WFOE Deregistration in China: Six Common Questions
For whatever reason, investors in China may be faced with the decision to cease their company’s operations.
Economic circumstances change rapidly, and the business assumptions that underlie the initial investment may have proven to be flawed.
In such a situation, it may be tempting to simply walk away from the entity in China and cut one’s losses. For a variety of reasons, this can be ill-advised.
The Chinese government imposes severe sanctions on investors who do not properly deregister their company, including barring companies and individuals from doing business in China. For investors with future prospects still open in terms of doing business in China, it is beneficial to carry out the company deregistration in a legally compliant and structured manner.
Here, we answer six common questions foreign investors often have during the WFOE deregistration process in China.
1. Are there alternative options to WFOE deregistration?
For a company looking to end operations in China, other than deregistering the company or simply “walking away”, a company may choose to explore the option of selling the company.
However, if a company may want to continue operations at a later point, the company should consider reducing operations while continuing to meet statutory company requirements, such as maintenance of an office lease and corporate bank account, tax filings, and annual reporting and inspections at a reduced level.
2. Why does it take so long to deregister a company?
Tax deregistration is the main culprit.
The longest and perhaps most difficult part of the deregistration process is usually the tax closure process. Before deregistering with other government authorities, a company will first need to complete a tax deregistration with both the state and local tax bureaus where tax authorities will be looking to see that all taxes have been paid correctly and in full.
This process, both at the local and state tax bureau, takes roughly six months for a WFOE to complete. However, the process can take considerably longer if unpaid taxes or other irregularities are found.
If so, the company may be required to submit additional documentation, settle any unpaid or incorrectly filed taxes, and/or pay late payment surcharges and/or penalties.
This can be particularly frustrating as tax filings that were previously reviewed and accepted while the company was in operation will again be reviewed and can be found to have irregularities, which will then need to be settled with the tax authorities. This point, in particular, underscores how important it is to have a competent and experienced accounting team or accounting service provider in place.
3. How will assets be handled during the WFOE deregistration process, and what is the role of the liquidation committee?
These will generally either be liquidated, or transferred to the shareholders. A liquidation committee is formed to liquidate the assets.
The timing and method of asset disposal will largely depend on the type of assets and the situation of the company.
Early on in the WFOE deregistration process, a liquidation committee, consisting of all shareholders, will need to be formed.
Once formed, the liquidation committee will be responsible for preparation of the balance sheet and a detailed list of all assets, properties evaluation, and formulation and implementation of a company liquidation plan, including liquidation of assets. Assets include intellectual property.
The liquidation committee will also be responsible for a number of other matters concerning the WFOE deregistration process, including notifications to creditors and the preparation of the liquidation report to submit to authorities. Here, it should be noted that a company should refrain from paying back creditors, until the liquidation plan has been made and approved by the board of shareholders.
4. What are the core maintenance issues investors should consider during the deregistration process?
Tax filing and business license compliance requirements.
Even after the official deregistration date of the company, a company will still need to continue to file taxes until the official tax deregistration process has been completed with both the local and state tax bureaus.
Additionally, until the official deregistration certificate has been issued by the AIC, a company will be required to maintain a valid business license and office lease during the deregistration process.
5. What are common tax noncompliance issues?
Diﬀerent issues can be raised by local and state tax authorities.
During the local tax deregistration process, authorities will review company contracts, accounting vouchers, and employee IIT payments. Common noncompliance issues cited by the tax bureau include unpaid stamp taxes on contracts as well as unpaid or improperly calculated employee IIT.
State tax authorities on the other hand will be looking to review tax filing reports and financial reports. Common noncompliance issues cited by the state tax bureau will typically be related to variances between bookkeeping, reporting, and tax filings, so a company will need to be able to explain these variances should they be challenged by the state tax bureau.
Having annual tax audit reports may help in this process and, depending on the requirements of tax authorities, a three-year tax clearance audit report will often be required, though not all tax bureaus will require this.
6. What if the company lease or business license expires during WFOE deregistration?
Penalties can be imposed, so investors should make sure to stay in full legal compliance until the entity is closed.
Under Chinese law, for deregistration noncompliance in these areas, a WFOE may be liable for penalties ranging from RMB 30,000 (US$4,400) to RMB 100,000 (US$14,663), though enforcement of these penalties is left broadly to the discretion of local authorities.
Given that the period of validity for a WFOE business license is quite long, this is typically not an issue during the deregistration process. However, for maintaining a valid lease agreement during the deregistration process, a company is advised to plan ahead and weigh the costs of maintaining a lease agreement against potential penalties.
To reduce costs of maintaining a valid lease agreement, the company may want to consider moving to a smaller, cheaper office if they will not require their current office space during the deregistration process. Speaking with the landlord about possibly negotiating a cheaper rental fee is an additional option.