Business closures, deregistration and termination in China and Hong Kong

The Open Door Policy proclaimed by paramount leader Deng Xiao Ping in 1979 opened the vast Chinese market for foreign investors who have since enjoyed remarkable business expansion, profitable business endeavors, and stock market leaps by becoming the The Factory of the World and the worlds largest consumer market.

Nowadays, many foreign invested companies are doing excellent business in China, however, as in the case of any foreign market, there are always companies who desire to withdraw from the market and return to their home base. This blog examines termination of businesses in mainland China and Hongkong, processes to be adhered to and how to navigate through the bureaucracy and possible blacklisting in case they wish to reenter the Chinese market again in the future.

I. FOREIGN INVESTED COMPANIES, CEASE BUSINESS AND DEREGISTRATION

It has been often said that establishing a presence at the Chinese market is much easier than withdrawing from the market, a saying which holds at least some truth. The Chinese government has enacted a number of prerequisites before the shutdown of a China business is allowed. Getting through these obstacles to exit is significantly easier if due care is taken throughout the life of the company. Therefore, keeping strong records of taxes, wages, and other financial and regulatory information is of the utmost importance when doing business in China.

Often it happens that foreign investors have just abandoned business, left the market, and ceased company operation and then found themselves with serious issues and prohibited to re-enter the market together with various other penalties and sanctions. Shareholders and individuals involved have been blacklisted, barred from leaving the country for unpaid debts or pending lawsuits and even arrested for non-compliance with criminal claims, therefore, issues related to business closures must not be taken lightly.

In China, deregistration and ceasing business operations is a lengthy termination process and requires a professional liquidation team with proper resources and efforts. The complexity of such operations will depend on the size of your company and the industry but the steps are largely the same. Most important to note is that national and local taxation bureaus are to be reported to and informed on the company tax liabilities. Furthermore, the labour rights of employees must be duly protected in settlement plans and unpaid salaries will have to be paid. Non-compliance might result in asset seizures and fines. This is not a situation that is to be desired.

II. TAX CLEARANCES, TAXATION RISK AND EXTRA LIABILITIES

In the deregistration and termination process tax clearances are the most tricky and time consuming issues. As they say, death tax and childbirth, there’s never a convenient time for them. Clearances on closure are to be received from National Taxation Authorities and Local Tax Bureaus, which may both have their own interest in determining whether all taxes have been duly reported and paid during the life-time of the enterprise. The time frame for such clearances can easily extend to over one year, so plan ahead.

Moreover, company termination and voluntary liquidations may trigger taxation audits since the authorities may challenge earlier reported and approved taxation arrangements. This
is again why maintaining proper records is crucial. Taxation bureaus might declare earlier financial and tax filing reports void, which creates a risk for additional tax liabilities. They may then ask foreign investors to submit additional taxation explanations, inspect accounting vouchers, company contracts and review tax residencies and individual income tax liabilities for persons staying more than 183 days in China at any concurrent period. With proper documentation this process, while painful, is a lot better than not having the relevant papers.

III. LIQUIDATION COMMITTEE, LIQUIDATION PLAN AND ASSETS

The Chinese Company Law requires that a Liquidation Committee consisting of shareholders, lawyers, accountants and company executives shall be established to handle the deregistration process, make a variety of announcements, inform creditors and finally dispose of company properties and intellectual property rights.

A Liquidation Plan shall be prepared where among other things, company assets shall be registered and listed in balance sheets and later transferred, sold or liquidated depending
on each individual case. Approvals are needed for many of the actions to be taken and creditors cannot be served before such a plan is approved by the company’s shareholders and reported to authorities.

IV. HR SETTLEMENT PLAN AND SEVERANCE PAYMENTS

In China, labour rights are well documented and the country practices strict policies in labour protection especially in recent years. Do not assume that things are the same as they were 30 years ago. Mass lay-offs are regulated for companies with more than 20 employees and legal reasoning for dismissal must be present in other contract termination cases as well.

Foreign investors are required to present a detailed settlement plan for HR issues and the most preferred way to end employee relationships are through compensation package preparations, negotiations, and mutual agreement with severance payments. General practice in China is one-month of compensation for each year of service at the company, so take note.

V. LEGAL COMPLIANCE, CERTIFICATE OF DEREGISTRATION AND TERMINATION

Foreign investors shall remember that legal compliance requirements, office premises and business licenses applicable to company operation and financial and taxation reporting are to be followed during the entire process until the entire tax deregistration process has been handled or face penalties for non-compliance.

Finally, at the end of the termination process, local Administration of Industry and Commerce authorities will issue foreign investors an official deregistration certificate.

VI. VOLUNTARY LIQUIDATION IN HONG KONG

Most foreign investors structure their China business architecture endeavors via Hong Kong Holding Companies. Such arrangements, where China legal entities are 100% owned by Hong Kong companies are done for various reasons, the most obvious being risk management, cash flow, and tax optimization.

In business termination cases where Holding Companies are involved, the process requires first to terminate and deregister China legal entities, as explained above, before commencing the voluntary liquidation process in Hong Kong.

In Hong Kong business termination is a straightforward process, which includes the Company Secretary and CPA making declarations to Inland Revenue Department for financial reporting, asset valuation and creditor issues. Board of Directors of the Hong Kong company must issue a variety of declarations to ensure proper handling of the process and, at the final stage, file for deregistration at the Hongkong Company Registry.

SUMMARY

Foreign investors are well advised to ensure that throughout the life of the company documentation is strong and organized, and then to spend considerable time before making a
decision on withdrawal from the Chinese market since the deregistration process is time consuming. It will, require a lot of resources and a variety of actions with numerous Chinese government authorities, customs, industrial and commercial bureaus, banks, taxation department, labour bureaus, just to name a few.

However, if such decisions are made, foreign investors are well advised to engage an experienced team of professionals to handle the entire process in China to avoid pitfalls or a black swan event during the process.

PRACTICAL ADVICE FOR BUSINESS CLOSURES

1. Play a Good Defence – Do not put Business Closure on Autopilot
2. Make a Detailed Plan – Unexpected Issues will Arise for Sure
3. Do not Ignore Predictions – Sheer Luck does not Happen
4. Respect other Perspectives – Other Options might be Viable
5. Expect the Unexpected – Anything can and will Happen

If you would like to learn more, these blogs are published every week in the lead-up and after the Fintrade-Mercer Pandas Go Olympics Business Cafe, held through the Management Institute of Finland on January 28th. The Business Café will be free to attend and is accessible through webinar and will discuss China opportunities, Pandas Go Olympics, and help you with your China knowledge and training.

Stay tuned to learn more.

Jari E. Vepsäläinen

CHAIRMAN FINTRADE-MERCER GROUP. THE PEOPLE´S UNIVERSITY OF CHINA, BEIJING