For reasons that ought to be apparent to anyone who reads the news, our China lawyers have of late been getting a whole host of emails from foreign companies looking to shut down or just flee from their China WFOEs. Reduced to their essence, these emails usually focus on one of the following questions:
- How do I do it correctly?
- If I don’t do it correctly, what are the possible repercussions? Will I be safe in China?
We will answer both questions in this post.
PRC law requires all corporations (foreign and domestic) follow a formal de-registration procedure be followed. When a WFOE is simply 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). Abandoned WFOEs typically have their licenses revoked for failing to complete their annual registration requirements (such as the annual audit and payment of fees) or for failing to file their annual tax return and paying the taxes due. In most cases, the revocation is for both.
When a license is revoked, the following is required:
- The WFOE must immediately cease doing business. All websites and other public announcements where the company offers to do business in China must be taken down.
- The official company seals must be collected and deposited with the licensing authority.
- All taxes and fees owed to the national and local governments must be paid.
- All salary owed to employees must be paid.
- The WFOE’s legal representative and directors 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, it is usually impossible to formally liquidate a WFOE if it owes taxes or employee salaries.
Failing to properly liquidate a WFOE results in penalties imposed on the management and the shareholder(s) of the company. The legal representative and the other directors (but not the general manager) are personally liable for any damages caused to creditors by the WFOE’s failure to comply with China’s WFOE liquidation requirements.
For improperly liquidated WFOEs, the first step by the Chinese government is to put all potentially liable parties on a “black list.” This includes the legal representative, the directors and the shareholders. Though the general manager is technically not liable, the name of the general manager often goes on the blacklist as well and we have seen instances where random high level employees make it on the list too. This blacklist goes to all SAIC (State Administration for Industry and Commerce) offices in China and to the PRC border control authority. Being placed on this blacklist usually means the following:
- The legal representative will not be permitted to act as a director, manager or supervisor of a Chinese company for three years from the date of the WFOE’s revocation.
- The shareholders of the WFOE will not be permitted to invest in another Chinese company for three years from the date of the WFOE’s revocation.
- The name of the WFOE cannot be used for a period of three years from the date of revocation.
The above is happens when the WFOE does not owe any taxes, fees, salaries or debts. If the abandoned WFOE owes any taxes, fees, salaries or debts, the situation is far more serious. In this situation, the PRC authorities may criminally prosecute the legal representative and the directors of the company for having failed to make the required payments. Failing to pay taxes is a crime in China and failing to properly liquidate is also a crime when that failure involves not properly paying creditors as provided by China’s WFOE liquidation rules.
Even if no crime has been committed, it is nearly impossible for a person or entity put on the blacklist to engage in investment or company management in China and it is also common for Chinese border authorities to refuse entry to the named person. If a crime has been committed, China will usually allow the person to enter China and then immediately arrest him or her for remand to the local authorities for prosecution. Our China attorneys have heard of many instances where key WFOE personnel were held hostage by their China creditors until their debts were fully paid. See How to Avoid Being Detained in China.
Fortunately, the process for proper WFOE de-registration and liquidation has become more systematic and easier to handle in China. For WFOEs that have paid their fees, do not owe taxes, and have paid their employees and their creditors, de-registration and liquidation is now a relatively straightforward process.
Bottom Line: If you need to shut down your China WFOE, follow the rules. If you ever want to set foot in China again, there is no alternative.