Closing Down a China WFOE: You Can Run But You Can’t Hide (Part 1)

As our recent series of posts on WFOEs have shown (go here for Part 10 on how to form a WFOE in China and then work your way backward daily), it is difficult and time consuming to form a WFOE in China. As you might expect, the procedure for shutting down a WFOE is also subject to formal procedures and regulations. You cannot simply abandon your company; PRC law requires for all corporations, foreign or domestic, that a formal deregistration procedure be followed. The most important part of this deregistration process is a formal liquidation of the company, similar to a Chapter 7 bankruptcy proceeding under U.S. law. Many foreign investors figure that they have already suffered enough from Chinese bureaucracy  so they avoid this formal process and simply abandon their WFOE. In taking this course of inaction, they assume that there will be an administrative dissolution and that will be the end of the matter.

They are wrong.

For China, as is typical, things are not so easy. Simply abandoning a WFOE is a major mistake that will have long term and personal repercussions and subject the management and shareholders of the WFOE to severe sanctions within China. When a WFOE is “abandoned,” the annual registration procedures and tax filings will not be conducted. As a result, the business license of the WFOE will be revoked (吊销) . This revocation will be publicly announced on the company information website maintained by the SAIC of virtually every district in China. For WFOEs that have simply been abandoned, there are  two possible reasons for license revocation. One is failure to complete annual registration requirements such as the annual audit and payment of fees. The second is failure to file an annual tax return and to pay taxes due. In most cases, the revocation is based on both.

When a license is revoked, the following is required:

1. The company must immediately cease doing business. This means, for example, that all websites and other public announcements where the company offers to do business must be taken down.

2. The official company seals must be collected and deposited with the licensing authority.

3. All taxes and fees owed to the national and local governments must be paid.

4. All salary owed to employees must be paid.

5. The legal representative and the directors of the company must immediately liquidate the company in accordance with China’s Company Law and local procedure. All company assets must be used to pay creditors in accordance with the liquidation procedure. Use of the company assets for any other purpose is a crime.

Though liquidation can be used to equitably extinguish the debts of normal creditors, in our experience it is impossible to formally liquidate a company if taxes and fees are owed or if employee salaries have not been paid. The government agencies normally treat taxes, fees and salaries as obligations that cannot be extinguished through liquidation. For this reason, any company considering liquidation should first ensure that taxes, government fees and employee salaries are paid in priority to other obligations of the company.

In tomorrow’s part 2 of this series, I will discuss the personal liability that arises from failing to follow the above rules.

The post Closing Down a China WFOE: You Can Run But You Can’t Hide (Part 1) appeared first on China Law Blog.

We will be discussing the practical aspects of Chinese law and how it impacts business there. We will be telling you what works and what does not and what you as a businessperson can do to use the law to your advantage. Our aim is to assist businesses already in China or planning to go into China, not to break new ground in legal theory or policy.