Liquidating a China Business

February 8, 2012 Posted by China Briefing Reading Time: 9 minutes

Tax, financial and regulatory compliance considerations when closing a foreign-owned business in China

Feb. 8 – Many foreign businesses in China do very well and are profitable. However, there will always be some that do not succeed commercially, or that may have to close because of external circumstances affecting their parent company overseas.

There are of course regulations under Chinese law for how these liquidation processes should properly be carried out to ensure that the company’s final bills are settled, tax is paid, and all the company’s remaining liabilities and statutory responsibilities are correctly discharged. In this article, we explain the procedures you would need to go through to close a foreign invested enterprise in China, and highlight the many related issues that you will need to address.

Company law and the liquidation process
The procedures for closing a wholly foreign-owned enterprise (WFOE) – its dissolution and liquidation – are no easier or shorter than the process of setting up such a company, and normally take between 12 to 14 months to complete.

According to PRC law, a WFOE must be dissolved if any of the following circumstances apply:

Its term of operation expires
It experiences financial difficulties and the board deems it necessary to dissolve the company
It is unable to carry out its business due to major losses caused by force majeure
It is bankrupt
It is terminated by the government; for example because it commits illegal acts damaging the public interest
Dissolution of the company is necessary due to any merger or de-merger to which the company is a party to
Other reasons for dissolution stipulated in the original Articles of Association have occurred.

For circumstances (2), (3), (6) and (7), dissolution will need the approval of the relevant authority.

Upon the declaration of dissolution, the company is required to start the liquidation procedures.

Creation of liquidation committee

The board will need to appoint a liquidation committee to handle the liquidation within 15 days of the date on which the circumstances leading to dissolution of the company occurred.
The liquidation committee shall liquidate and value the company’s assets in accordance with PRC Law and the Articles of Association.
The liquidation committee of a WFOE (limited liability company) shall be comprised of its shareholders.
The liquidation committee shall exercise the following functions and powers during liquidation:

Liquidate the assets of the company, prepare a balance sheet and list of assets, and formulate the liquidation plan
Notify the company’s creditors by way of notice or public announcement
Complete any unfinished business of the company
Submit the appraisal and valuation of assets and the basis for calculation
Pay all outstanding taxes
Pay all outstanding debts in full
Settle all of the company’s claims and debts
Dispose of the remaining assets after the company’s debts have been settled
Represent the company in any civil litigation
Produce the Liquidation Report and submit to the Board of Directors and the authorities for approval

Liquidation audits
Liquidation audits are generally required twice in the process:

When the termination application is submitted to the authorities and the application is approved by those authorities
When all termination procedures have been completed

As well as normal audit procedures, liquidation audits will focus on these additional issues:

1. The financial performance and transactions of the company for the last three years before the date of declaring liquidation.

2. The completeness and truth of information on assets, such as:

Whether the calculation of accounts receivable is correct
Whether the bad debts write-off was properly authorized
Whether the bank account records are complete
Whether physical assets properly belong to the company
Whether disposal/loss of fixed assets is approved by related authorities
Whether investing assets are recorded and distributed correctly

3. The liabilities of the company, such as:

Whether salaries payable are calculated correctly
Whether tax payable has been cleared properly
Whether other liabilities have been cleared properly

4. The liquidation expenses, including a check on whether these expenses were spent in compliance with the law.

Liquidation deadlines
The liquidation committee shall observe the following deadlines:

Within 15 days of beginning the liquidation, the liquidation committee must be established
Within 10 days of the establishment of the liquidation committee, the committee member list and in-charge person must be filed with registration authority
Within 10 days of establishing the liquidation committee, it must notify known creditors and ask them to declare their claims
Within 60 days of establishing of the liquidation committee, it must release an announcement in both a national newspaper and an appropriate provincial or municipal newspaper

Distribution of liquidated proceeds
In accordance with PRC Law, revenues from the sale or disposal of the liquidated assets shall be paid out in the following order:

Liquidation expenses
Employee wages
Social insurance premiums and legal indemnity premiums
Outstanding taxes
Outstanding debts

After payments have been made in accordance with provisions above and upon completion of the liquidation procedures, the remaining revenue shall be converted into U.S. dollars, or any other foreign currency acceptable to the investor through a designated foreign exchange bank or any other method permitted by PRC Law, and can be freely remitted or transported abroad.

Cancellation of registration
Upon completion of the liquidation procedures, the liquidation committee shall submit the Liquidation Report, approved by the Board, to the original approval authority. The committee should return its business license and cancel its registration with the relevant government authorities including the Ministry of Commerce, the State Administration of Industry and Commerce, the customs administration, the tax authorities and the State Administration of Foreign Exchange. All of the company’s bank accounts should be closed.

The investor shall have the right to preserve the originals of all accounting records and business documents of the company.

After submission of the Liquidation Report, the company should perform de-registration with the authorities. After de-registration, the company can repatriate the remaining funds back to the investor. These de-registrations and other processes are:

De-registration from Ministry of Commerce, and cancellation of the Approval Certificate
Tax audit and de-registration from the local tax bureau
Tax audit and de-registration from the state tax bureau
Customs de-registration
De-registration with the State Administration of Foreign Exchange
De-registration from the State Administration of Industry and Commerce
De-registration of the Business Code Certificate
Public announcement in a newspaper to terminate the business
Remit funds back to investors
Close bank accounts

In addition, some companies in particular sectors may have other specialized registrations and those should be closed off as well. Although not strictly a financial issue, foreign investors should also ensure that, for example, unused raw materials and unsold products are disposed of properly, and in an environmentally sensitive way, and that buildings and other major assets are dealt with properly. Do not walk away from your responsibilities!

Financial and tax considerations when liquidating
Foreign invested enterprises in China that undergo liquidation will need to deal with two main tax issues. These are:

Clearance of outstanding tax liabilities: the liquidation committee must meet any potential and actual tax liabilities. After confirmation, the liquidation committee will pay the outstanding tax liabilities to relevant departments.
New tax liabilities during liquidation: the liquidation itself may raise new tax liabilities – for example, fixed asset disposal may raise some turnover taxes, and employee compensation will be subject to individual income tax.

Clearance of outstanding enterprise income tax liabilities
Some foreign enterprises may still be receiving various incentives, including “tax holidays” such as a two-year exemption and three-year 50 percent reductions on enterprise income tax. Such “tax holidays” normally only apply to companies on the assumption that they are expected to operate for at least 10 years. Enterprises which are granted this tax relief, but actually operate for less than 10 years, are technically required to repay the amount of tax exempted or reduced.

Whether the above actually applies depends on the local practices of the authorities in different cities and districts.

The enterprise income tax refund that was previously offered for reinvestment of profits is no longer available.

New tax liabilities during liquidation
For enterprises with normal operations, several transaction taxes (e.g. stamp duty and deed tax) should be declared within a certain period after the relevant activity occurs. But the majority of taxes are declared periodically, for example monthly.

Thus, after liquidation begins, there is a possibility that the enterprise’s remaining tax amount is not declared and paid. And business transactions before liquidation could still be completed within the liquidation period and would bring new tax liabilities. Both these issues will need to be taken into account by the liquidation committee.

During the liquidation period, asset disposal and termination of employees, among other issues, may possibly create new tax liabilities.

Asset disposal
There is no difference between asset transferring during liquidation and asset disposal in daily operations. But as the purpose of asset transfers during liquidation are for asset distribution, the tax liability would be considered differently. Part of the tax liability would be considered as a liquidation expenses and paid preferentially in advance of other expenses.

Import VAT and customs duties
Customs prescribes different monitoring years for imported products of different kinds. During the monitoring period, goods should be depreciated at true value if Customs authorizes their sale, transfer or move for other uses, for example during liquidation. In this situation, both import VAT and customs duties should be levied.

The relevant formula is:

Price after tax = CIF price x [1 – actual number of months used/(management years x 12)]

Secondly, if a foreign invested enterprise wishes to transfer goods originally imported with an import VAT exemption, if goods are left with a Chinese partner or transferred or sold to a domestic enterprise, Customs would calculate the tax amount based on the depreciation year. If they are transferred to other foreign enterprises enjoying preferential tax treatment, then the goods could still enjoy such preferential treatment.

Turnover taxes
Turnover taxes involved in asset transfers during liquidation will usually be value added tax, business tax, consumption tax and land appreciation tax. There is no specific regulation related to turnover taxes for asset transfers in liquidation.

Asset taxes
Relevant taxes could include real estate tax and vehicle and vessel tax for foreign-invested companies. During liquidation, before transfer of such vehicles and vessels, foreign enterprises would still have tax liabilities.

Individual income tax
Employees from liquidated enterprises will usually receive a certain amount of compensation, and foreign enterprises must withhold individual income tax for such payments in the normal way. If they do not do so, then tax bureau could pursue these tax amounts, which may increase the cost of liquidation.

Enterprise income tax
The liquidation period should be considered as a separate taxable period to calculate enterprise income tax. The relevant formulas are:

Liquidation gains/losses = (gains/losses from inventory disposal) + (gains/losses from non-inventory disposal) + (gains/ losses from asset disposal)

Net assets/retained assets = (liquidation gains/losses) – (salary/mandatory welfare benefits payable) – (liquidation expenses) – tax due – other liabilities – losses on bad debts + income from repaid debts

Liquidation income = net assets/retained assets – accumulated loss – net assets value on tax basis +(-) other tax adjustment

In most cases, the liquidation period will probably be the final tax payment period. According to current law, profits from the current year can only be offset against the previous year’s loss. Therefore, classification of income and expenses for the liquidation period and the previous year is quite important. Choosing the correct liquidation date could mean significant tax efficiencies. As ever in these circumstances, get good professional advice!

Special treatments for liquidation on bankruptcy
Normally liquidation is performed when assets are greater than liabilities, and there should be no problem in paying any taxes that become due.

But if foreign enterprises make losses due to poor operation and management and cannot pay their tax liabilities, or assets are less then liabilities during liquidation, then the enterprise would be considered as insolvent or bankrupt. Because assets from such insolvent enterprises cannot meet all their liabilities, it is very important to determine the order in which taxes are tax cleared.

When a foreign enterprise performs insolvency liquidation, the Enterprise Bankruptcy Law and other related civil laws will apply. But in these civil laws there is no specific definition of insolvency expenses, and foreign enterprises may therefore have some flexibility when dealing with this issue, subject to the order of expenses priority as set out in the Enterprise Bankruptcy Law

According to the regulations, the tax should be paid before asset disposal; otherwise it would affect asset transfers. These tax liabilities should be paid preferentially. For other tax liabilities, if they are considered as liquidation expenses, it may affect the repayment rights for other debts, while if they are combined with other due taxes, then it would affect repayment rights for other debts before taxes due. Overall, the tax authorities might lose some income.

All of this complexity means a foreign enterprise must, in such circumstances, think very carefully about how it proceeds, and take proper professional advice.

Tax de-registration
After the foreign enterprise completes all its liquidation procedures and pays its taxes, the relevant tax bureau would proceed to cancel its tax registration. After that, the foreign enterprise can complete the other de-registration procedures mentioned previously.

The following materials should be submitted to the tax bureau:

Application letter, with relevant authorization certificate and other documents
Liquidation audit report
Liquidation report
Tax clearance certificate for all taxes
Approval letter for liquidation from authority that approved original establishment
Application and examination form for tax registration termination, and other documents required by the tax bureau

Dezan Shira & Associates is a boutique professional services firm providing foreign direct investment business advisory, tax, accounting, payroll and due diligence services for multinational clients in China, Hong Kong, India, Singapore and Vietnam. For more information and advice regarding liquidating a China business, please email china@dezshira.com, visit www.dezshira.com, or download the firm’s brochure here.

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