Financial and Tax Considerations when Closing a Company in China

Foreign invested enterprises need to be aware of the tax considerations of closing a business in the mainland as follows:

Clearance of outstanding corporate tax liabilities

According to new PRC GAAP,  manufacturing enterprises should accrue 2 percent into the trade union fund. It should be noted that the 2 percent accrued into the trade union belongs to the trade union on liquidation, not to the liquidation committee.

For enterprises with normal operations, several transaction taxes e.g. stamp duty, deed tax should be declared within a certain period after the relevant activity occurs. But 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.

New tax liabilities during liquidation

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

Asset disposal

There is no difference between assets transferring during liquidation and assets disposal in daily operations. But as the purpose of assets transfer during liquidation is for assets 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 expense.

Import VAT and custom duty

Customs prescribe 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 custom 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 assets transfer 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 assets transfer in liquidation.

Assets taxes

Relevant taxes could include urban real estate tax and vehicle and vessel usage 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 would 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 would pursue these tax amounts, which may increase the cost of liquidation.

Corporate income tax

Based on the new Corporate Income Tax Law, if an enterprise terminates its business activities after the beginning of a tax year with the result that the actual period of operations during such tax year is less than 12 months, its actual period of operations shall be treated as a tax year. When an enterprise is liquidated according to the law, the liquidation period shall be treated as a tax year.

If an enterprise terminates business operations during a tax year, it shall carry out full and final settlement of corporate income tax for the current period with the competent tax authorities within 60 days from the date on which it actually terminates business. Before an enterprises deregisters, it shall file a return with and pay tax to the authorities in accordance with law in respect of its income from liquidation.

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 - (undistributed profits + various funds + paid-in capital)

In most cases, the liquidation period will probably be the final tax payment period. According to current law, profits from the current year could only be set off 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. 

To read the full version of this article, please purchase the Closing Down Representative Offices and Liquidating Businesses in China issue of Asia Briefing Bookstore. Companies requiring assistance may contact any Dezan Shira & Associates' nine national offices at china@dezshira.com for advice or visit www.dezshira.com.