Download How to Make a Successful Exit

BUSINESS
| Features
How to Make
a Successful Exit
Chinese Liquidation Processes and Tax
Consequences
by Kristina Koehler-Coluccia
China's economy grew 7% year-on-year in the first quarter of 2015 its worst performance in six years. According to the European Union
Chamber of Commerce in China’s latest survey of 541 European
companies, China reached an economic slowdown. Nearly one-fifth
of the companies surveyed said they are considering shifting some
of their China investments to other markets. One of the reasons for
this development is the difficulties set by the Chinese government
towards foreign companies. These include: restrictions for market
access to foreign banks and brokerage houses or the blocking of
internet firms like Facebook and Twitter. Regardless of how attractive
and profitable China might be for foreign investors, there will always
be companies that do not succeed or may have to liquidate due to
external factors.
There are three different ways to exit the Chinese market: the
liquidation of the company, the sale of the company within China,
and the sale of the shareholding company (either in Hong Kong
or another jurisdiction). In this article, we will explore each of the
possibilities and analyze the legal and tax components.
1. Liquidation of a Company in China
One option is to formally dissolve the company. This means long
drawn out government audits and a process that can take up to two
years. The main advantage is the possibility to return to China or
36
October - November 2015
open a new business without any negative history.
For the liquidation process in China there are existing regulations
under Chinese law and the process involves a complex government
approval process. A distinction is made between a limited company
(LTD) and a representative office (RO).
The procedure for closing a limited company in China – its
dissolution and liquidation – takes approximately 18 to 24 months
to complete. According to PRC law, a limited company must be
dissolved if any of the following circumstances occur:
n The term of operation expires and is not renewed
n The company experiences financial difficulties and the board
deems it necessary to dissolve the company.
n Due to force majeure, the company is unable to continue its
business
n The company is bankrupt
n The government has decided to close down the entity due to
illegal acts damaging the public interest.
n Other reasons for dissolution and/or termination clauses
stipulated in the original joint venture contract and/or the articles of
association
Upon the declaration of dissolution with the approval authorities,
www.china.ahk.de
the company is required to start the liquidation procedures. As
stated in the joint venture contract and/or the articles of association,
a liquidation committee must be formed in order to handle the
procedure. A final audit is required to check that all financial
aspects associated with the company have been dealt with, such
as all accounts payable and receivable, tax payable, and writeoffs for bad debts, etc. Once the audit is completed, deregistration
of the company is necessary with all the relevant government
authorities, such as Ministry of Commerce, State Administration
of Industry and Commerce (SAIC), the customs administration,
the tax authorities and State Administration of Foreign Exchange
(SAFE). All the company's bank accounts must be closed. In addition,
some companies in particular sectors may have other specialized
registrations and those should be closed as well. Although not
strictly a financial issue, foreign investors should also ensure that,
for example, unused raw materials and unsold products are disposed
of properly, and in an environmentally sensitive way, and those
buildings and other major assets are dealt with properly.
Case Study: a joint venture in Shanghai decided to dissolve the
company due to lack of new business developments in the country.
They began the liquidation process and it was discovered that a
pack of 10 “fapiao” sheets had disappeared. As a consequence,
during the audit phase the tax bureau informed the company there
would be a penalty of up to RMB 10,000 per missing sheet and a
public announcement needed to be made in the local newspaper.
The company did not want to pay the penalty and so they never
completed the liquidation process. As a consequence both investors
(i.e. the shareholders) were blacklisted within the Administration of
Industry and Commerce’s system.
Since a representative office (RO) is not a legal entity, an RO will be
deregistered rather than liquidated. According to the “Administrative
Regulations on the Registration of Permanent Representative
Offices of Foreign Enterprises,” a foreign enterprise shall apply for
deregistration if:
n The RO is required to shut down in accordance with the law
n The parent company is being closed or business activities have
changed
n The RO no longer engages in business activities upon the expiry
of its period of residence
n The company decides strategically to exist the country or to
“upgrade” and establish a limited company.
The first step of a RO deregistration is the tax deregistration or
tax closure. However, a successful tax deregistration process is the
requirement for the issue of the official deregistration certificate
by the Administration of Industry and Commerce (AIC). Tax
clearance is the most time-consuming procedure due to multiple
rounds of communication with the relevant tax authorities. It
usually takes 6 to 12 months to complete the entire process of
tax deregistration. The process is completed when both Local
Tax Bureau and the State Tax Bureau approve that all taxes
have been paid correctly and in full. In case of unpaid taxes or
other irregularities, the process can take considerably longer and
additional documentation will be required. The last step of an RO
deregistration is the closing of the bank account, deregistration
with the State Administration of Foreign Exchange (SAFE) and
with customs authorities.
SIP
October - November 2015
37
BUSINESS
| Features
2. Merger and Acquisition – Selling the Shares of
your China Company
Handling a merger and acquisition in China can be just as
cumbersome as anywhere else in the world. The key issue is finding a
suitable buyer, which requires having a network of potential investors
– whether that is a strategic partner or a private equity firm.
The next step is the due diligence process that the buyer will
perform on the Chinese entity – not only from a legal perspective
but also from a financial one. It is important to note that the ease of
finalizing an M&A transaction would be that the company has had
no “bad” history and most importantly has all its papers filed in an
orderly manner.
The due diligence would then be followed by the contract
negotiations for the sale and purchase of the shares and the equity
transfer. This alone would require the buyer as well as the seller to
understand the ins and outs of PRC Law.
Naturally, a key component of the transaction would be whether
there are any tax implications that befall the buyer or seller in
terms of Capital Gains tax. Things are complicated by the fact that
the Capital Gains tax levied in China varies according to where
the selling entity has its tax residence. The Capital Gains tax for
foreign investors from most countries is around 10%. However, some
jurisdictions, especially those with whom China has successfully
completed DTAs, benefit from lower Capital Gains taxes. For example,
for foreign investors coming from Hong Kong, a Capital Gains tax of
only 5% is levied.
Finally, when the M&A transaction is finalized, the next step would
be handling the change of shareholder and all internal positions
within the Chinese entity. These procedures all require government
approval.
3. Advantages of Selling from the Shareholding
Entity that Holds the China Subsidiary – an Example
Would be a Hong Kong Company
In many ways, terminating operations in China when your foreign
invested enterprise is already part of a Hong Kong holding company
is comparatively easy. All the obstacles encountered when trying to
sell a company in mainland China directly will mostly fall away.
In brief, this is due to the fact that the sale is carried out completely
under Hong Kong’s institutional framework. This guarantees limited
governmental regulations and procedures, as well as a transaction
underwritten by clear and unambiguous common law. As outlined
above, transfer of ownership of a foreign invested enterprise entity
in the PRC requires governmental approval. This can lead to nontrivial bureaucratic proceedings resulting in months’ worth of delays.
In Hong Kong, on the other hand, no such governmental approval is
required, and transfers of ownership can take as little as three to five
days after all required documents are available.
When selling the Hong Kong holding company, the company’s shares
are usually being transferred. Such transfers will attract Hong Kong
stamp duty. The rate is based on the value of the company’s net
assets. There will be no capital gains tax. In case it is only possible or
necessary to sell the China business and not the Holding company,
the Double Taxation Agreement between Hong Kong and China also
provides a tax exemption relief to the Hong Kong investors. Capital
gains derived from the transfer of shares in mainland companies will
be tax free, provided that the following criteria are met:
n The shares transferred amount to less than 25% of the entire
shareholding of the mainland company; and
n The assets of the mainland company are not comprised mainly
of immovable property situated in Mainland China
EWM AD
When exiting any jurisdiction, it is important to make a clean and
transparent exit. It is recommended that when entering the Chinese
market, exit strategies are indicated in either the joint venture
contract (in the case of joint venture companies) or in the articles
of association (in the case of a Wholly Foreign Owned Investment).
It is also recommended to consider whether a Holding Company
may be an advantage to the company in terms of selling the China
operations.
It can be concluded that there is no “ideal way” to exit the Chinese
market. It all depends on the future objectives of the company and
whether the investor is planning to enter China again in the future.
Kristina Koehler-Coluccia is the China director at Koehler Group, an
international accounting and management consulting firm, providing
a range of market entry consulting incorporation, tax accounting and
human resource services to organizations interested in entering and
expanding throughout Singapore and Greater China.
38
October - November 2015