The new Defence City mechanism: will it increase weapons production in Ukraine in 2026?

"Defence City should help Ukraine become one of the world's top 5 arms suppliers," said co-author of this legislative initiative, MP Danylo Hetmantsev.Defence City is a new legal regime that offers benefits to manufacturers of military equipment. Ukraine already has a similar mechanism, Diia.City, which eases the tax burden for IT companies.But how long will it take to see real results from Defence City? Will it increase arms production as early as 2026? I talked to the heads of defense associations and leading arms manufacturers about this.What is Defence City: benefits and risksDefence City is a set of laws and government regulations that makes it easier for defense companies to produce military equipment.Only those companies that have voluntarily applied for the program – "residency" – and have been approved by the Ministry of Defense are eligible for the benefits provided by Defence City. In practice, Defence City is not a "city" as its name implies, but a register of defense companies entitled to facilitated business conditions.One of the biggest advantages of Defence City for military equipment manufacturers is the exemption of residents from income tax, provided that the company reinvests this money in the development of its enterprise.In addition, it is proposed to exempt producers from land, property and environmental taxes, simplify customs procedures, and provide state support for strengthening physical protection and relocating enterprises to safer regions."A significant advantage of the regime will be the possibility of export. But for now, this is a prospect for the next six months," says a joint response from autonomous drone manufacturer The Fourth Law and thermal imaging camera manufacturer Odd Systems to a request from LIGA.net.At the same time, Defence City also has risks: both for residents and the entire country."Privileges reduce budget revenues in the short term. This is justified only if the regime increases production and supply of weapons to the Defense Forces," emphasizes Ihor Fedirko, Executive Director of the Ukrainian Armorers' Council.In addition, according to Fedirko, the exemption of residents from environmental tax also poses a risk. "Minimum standards for hazardous materials and waste management must remain under control," he emphasizes.Among the main risks for residents are the following, according to the FPV drone manufacturer General Chereshnya:excessive or uneven regulatory control if the rules are interpreted differently by different authorities;declarative – if the declared incentives are not backed up by real mechanisms;investment risks if the residency status is not sufficiently stable over time and changes along with political cycles.There is still a risk of expanding production faster than the market will buy the series, because the benefits do not replace contracts, emphasizes Fedirko."But we do not see the risks as a reason to abandon this instrument. On the contrary, the dialog between the state and producers is critically important at this stage," emphasizes General Chereshnya.Read alsoA "fully Ukrainian" drone is still a long way off: how Ukraine is reducing its dependence on ChinaWho is already in Defence City and who is planning to joinSkyFall, a manufacturer of Vampire and Shrike drones and Shahed interceptors, became the first resident of Defense City. Other companies are not in a hurry to establish a residence."We are considering the option of joining, but we are not yet at the active stage of applying. We are studying, among other things, the peculiarities of taxation and booking in this mode," reads the joint response from autonomous drone manufacturer The Fourth Law and thermal imaging camera manufacturer Odd Systems."We are interested in the real content of the legal regime: how much it will be filled with practical tools for producers in terms of tax incentives, customs procedures, access to infrastructure and landfills, export mechanisms and interaction with government customers," says General Cherry. The company is also analyzing how the proposed format fits its production and R&amp;D strategy.The Technological Forces of Ukraine Association, which includes about 60 miltech companies, said it expects to receive a consolidated position of manufacturers no earlier than the end of January, when the arms industry will study the features of the new regime.Competition with Diia.City remains an important issue for Defence City's success, as companies are not allowed to be residents of both legal regimes at the same time. For example, more than half of the 125 members of the National Association of the Defense Industry of Ukraine (NAUDI) are members of Diia.City, and some of them are unwilling to change the "legal city," says NAUDI Executive Director Serhiy Honcharov."The decision to join will be made after analyzing the actual results of this regime and comparing its conditions with other available preferential regimes for deftech companies, including Diia.City, where we are already residents," says Frontline Robotics, which manufactures drones and turrets.At the same time, for Himera, a manufacturer of modern secure communication systems that is also considering joining Defence City, an important issue is the practical combination of the tools of this legal regime with other existing preferential projects, including Diia.City, says Kateryna Bumaga, the company's chief legal advisor.Read alsoLiving artificial intelligence: how FinalSpark makes a computer out of human brain neurons – an interview with the CEOWhen to expect an increase in production"Defence City can provide significant growth for the defense industry by the end of 2026 if it really helps to launch and scale up serial production, and serial production is reinforced by contracts and projected funding," Fedirko says.Goncharov also says that the real growth in arms production due to the Defense City regime will not be seen soon, but at least in three months."The mere fact of residency will not increase our production. However, the situation may change if Defence City simplifies the import of components and equipment, improves forecasts for long-term contracts and investments, and reduces transaction costs when interacting with the state," General Cherry emphasizes.If all the benefits of Defence City really work, General Chereshnya could increase drone production by tens of percent by the end of the year, the company expects. Other manufacturers interviewed are not yet ready to even estimate the potential for increased production due to the new legislation.What kind of equipment should be produced in the first place? According to Goncharov, these are aircraft, ground and sea drones, as well as electronic warfare equipment, as foreign markets are interested in these products. Fedirko makes a similar prediction: according to him, short-cycle segments will take off first: drones, electronic warfare, sensors, communications, components, repair and service. "In capital-intensive areas with long cycles, there will be an effect, but with a longer lag," Fedirko adds.

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