Exiting From China – Three Options You Should Be Aware Of

Exiting from China is a difficult decision, but recently many business owners have been considering or made such a decision due to various reasons to either reorganize and optimize their corporate structure, save costs, or simply rescue what could possibly be rescued from already sunken costs.

If this is the case for your business, this article will provide a practical guide for self-evaluating the options to wind up a business in a legally compliant manner in China. For ease of reference, we will explain the simplest followed by the more complicated options.

Simplified Deregistration

You may infer from the heading that this should be the simplest way to close a business in China. A simplified deregistration generally applies to small scale companies which either:

  1. have not commenced operations since their establishment;
  2. have not incurred any debts or credits before the deregistration application; or
  3. have properly cleared all their debts and credits, including remuneration and compensation to employees, social security, contractual debts, taxes etc.

However, it should be noted that there are several circumstances where companies are not allowed to apply for simplified deregistration. These circumstances include the company being subject to foreign investment restrictions, the company having its business license revoked, the company having its equity interest frozen or charged, or there being an on-going government investigation against the company, among other things. Moreover, the local Administration for Market Regulation (AMR), that is, the company registry in China, may impose other restrictions on the applicant and the practices in different provinces/cities may vary.

Usually, simplified deregistration would not be a good option unless the company’s operations are very limited, and all debts are properly paid up. This is because shareholders will need to submit an undertaking to the AMR, that all shareholders shall be held liable after the deregistration if creditors show up eventually to collect their payments.

It is therefore desirable to first evaluate the scale of business operations and decide if a simplified deregistration suits the company’s situation. If indeed that is the case, the company should start dismissing employees, terminating contracts with vendors and customers, and wrapping up its business operations. During this process, the shareholder(s) may engage a law firm or consultancy firm to handle all the procedural and documentational requirements for the deregistration application, which usually can be completed via the AMR’s online application system.

Simplified deregistration usually takes less than 3 months, including a mandatory 20 day announcement period during which the decision of deregistration will be published to allow third parties to file an objection against such deregistration.

After the AMR has processed the company’s application, the company will need to complete the post-deregistration formalities, including but not limited to deregistration at other government authorities such as the foreign exchange authority, social insurance authority, and customs authority, closure of the company’s bank accounts, and destruction of the company seals.

Liquidation Deregistration

Usually, liquidation deregistration applies to companies which have a larger scale of operations and a more complicated debt and credit structure. Liquidation deregistration is more common in China than simplified deregistration.

While simplified deregistration does not require a company to set up a liquidation committee, liquidation deregistration requires this. The liquidation committee usually consists of the shareholder(s) or persons elected by the shareholder(s), unless otherwise specified by the company’s Articles of Association. It is not necessary for all the shareholders to sit on the liquidation committee. After the formation of a liquidation committee, the company will need to record the members of the liquidation committee with the AMR.

After this has been completed, the liquidation committee can start their work, including conducting a preliminary review of the company’s financial numbers, preparing the balance sheet, profit and loss and cash flow statements (or engaging qualified auditors to do this), and formulating a plan to settle all the debts and dispose of all the assets of the company by sale or auction. The liquidation committee must then prepare a liquidation report on its completed works, and auditors must prepare a qualified auditing report, both of which will need to be submitted to the authorities. If it turns out that the company’s assets are unable to cover all of its debts, the liquidation committee should file for bankruptcy at the local court and hand over all the liquidation matters to the court.

The company must then publish an announcement to liquidate and deregister in the newspaper (or on the AMR’s website, subject to the local requirements), informing creditors to submit their claims. After 45 days of such announcement, the company can proceed to the next step of the liquidation deregistration by filing the application at the AMR.

It is important to deregister with the taxation administration before making an official application to deregister the company at the AMR. The company will need to ensure that it has paid all taxes, surcharges and penalties, and has liquidated its assets before the taxation administration allows the company to continue with the liquidation process.

Like simplified deregistration, all post-deregistration formalities need to be completed for liquidation deregistration.

A liquidation deregistration typically takes more than 6 months, largely depending on the efficiency of the liquidation committee and the conditions of the company’s tax compliance. The AMR’s review will generally not exceed 1 week if all the documents are properly prepared.

Selling the Company

If the company still retains a large amount of assets, satisfactory production lines or customers of value, the shareholder(s) may consider selling the company to potential buyers. Selling a company could be proceeded in two ways: (1) selling the equity interest of the company (an equity deal), or (2) selling the assets of the company (an asset deal). An asset deal is quite similar to a liquidation deregistration during which the shareholder(s) disposes the assets of the company and the applicable taxes are more or less similar. An equity deal, on the other hand, may prove to be more favorable as compared to a liquidation deregistration in many ways. Therefore, we will focus on the transfer of equity to the seller in the following paragraphs.

Usually, the sale of a foreign invested entity in China will be subject to stamp duty tax of 0.05% and income tax of 10% (for company shareholders) or 20% (for individual shareholders). Of course, if the income from selling the company cannot even cover the shareholder(s) investment, then income tax should generally be minimal.

On the other hand, if the shareholder(s) liquidate the company, the shareholder(s) will need to sell the company’s assets. In this regard, the company will need to pay stamp duty, value added tax, and local additional surcharge etc. In addition, when the shareholders receive the remaining distribution of assets after liquidation, income tax will also be applicable. Hence, a liquidation may potentially subject the company and its shareholder(s) to higher taxes.

Moreover, the buyer may retain the employees of the company and therefore save the company the cost of dismissing its employees and having to pay them statutory severance payments.

However, no option for exiting China is perfect and there are still cons if one chooses to sell the company. In an equity deal, the shareholder(s) will need to consider whether any antitrust filings are required both in China and/or any other jurisdictions where the buyer has business operations. Especially when the company’s or the buyer’s market share in the industry is considerably large, the sale and acquisition may mean an antitrust review is required by the relevant authority. Moreover, if the company possesses special permits or licenses that require approval from, for example, authorities that oversee a specific industry, such permits or licenses may need to be renewed for the buyer to continue the company’s operations after it acquires the company.

An equity deal will need professional lawyers and/or financial advisors to guide the company and its shareholders through the process since it involves, legal, financial, and tax due diligence conducted by potential buyers on the company, preparation of complicated transaction documents, lengthy negotiations, specialist knowledge (for example, on foreign exchange restrictions which is quite unique in China and which complicates the cross-border transfer of funds), coverage of the sellers’ representations and warranties, price adjustment mechanisms and/or closing procedures, among other things.

Once the transaction agreements are signed, regulatory filings are also required. Normally, the company should file for the change of shareholders at the AMR, record the foreign investment change through an online registration system, and record the new shareholder at the local administration of foreign exchange and local taxation administration etc. All these filings should be quite straight forward.

An equity deal generally takes around 3 to 6 months but sometimes takes longer depending on the negotiation process between the parties.

Concluding Remarks

To sum up, a company’s China exit plan needs to be tailor-made based on the company’s specific circumstances and there is no uniform approach for all companies.

It would certainly not be wise to simply leave China without completing all company deregistration filings and procedures as required under the laws of this country, as this may lead to heavy penalties from the government. If you intend to temporarily close your business, please note that China now allows a short dormancy period of 3 years for companies that face difficulties in their operations due to natural disasters, accidental disasters, public health events, social safety events etc., subject to approval by the AMR.

Professional opinions should always be sought before any actions are taken to avoid potential legal issues and liabilities in the future.