How to liquidate a Chinese company?

Doing business in China can be rewarding and make you incredible rich, but sometimes things can go wrong. In this case, closing your company might be the only solution. However, liquidating a business in China can be a challenge of its own kind. The process is long and involves multiple applications, deregistrations and negotiations. 

In order to help you, this article offers some guidance on the proper completion of application forms, deregistering of certificates, and the answers and explanations you have to give to the tax authorities. Therefore, we will go through all the steps and procedures involved in the liquidation process. Along the way, we’ll discuss the key challenges, the potential problems and consequences, and lastly, we will offer some helpful hints to facilitate your process.

The Liquidation process

Once the company has decided and declared its decision to dissolve, the liquidation process begins. The liquidation process can be time-consuming, usually taking up to 12 months, but may differ depending on the reaction time of the company, the authorities and other unforeseeable circumstances.

The figure below gives a rough overview of the liquidation procedure.

Liquidation1 EN

The liquidation process can be roughly divided into three phases. The tasks and steps involved in the first stage are mainly the decision making, preparation of documents and other activities which ultimately end in the obtaining of the Approval Letter for the Termination of the Article of Association of the company. This letter is then submitted with all other liquidation documents to the Administration of Industry and Commerce.

The second phase involves the actual laying off of employees, settling of assets and the distribution of proceeds. These processes are where most of the key challenges arise. These challenges will be further discussed below.

The final phase is where all the loose ends are tied up. This involves resolving outstanding payments, applying for deregistration at multiple government authorities and a post-liquidation audit. After this phase, the company will have officially deregistered.

The First Phase

The first phase of dissolving a company usually takes up to four months and comprises seven steps which have to be taken according to Chapter 10 of the Chinese Company Law passed in 2014.

Liquidation2 EN

There might be multiple reasons for dissolving a company. The most common are:

– Terminated by the government due to illegal acts or harming public interest

– Unable to continue business operations because of external forces, such as natural disasters or war

– Expiration of Terms of Operation

– Liquidation due to financial difficulties

– Liquidation due to mergers or split of company

If the decision is taken voluntarily, it should be passed by a shareholder meeting, representing at least two thirds of the voting rights. However, according to the Articles of Association, and more commonly seen in practice, is the need to unanimously pass a resolution for liquidation by the share-holders or the company’s directors, or both.

However, foreign owned enterprises might need a permission from the authorities to liquidate before they can proceed with the next steps (see Art. 72 of the Detailed Rules for The Implementation of The Law on Wholly Foreign-Owned Enterprises). The company will need to take its correctly completed application, along with the relevant documents regarding the company (e.g. the resolution to liquidate and company license) to the Beijing Municipal Commission of Commerce in order to receive the Approval Letter for the Termination of the Article of Association. As the obtaining of the permission may be a tedious wait, ECOVIS Beijing recommends you to make sure that you have all the necessary documents ready and the application correctly filled out. This may save you the trouble from going twice or even three times. With this permission, the company can now start settling assets.

Once the decision has been made and the necessary permission obtained, the company is then required to form a liquidation committee within 15 days (Art. 183). The liquidation committee will take responsibility for and manage the liquidation process (Art. 184). The main responsibilities of the liquidation committee include:

– Notifying the general public & creditors of the liquidation of the company

– Overseeing the pre- and post- auditing process

– Value and liquidate the assets of the company according to the PRC Law and the Articles of Association

– Formulation of a Liquidation Plan

– Settling all unfinished business, outstanding taxes and debts

– Produce and obtain confirmation of Liquidation Report from the Board of Directors and then the approval from Authorities

– Overseeing the deregistration from tax, customs, foreign exchange, social insurance, etc.

– Closing down bank accounts

The liquidation committee generally includes at least 3 members including a chairman. The chair-man has the responsibility to represent the company towards third parties. In general, the liquidation committee is usually fully comprised of its shareholders, where the shareholders then directly participate in the managing of the liquidation process.

It is important to note that the liquidation committee or an individual committee member may be held personally liable for any action that results in losses to the company or creditors. This can be either intentional or due to gross negligence. But in any case, the consequences can be quite severe.

After the establishment of the liquidation committee, the committee members have 10 days to notify the company’s creditors and 60 days to notify the general public of the dissolution. After the notification to the creditors, the known creditors then have 30 days to submit their claims. For the unknown creditors, they have 45 days after the public notification to submit their claims (Art. 185). This is the opportunity for the creditors to tell the liquidation committee further details on the stakes they have in the company.

Once the company has been registered and declared to be liquidating, the company is required by law to abstain from all business activities except for those involved in the liquidation process. This means that only activities involving the ending of existing commercial relationships, terminating employment, selling assets, etc. are allowed.

The first audit in the liquidation process comes after the authorities have given the approval for termination. The Pre-Liquidation Audit Report, which has to be signed by a CPA accountant, is to ensure the tax authorities that the business dealings and company accounts are valid and in proper order prior to the liquidation decision. Therefore, the Pre-Liquidation Audit will need to cover at least:

– A summary of the financial position – the results of its operations and cash flows – starting from the day the liquidation team is set up to the date the report is done

– A summary of the liquidation process, which is in compliance with the law. This should include:

– Liquidation accounting policy including the period of liquidation, the liquidation basis & liquidation property payment order

– Situation of liquidation: the liquidation of creditor’s rights & the debts that have been cleared by the end of liquidation

– The distribution of the surplus property

– Other instructions

Having completed the first 6 steps of the first phase of the liquidation process, you are ready to head back to the Administration of Industry and Commerce (AIC), the authority who registered the approval and establishment of your company, to hand in your documents and register the liquidation.

The Second Phase

The second phase includes the termination of employment contracts, the liquidation of company assets, the collection of outstanding debt, and the distribution of proceeds.

The liquidation of a company creates a legal ground on which a company can lawfully lay off employees. For foreign invested enterprises, Chinese authorities often require an employment settlement report, including details regarding termination, transfer, notice and severance pay. However, this doesn’t mean that all employee contracts should be terminated immediately. In fact, it is often avisable that some employees are kept to help and support the liquidation process.

In the event of liquidation, all fully owned assets by the company are valued and sold to pay off the liquidation expenses, outstanding debts, fees and taxes. It is crucial to understand that all assets should be valued and sold at a reasonable amount or they may create losses to the company, for which the liquidation committee can be held liable. In addition to the timing of the liquidation of assets, it’s also important to differentiate the bonded assets and non-bonded assets. These assets must be dealt with separately as they have different regulations regarding its disposal. While non-bonded assets can be simply sold for proceeds, non-bonded assets are harder to sell, since they were imported without VAT and duty tax. As a result, bonded assets can in theory only be disposed via the following methods:

– Selling the bonded asset to a foreign entity and directly exporting it out of China

– Selling the bonded asset to a domestic entity and paying the exempted VAT and duties

 

Once the company enters liquidation, the company should try to collect all outstanding debt with its clients and other entities. This would help pay off the creditors in the next step. Since there is a high risk there is a high risk that debtors, who are aware of the liquidation process, renege on their duty, and lawsuits are costly and time consuming, it might be a good idea to transfer the collection rights to a third party.

 

After all, receivables have been claimed and assets are converted into proceeds, these proceeds then need to be paid off to the creditors. The priorities in which creditors should be paid is outlined by the PRC law and should be paid in the following order:

Liquidation3 EN

 

 

The Third Phase

The third phase, finally, consists of the post-liquidation audit, the deregistration, the final distribution of funds, and the closing down of bank accounts.

After the settlement of assets and the distribution of proceeds, a second audit report will need to be done. This audit process would be similar to the first audit except with a focus on the balance sheet regarding the liquidation. Where the first audit was a plan of the liquidation process, this audit will be verifying the actual transactions during liquidation. This should include liquidation expenses, revenue from the assets and the distribution of proceeds.

Once the post-liquidation audit report is completed, the deregistration processes can then begin. Certificate approval, business licenses, tax registration certificate, foreign exchange certificates, financial certificates, statistical certificates will all need to be filed for deregistration. This will involve various authorities such as the Ministry of Commerce, the State Administration of Industry and Commerce, the customs administration, the tax authorities and the State Administration of Foreign Exchange.

Liquidation4 EN

One of the key challenges a company will face during the process is the settling of outstanding and new taxes with the tax authority. Company owners should be aware that tax bills might increase considerably, especially if they previously had enjoyed tax benefits. Tax authorities have often required dissolving companies to pay back these discounts, since the underlying assumptions for granting this advantage have become obsolete due to the liquidation process.

Equally, a range of new taxes can emerge during the liquidation of assets. Where there is revenue, there often comes tax. The taxes that may arise include: asset tax, import VAT and custom duty, turnover tax, individual income tax & corporate income tax.

Finally, the remaining funds after de-registration should be then distributed to the share-holders and all company bank accounts should be closed down.

Liquidation Risks

Throughout the liquidation process, with careful financial planning and truthful reporting, everything can potentially run very smoothly. However, risks of miscalculation or incorrect litigation procedures should be taken seriously.

Most companies enter liquidation under the impression that their assets and receivables are able to cover both the costs of liquidation as well as its debts. However, due to the wide range of variables that can alter the company’s ability to pay, i.e. receiving less for assets or increase of taxes paid, bankruptcy may occur.  In this case, the liquidation process and the company is then placed in the hands of a court. An independent administrator will then take-over the process and be in charge of further action. Just one unsatisfied creditor is enough to file for the company’s bankruptcy.

Another risks lies in an inaccurate liquidation process. This risk can come from a spectrum of different activities. These include: bad faith asset disposal, failure to file the Liquidation Audit Report, failure to properly notify creditors of the liquidation proceedings, as well as unpaid taxes, debts, salaries or social insurance contributions. The consequences depend on the action, but can generally result in fines, imprisonment and asset confiscation.

 

Other than immediate penalties, incorrect liquidation can also become a barrier for future investments in China. In fact, to prevent foreigners just leaving China and their unfinished business behind, the Chinese government has prohibited individuals that face civil lawsuits, criminal charges or have unfulfilled payment obligations to leave the country. This means that fleeing individuals can face the probability of a travel restriction, the freezing of assets and a no-departure restraining order.

For further information read articles about similiar topics like 4 Steps to Liquidate a Wholly Foreign Owned Enterprise or Company Liquidation.

ECOVIS Beijing offers liquidation services for foreign companies in China. If you have questions, please contact: richard.hoffmann@ecovis-beijing.com

 

 Richard2017 150x225   Richard Hoffmann

Richard Hoffmann is a partner at ECOVIS Beijing China. Richard obtained an honors degree in law and worked in Germany, the United States, and China for various prestigious law firms prior to joining ECOVIS. In addition to being a member of the board of ECOVIS International, he is Supervisor for the China business of a respected German company and shares his extensive knowledge to students by teaching commercial law in China at SRH Hochschule Heidelberg. He has published more than fifty articles in international magazines, frequently speaks at high profile events in China and abroad and is often invited as a legal expert by international TV stations. Contact: richard.hoffmann@ecovis-beijing.com

 

Ecovis Beijing is the trusted tax and legal advisor to several embassies and official institutions in China. It specializes in mid-sized international companies and is focused on tax & legal advisory, accounting and auditing. If you’re interested in finding out more about tax and legal, don’t hesitate to sign up for our Newsletter, give us a call +86 (10) 6561 6609 or contact us directly via service@ecovis-beijing.com