Defence City: Boost for defence industry or closed club for chosen few?

Author: Vladyslav Nedashkivskyi

Drone Industry

On August 21, the Verkhovna Rada passed, on second reading and in full, two key bills to implement the Defence City initiative, a special legal regime for defence industry enterprises.

The idea behind Defence City is to create favourable conditions for companies engaged in manufacturing weapons, military equipment, and related products. The regime is being introduced to spur growth in a sector that is critical not only to defence but also to Ukraine’s economy.

Ukraine’s defence industry has, over three years of full-scale war, hit its highest level since independence. If in 2022 the sector’s potential was estimated at $1 billion, in 2025 it is put at $35 billion. In 2024, the defence sector accounted for a third of the country’s GDP growth. Defence City is expected to take the industry to new heights.

"The launch will make it possible to significantly ramp up production of modern Ukrainian weapons and military equipment, develop cutting-edge technologies, attract investment in the sector, and enhance the capabilities of the Defence Forces," says Defence Minister Denys Shmyhal.

Residents of Defence City will receive a range of benefits, primarily tax exemptions and streamlined customs procedures. Participation is open to enterprises that are of strategic importance to the state’s defence capability, meet transparency requirements, and satisfy other specified criteria.

Arms manufacturers generally welcome the initiative but also criticise it, above all, the programme’s participation requirements. The main concern is that Defence City could end up not as a breath of fresh air for the market but as a "club for the chosen," with enterprises virtually preselected to get in. Manufacturers also fear the sector’s problems will not go away.

"Any legislative initiatives adopted to foster the development of Ukraine’s defence industry are welcomed. However, we sincerely hope that under the new "banner" the old problems, such as mobilisation exemptions, export controls, and others, will not remain," says DEVIRO, a company that has been developing, designing, and manufacturing unmanned aerial vehicles and associated software since 2014.

Business Censor examines the nuances of Defence City and what Ukrainian arms manufacturers expect.

What Defence City provides

The bills adopted by the Verkhovna Rada introduce amendments to the Tax Code and the Customs Code that will apply to residents of the Defence City regime:

• Bill No. 13420 – amending the Tax Code of Ukraine and other laws of Ukraine to support defence industry enterprises;
• Bill No. 13421 – amending Section XXI "Final and Transitional Provisions" of the Customs Code of Ukraine to support defence industry enterprises.

The key provisions set out in the bills include:

• The Defence City legal regime is introduced until January 1, 2036 (or until Ukraine joins the EU);
• Instead of the List of Defence Industry Enterprises, a Defence City Register will be established and administered by the Ministry of Defence. Companies must submit quarterly reports on their activities, including production volumes, sources of income, and contract performance;
• Clear rules for residents are established: their status, the conditions for obtaining it, and oversight are defined by the Law "On National Security of Ukraine";
• The resident’s qualified-income share is set at a minimum of 75% (50% for aircraft manufacturing).

Enterprises that obtain Defence City resident status will be eligible for a number of benefits:

• tax breaks – exemption from corporate income tax provided profits are reinvested, as well as from land, property, and environmental taxes;

• simplified customs procedures;

• simplified  export controls for military-purpose goods;

• the possibility for the National Bank of Ukraine to set specific conditions for foreign exchange supervision;

• support for relocation and enhanced security of production facilities.

"This is the foundation for developing Ukraine’s defence industry, which will not only strengthen the state’s defence capability but also create new opportunities for investment, technologies, and jobs," Hetmantsev stresses.

At the same time, DEVIRO says the proposed tax breaks for manufacturers are not significant enough to materially affect defence companies’ financial performance.

"Introducing such incentives is needed more by the state than by manufacturers, because exemption from these taxes "takes pressure off" the pricing of products and services," the company’s representatives say.

Overall, the legislative package to establish Defence City, initiated by Servant of the People representatives Danylo Hetmantsev and Davyd Arakhamiia, consisted of four bills: No. 13420, No. 13421, No. 13422, and No. 13423.

However, Bill No. 13423 drew sharp criticism, as it would, in effect, grant amnesty for all violations committed in the performance of defence contracts if they were "in the interests of enhancing defence capability." According to experts, this creates legal grounds for a lack of oversight and impunity in the sector.

Defence City requires further refinement

Associations of arms manufacturers have been actively involved in drafting the Defence City bills. According to Danylo Hetmantsev, Bills No. 13420 and No. 13421, which have already been adopted, "were substantially revised together with the Ministry of Defence of Ukraine and in close cooperation with business for the second reading."

"The changes we advocated and championed were aimed at ensuring that the new legislative initiative lays the groundwork for exports, the integration of innovation, and localisation of production. We expect Bill No. 13422-1 to be considered at the next sitting of the Verkhovna Rada. I am convinced that all the adopted amendments will help create in Ukraine a foundation for the defence industry sector’s resilience and the state’s long-term defence capability," commented Kateryna Mykhalko, Executive Director of Technological Forces of Ukraine, on the passage of the key Defence City bills.

The Ukrainian Council of Defence Industry also welcomed the initiative. It noted that, in the final version, MPs enshrined a separate section in the Law "On National Security of Ukraine," lowered the threshold for the qualified-income share to 75% (50% for aircraft manufacturing), expanded the list of defence products, allowed simultaneous residency with Diia City, albeit without Defence City tax breaks, and provided for tax incentives, voluntary relocation, and the temporary protection of sensitive data.

"This adds legal certainty and allows production to be scaled up in wartime. We support the decision and, at the same time, will initiate targeted improvements during implementation, specifically, ensuring consistency with Diia City and further expanding the list of goods where the full production cycle requires it," stresses Ihor Fedirko, Executive Director of the Ukrainian Council of Defence Industry.

"The emergence of this initiative is timely and long-awaited, because in wartime the development of defence industries goes beyond an economic category—it is a factor in preserving independence and national resilience. The very fact of such an initiative was received positively by defence-industry stakeholders, associations, and the public, since for the first time in three years of full-scale war MPs have demonstrated a willingness to provide systemic support to the domestic defence industry," says Serhii Honcharov, Executive Director of the National Association of Ukraine’s Defence Industry (NAUDI).

At the same time, on the eve of the parliamentary vote, NAUDI called on MPs not to pass the Defence City bills in their current form and to return them for further revision.

"First and foremost, this concerns the proposed model for forming the Defence City participant register, which creates risks of limited access and may leave a significant number of enterprises outside the system. This means that a significant share of Ukrainian defence manufacturers could find themselves outside Defence City, which runs counter to the core idea—developing the defence industry," Honcharov explains.

He reminded that Defence City is not about benefits for individual businesses or attempts to evade responsibility, but about investing in the state’s security and resilience.

"The National Association of Ukraine’s Defence Industry has repeatedly taken part in the expert review of this initiative, proposing to expand opportunities for involving defence enterprises and to strengthen transparency mechanisms. Unfortunately, these proposals were not taken into account by the initiators. At the same time, NAUDI members consistently advocate creating transparent and sustainable conditions for the development and functioning of Ukraine’s defence industry.

Defence City must become an effective mechanism for the entire sector, not a closed club for the chosen few. It is critically important to ensure equal access rules for all strategically important enterprises, regardless of size, form of ownership, or production volume," Serhii Honcharov stresses.

A similar view was expressed in an interview with Defense Express by Valerii Borovyk, founder of the technology company First Contact.

"Who will decide, and how, who gets the green light and who does not? The procedure for entry and exit must be as transparent as possible for all participants. No division into ‘insiders’ and ‘outsiders.’ No ‘manual’ interference. Otherwise, it will create room for corruption and other abuses. This must be a clear, transparent, and well-reasoned process," he said.

DEVIRO emphasises that the most sensitive issue has been and remains the mobilisation exemption of workers.

"The latest change of the state curator for deferments is not helpful, and we can only guess whether these changes will be final or whether arms manufacturers will once again have to wait for new reforms," the manufacturer told Business Censor.

At the same time, DEVIRO views Defence City with hope:

"We hear statements by MPs that the adopted law will provide ‘streamlined export controls for military goods,’ and this gives us hope that manufacturers will soon be able to attend international exhibitions and stage demonstrations for our allies and partners of Ukrainian weapons forged in today’s battles."

Read more: How Ukraine became global leader in UAV production and deployment

The fact is that, at present, manufacturers attending international arms exhibitions cannot take serviceable specimens abroad—only mock-ups. Securing an export permit is problematic, if possible at all. And any border crossing requires approval from the export commission.

Defence City lays the groundwork for unblocking arms exports, which manufacturers have been trying to achieve since last autumn. Arms exports are not prohibited in law; there is even a dedicated procedure, but it simply does not work.

Read more: Lack of specialists affecting country’s defence capability. What to do?

"We have supported our defence industry so that it ranks among the world’s top five in arms exports," explained Danylo Hetmantsev.

"Make Ukrainian Defence industry great again," he added, alluding to U.S. President Donald Trump’s campaign slogan.

As is known, the Ukrainian side has prepared and proposed to the United States a $50 billion drone deal. It is designed for five years and provides for the production of 10 million drones per year. According to President Volodymyr Zelenskyy, the programme will most likely start after the war, although earlier he said that the Americans would buy drones from Ukraine as soon as Ukraine opens arms exports.