Company Liquidation: A comprehensive guide on how to proceed [3/4]

5 min.

By Richard Hoffmann and Michelle Yan, ECOVIS Beijing China

Doing business will always have its success and failures. However, in the case where it really comes down to needing to liquidate your company, there are formal steps in which you should closely follow. The process is long, involving multiple application, de-registration and negotiations. We can help you with the proper completion of application forms, deregistering of certificates and answering & explaining to the tax authorities your actual situation.

In the third part of the four-part series, we enter the second phase of the actual liquidation and settlement of assets, the termination of employees and ultimately the distribution of proceeds.

The Second Phase

1. Terminating Employee Contracts

The liquidation of a company creates a legal ground in which a company can lawfully lay off employees. For foreign invested enterprises, Chinese authorities often request for an employment settlement report, including details regarding termination, transfer, notice and severance pay.

In the case where employee contracts are terminated upon liquidation of the company, the company needs to pay severance pay. This amount is specifically calculated based on the PRC laws & regulations and will vary depending on the individual salaries and the duration of employment of each employee at this company.

Helpful hint: Employees from the sales department and the accounting department can both help with the liquidation process. The sales employees are more familiar with the company’s clients, making it easier for them to claim outstanding debts and receivables. The accountants on the other hand can contribute by managing the liquidation balance sheet, to ensure the payment to all creditors from the proceedings from the sales of assets. Therefore it would make sense to keep them to support the liquidation process instead of terminating them immediately.

However, just because liquidation is underway, this doesn’t suggest that all employee contracts should be terminated immediately. In fact, it is often the case and preferential that some employees are kept to help and support the liquidation process.

2. Liquidation of Company Assets

In the event of liquidation, all fully owned assets by the company are valued and sold to pay off the liquidation expenses, outstanding debts, fees and taxes. It is important to understand that all assets should be valued and sold at a reasonable amount or it may be considered as losses to the company, making the liquidation committee liable for the losses. In practice, potential buyers knowing that liquidating companies have to sell their assets, usually offer less as they know they have more bargaining power.

Helpful Hint: To avoid having potential buyers offer a lower price, companies can consider starting to sell off assets before the commencement of liquidation. Though it may help with getting more valued prices for assets, any undervalued sales within one year before liquidation can still be claimed by creditors as a loss to the company.

In addition to the timing of the liquidation of assets, it’s also important to differentiate the bonded assets and non-bonded assets. These assets must be dealt with separately as they have different regulations regarding its disposal.

For non-bonded assets, the disposal process is more lenient, where it can be sold directly for proceeds or distributed to shareholders.

However, for bonded assets, they were imported into the country exempted from both duty and Value Added Tax. This means, that this asset cannot be as leniently disposed of because if this was to be simply sold to a domestic entity, it would be cheaper because of the lack of duty added to its costs.

As a result, bonded assets can in theory only be disposed in the following methods:

Directly transferring the bonded asset to a shareholder of the company outside of China
Selling the bonded asset to a foreign entity and directly exporting it out of China
Selling the bonded asset to a domestic entity and paying the exempted VAT and duties

3. Collection of outstanding Debt

Once the company enters liquidation, the company should try to collect all outstanding debt with its clients and other entities. This would help pay off the creditors in the next step. However, debtors often see the liquidation of a company as an opportunity to not pay back this debt. The reasoning for this is because though the liquidating company has the right to file a lawsuit against the debtor, it often results in a costly and timely process. As this would not only prolong the liquidation process and possibly eat into the proceeds to pay off creditors, companies often not pursue the debtor with a lawsuit.

Helpful hint:A good solution to collecting debt is to transfer the collection rights to a third party. Therefore collecting immediate returns, though sometimes at a lower rate.

4. Distribution of Proceeds

After all receivables have been claimed and assets are converted into proceeds, these proceeds then need to be paid off to the creditors. The priorities in which creditors should be paid is outlined by the PRC law and should be paid in the following order:

Liquidation Expenses
Employee Wages
Social Insurance Premiums and Legal Indemnity Premiums
Outstanding Taxes
Outstanding Debts

Ecovis Beijing is the trusted tax and legal advisor of several embassies and official institutions in China. It specializes in mid-sized international companies and focused on tax & legal advisory, accounting and auditing. Moreover, Ecovis was awarded the No. 1 auditing firm for mid-sized companies in Germany in 2013.If you’re interested in finding out more about tax and legal, don’t hesitate to sign up to our newsletter or give us a call +86 10-65616609 (ext 811/806) or contact us directly via Beijing@ecovis.com