Foreign invested enterprises in China that undergo liquidation will need to deal with two main tax issues. These are:

• Clearance of outstanding tax liabilities: the liquidation committee must meet any potential and actual tax liabilities. After confirmation, the liquidation committee will pay the outstanding tax liabilities to relevant departments.
• New tax liabilities during liquidation: the liquidation itself may raise new tax liabilities – for example, fixed asset disposal may raise some turnover taxes, and employee compensation will be subject to individual income tax.

Clearance of outstanding enterprise income tax liabilities

Some foreign enterprises may still be receiving various incentives, including “tax holidays” such as a two-year exemption and three-year 50 percent reductions on enterprise income tax. Such “tax holidays” normally only apply to companies on the assumption that they are expected to operate for at least 10 years. Enterprises which are granted this tax relief, but actually operate for less than 10 years, are technically required to repay the amount of tax exempted or reduced.

Whether the above actually applies depends on the local practices of the authorities in different cities and districts.

The enterprise income tax refund that was previously offered for reinvestment of profits is no longer available.

New tax liabilities during liquidation

For enterprises with normal operations, several transaction taxes (e.g. stamp duty and deed tax) should be declared within a certain period after the relevant activity occurs. But the majority of taxes are declared periodically, for example monthly.

Thus, after liquidation begins, there is a possibility that the enterprise’s remaining tax amount is not declared and paid. And business transactions before liquidation could still be completed within the liquidation period and would bring new tax liabilities. Both these issues will need to be taken into account by the liquidation committee.

During the liquidation period, asset disposal and termination of employees, among other issues, may possibly create new tax liabilities.

Asset disposal

There is no difference between asset transferring during liquidation and asset disposal in daily operations. But as the purpose of asset transfers during liquidation are for asset distribution, the tax liability would be considered differently. Part of the tax liability would be considered as a liquidation expenses and paid preferentially in advance of other expenses.

Import VAT and customs duties

Customs prescribes different monitoring years for imported products of different kinds. During the monitoring period, goods should be depreciated at true value if Customs authorizes their sale, transfer or move for other uses, for example during liquidation. In this situation, both import VAT and customs duties should be levied.

The relevant formula is:

• Price after tax = CIF price x [1 - actual number of months used/(management years x 12)]

Secondly, if a foreign invested enterprise wishes to transfer goods originally imported with an import VAT exemption, if goods are left with a Chinese partner or transferred or sold to a domestic enterprise, Customs would calculate the tax amount based on the depreciation year. If they are transferred to other foreign enterprises enjoying preferential tax treatment, then the goods could still enjoy such preferential treatment.

Turnover taxes

Turnover taxes involved in asset transfers during liquidation will usually be value added tax, business tax, consumption tax and land appreciation tax. There is no specific regulation related to turnover taxes for asset transfers in liquidation.

Asset taxes

Relevant taxes could include real estate tax and vehicle and vessel tax for foreign-invested companies. During liquidation, before transfer of such vehicles and vessels, foreign enterprises would still have tax liabilities.

Individual income tax

Employees from liquidated enterprises will usually receive a certain amount of compensation, and foreign enterprises must withhold individual income tax for such payments in the normal way. If they do not do so, then tax bureau could pursue these tax amounts, which may increase the cost of liquidation.

Enterprise income tax

The liquidation period should be considered as a separate taxable period to calculate enterprise income tax. The relevant formulas are:

• Liquidation gains/losses = (gains/losses from inventory disposal) + (gains/losses from non-inventory disposal) + (gains/ losses from asset disposal)
  
  
• Net assets/retained assets = (liquidation gains/losses) – (salary/mandatory welfare benefits payable) – (liquidation expenses) – tax due – other liabilities – losses on bad debts + income from repaid debts
  
  
• Liquidation income = net assets/retained assets – accumulated loss – net assets value on tax basis +(-) other tax adjustment

In most cases, the liquidation period will probably be the final tax payment period. According to current law, profits from the current year can only be offset against the previous year’s loss. Therefore, classification of income and expenses for the liquidation period and the previous year is quite important. Choosing the correct liquidation date could mean significant tax efficiencies. As ever in these circumstances, get good professional advice!

Special treatments for liquidation on bankruptcy

Normally liquidation is performed when assets are greater than liabilities, and there should be no problem in paying any taxes that become due.

But if foreign enterprises make losses due to poor operation and management and cannot pay their tax liabilities, or assets are less then liabilities during liquidation, then the enterprise would be considered as insolvent or bankrupt. Because assets from such insolvent enterprises cannot meet all their liabilities, it is very important to determine the order in which taxes are tax cleared.

When a foreign enterprise performs insolvency liquidation, the Enterprise Bankruptcy Law and other related civil laws will apply. But in these civil laws there is no specific definition of insolvency expenses, and foreign enterprises may therefore have some flexibility when dealing with this issue, subject to the order of expenses priority as set out in the Enterprise Bankruptcy Law

According to the regulations, the tax should be paid before asset disposal; otherwise it would affect asset transfers. These tax liabilities should be paid preferentially. For other tax liabilities, if they are considered as liquidation expenses, it may affect the repayment rights for other debts, while if they are combined with other due taxes, then it would affect repayment rights for other debts before taxes due. Overall, the tax authorities might lose some income.

All of this complexity means a foreign enterprise must, in such circumstances, think very carefully about how it proceeds, and take proper professional advice.

Tax de-registration

After the foreign enterprise completes all its liquidation procedures and pays its taxes, the relevant tax bureau would proceed to cancel its tax registration. After that, the foreign enterprise can complete the other de-registration procedures mentioned previously.

The following materials should be submitted to the tax bureau:

1. Application letter, with relevant authorization certificate and other documents
2. Liquidation audit report
3. Liquidation report
4. Tax clearance certificate for all taxes
5. Approval letter for liquidation from authority that approved original establishment
6. Application and examination form for tax registration termination, and other documents required by the tax bureau

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