment

Foreign legal entities, foreign citizens and joint ventures with foreign participation may purchase land only according to the agreed procedures set out in the Land Code and are subject to its limitations. All foreign entities, citizens and joint ventures with foreign participation are prohibited from owning agricultural land. Foreign citizens, foreign entities and stateless persons are entitled to purchase non-agricultural land within and outside city limits, provided that they purchase the real estate property located there.

With the consent of Parliament, state-owned land (except for land where real estate objects subject to privatisation are located) may be sold to foreign states and foreign legal entities by the Cabinet of Ministers. Land owned by communities may be sold to foreign states and foreign legal entities by the local council with the consent of the Cabinet of Ministers. There is no legislation detailing the procedures for obtaining such approval. As a result, the process is lengthy and complicated.

The registration of a foreign legal entity's representative office in Ukraine is compulsory for acquisition of state or communal land. Once foreign legal entities' representative offices (ROs) are registered to conduct commercial activity in Ukraine, such land may be purchased. The Land Code does not list wholly foreign-invested entities among the parties that may purchase state or community-owned land. In spite of this, there have been cases where such enterprises successfully solicited approval of the Cabinet of Ministers to purchase such land plots.

According to currency regulations, a foreign investor intending to purchase real estate in Ukraine should open a special investment account with a Ukrainian bank for making payments for real estate.

There is a problem with determining the moment of origination of ownership title to real estate. According to Article 334 of the Civil Code the ownership of real estate originates after state registration of the agreement. In contrast with this Article, Article 331 of the Civil Code provides for origination of ownership title of real estate from the moment of registration of this title with the respective register. In practice, provisions of Article 331 prevail.

Taxation problems

Although the Law of Ukraine On the Taxation System provides for a real estate tax, such a tax does not exist in fact. In recent years all attempts to introduce it have been failed because the Parliament has refused to support the initiatives. Nonetheless, most specialists acknowledge that the relevant law could be adopted in a tight schedule.

At the same time a land tax exists in Ukraine. It is estimated in accordance with the Law on Land Payment and special method of the Cabinet of Ministers of Ukraine.

Current tax legislation does not clearly stipulate what shall be deemed an assessment basis for withholding tax. The Law on Corporate Profit Tax prescribes that a withholding tax shall be paid on a total income earned from sale of real estate. The State Tax Administration of Ukraine states that the withholding tax shall be paid on the difference between total purchase price of a real estate object and its current book value. In practice, legal entities that are nonresidents pay the withholding tax on the difference.

At present, both tax legislation and current practice lack procedures for payment of VAT by a nonresident. As opposed to its RO, nonresidents cannot directly register as VAT payers. Thus, nonresidents sometimes pay VAT through their ROs in accordance with their own procedures. It should be mentioned, however, that payment of VAT on real estate transactions of nonresident legal entities are not controlled effectively. Notaries are not responsible to inspect whether a seller of real estate pays VAT.

Hence, many nonresident sellers do not pay VAT on sale of real estate in favour of individuals, because, in contrast to legal entities, individuals cannot act as tax agents for payment of VAT to a budget. It is difficult to foresee whether the procedure for a VAT payment will change in the near future. The question is often raised by both taxpayers and tax authorities. It should be mentioned, though, that current legislation provides for responsibility of those persons that evade taxes.

Although the Law on Land Lease prescribes that the amount, form and terms of land lease payments are set forth upon agreement between a landlord and a tenant, said Law stipulates minimum and maximum rates of lease payment for community and state owned land. According to that Law with the recent amendments introduced by the Law on the State Budget, a minimum annual lease payment for agricultural land is 1% of their normative monetary value. For other land it is 3% or more of its normative monetary value.

Pursuant to the Law on Land Lease, the annual lease payment for community and state-owned land may not exceed 12% of its normative monetary value. Such a limit can be increased if a tenancy is determined by the results of a land auction.

There is a requirement that a foreign owner leasing real estate in Ukraine to Ukrainian lessees should establish a representative office or appoint a Ukrainian representative, which should report rental income to Ukrainian tax authorities. Payment of rental in respect of real property should be through Ukrainian banks.

The amount of lease payments to real estate objects is not subject to state regulation, except for lease payments for state and communal property objects, which are calculated on the basis of procedure approved by the Ukrainian government. Nevertheless, the Cabinet of Ministers of Ukraine approved the procedure for calculating minimal amount of lease payment for real estate owned by private persons. The aim of the procedure was to prevent income tax avoidance. But there is little guidance on existing practice for applying the procedure.

It is not an exaggeration to say that the Ukrainian real estate and construction markets are among the most prospective and lucrative for foreign investors. However, liberalisation and unification of national legislation in the field of investment activity still has to be performed. The development of real estate and construction is a slow steady process; but there are definite signs of improvement, as the legislation gradually becomes more mature.

Author biography

Timur Bondaryev

Arzinger & Partners Ukraine

Timur Bondaryev is Co-Founder, Partner, and Head of Real Estate and Construction Desk.

Specialisation:
Real estate and construction, corporate law, M&A, anti-monopoly law, foreign investments

Education:
2006: Bournemouth Business School International
1998: Vienna Economic University (international commercial and tax law, summer university)
1994-1998: National Taras Shevchenko University of Kyiv, Institute of International Relations (international private law, interpreter of German language)
1992 - 1994: Horlovka High School of Foreign Languages

Career:
2002-present: Arzinger & Partners, Ukraine. Partner, Head of Real Estate and Construction Desk
2000-2002: Ukrainian Aluminium, Kyiv, Ukraine (subsidiary of Russian Aluminium), head of legal department
1997-2000: State Property Fund of Ukraine, head of legal department

Membership: International Bar Association, Ukrainian Bar Association, Kyiv Bar, Ukrainian-German Society of Lawyers

Academic activities: Lecturing at law faculty of the National University of Ukraine, Kyiv-Mohyla Academy, writing books Real Estate and Construction in Ukraine 2006, 2007 and 2008, Getting the deal through in Ukraine 2007, 2008, M&A in Central Europe and CIS 2008.

Languages: Ukrainian, Russian, German and English