Imagine a reconstruction fund so tax-preferred it makes municipal bonds look like a comparative raw deal—that’s what the United States-Ukraine Reconstruction Investment Fund may have just created.

The fund, formally established through an agreement between the U.S. and Ukraine in April, is structured as a limited partnership between two state-backed agencies: the U.S. International Development Finance Corporation and Ukraine’s Agency on Support Public-Private Partnership.

The purported ambition is the reconstruction and rebuilding of Ukraine post-Russian invasion—with a strong preference toward a steady infusion of international capital. The fiscal kicker is that all income flowing into, within, and out of the fund is completely exempt form Ukrainian taxation. No income tax, no withholding, no levies.

At first blush, this looks like a dream scenario for foreign investors—more specifically Americans. But how does this work in policy terms?

The agreement between Ukraine and the U.S. is not without precedent; conflict-torn states often resort to tax exemptions in order to lure back capital. From Iraq to Rwanda, domestic tax codes have been leveraged to jump start rebuilding.

What makes this agreement different is the scope, permanence, and primacy. The agreement appears to essentially lock in the exemptions in perpetuity, requiring any future Ukrainian legislation to defer and yield to this international treaty. In fact, Ukraine explicitly agrees that no domestic law can override the terms of the agreement, and it can’t plead any internal law in order to avoid compliance.

This undermines one of the core sovereign powers any state wields in a globalized economy: the right to tax within its borders. Ukraine is trading that for long-term capital and, perhaps more to the point, strategic alignment with the west. One could be excused for seeing the bargain as Faustian.

From Washington’s perspective, this is more than a modern day Marshall Plan, its an invitation to shape post-war Ukraine in America’s image—market-centered, investor-friendly, and western aligned.

Perhaps more to the point, there is little to lose. The U.S. tax implications would have always been minimal because income sourced outside the U.S. and not effectively connected to a domestic trade or business is not taxable to foreign persons. The U.S. portion of the tax-free agreement merely reflects this ongoing assumption, making no affirmative commitments with regards to taxation whatsoever.

This means that, most likely, a Ukrainian partner would not face U.S. tax exposure, and American investors could receive returns free of Ukrainian tax and with the usual array of U.S. international tax planning tools and schemes at their disposal. One can reasonably expect some savvy fund managers to route investments through this new partnership in order to arbitrage other treaties and preferred tax treatments.

Ukraine has been angling for accession to the EU for some time—and the agreement contemplates this. The EU would very likely frown upon the wholesale tax base erosion inherent in the agreement—so there is language acknowledging community obligations and allowing for renegotiation of the fund’s structure collides with future accession plans or terms.

But taxation isn’t the only tool Ukraine is giving up. The agreement mandates full convertibility of the hryvnia into dollars for all partnership-adjacent transactions. Even during martial law, the fund retains special privileges on transfers. If Ukraine breaches any of these agreements, it is required to indemnify both the fund and its partners for any losses.

In effect, this provision transforms the fund into something like a sovereign entity—which the EU may not look on favorably. The fund bypasses traditional capital controls even when the rest of the Ukrainian economy might be locked down—tough stuff.

Ultimately, the question remains an open one whether this agreement is a one-off or the first foray into a new post-conflict economic rebuilding plan for the U.S. The Global South has, for some time, been looking for alternatives to International Monetary Fund financing and the West has, for almost as long, been looking for methods to counter China’s Belt and Road.

Tax-sheltered reconstruction zones backed by treaties may be the next frontier in economic diplomacy.