Imagine yourself in the following situation.
Your company finally moved you back to your home country putting your life in China to an end. In the rush of last weeks your company decided to settle everything from an economic point of view. However, as it took an extraordinary proceeding you did not formally liquidate and dissolved the WFOE previously set up.
Now, imagine yourself three years after. You come back to China for business or just for fun to visit good old friends. Suddenly, when you are about to cross the immigration check, some of the officials at customs request you to accompany them. It seems you did not fully comply with your obligations when you left China last time…
According to the Law of the People's Republic of China on Wholly Foreign-Owned Enterprises and Provisions of the Supreme People's Court on Several Issues concerning the Application of the Company Law of the People's Republic of China (together “PRC’s Law”) terminating a WOFE shall undergo a process for issuing a public notice, completing its liquidation and nullifying its registration.
Therefore, there are a set of legal requirements which are not only mandatory but also necessary to avoid any further liability for the company or its directors when a decision for a WFOE to cease operations is taken.
Thus, when a foreign-funded enterprise has decided to finally stop its business operations, a specific proceeding aimed to nullify its registration in the Administration of Industry and Commerce (AIC) and hand over its business license for cancellation shall be followed.
Failure to comply with such obligations and not starting the liquidation of the company within the statutory period may end up in punitive sanctions not only for the legal entity but also for the individuals in charge of the WFOE as directors and/or legal representatives. To that extent, PRC’s Law states several provisions to protect the interest of any shareholder or creditor of the company in the event the WFOE is not dully dissolved.
Hence, if any company fails to initiate the proceeding for its dissolution and report to AIC about its decision to suspend the business operations after six consecutive months of inactivity, then its business license may be cancelled by the AIC.
As a result, in the event of failure of formal liquidation as stated before, the shareholders, directors and/or actual controllers of the WFOE may be found liable and face the following legal consequences:
- Compensate the creditors for any debt of the company or damage caused.
- Compensate the creditors or other shareholders (if any) for the company loss if the situation caused the depreciation, loss, damage or disappearance of the company’s assets.
- Assume the joint liability for the debts when non-performance of the obligations indicated above caused the disappearance of main properties, accounts and important documents of the company and caused the liquidation unable to be conducted.
Besides, when any of the aforesaid circumstances occur due to the actual controllers of the WFOE, if any creditors claim that the actual controllers shall assume the corresponding civil liability for the debts of the company, the people's court shall support the claim.
That means any director “de facto” of the Company might also be obligated to assume the same liabilities as a result of the non-performance of the obligations to dully dissolve the company, even if such directors are not formally appointed.
In addition to that, if the WFOE goes through the aforementioned circumstances the AIC has also the faculty to take the following measures:
- Labeled the WFOE as an enterprise with abnormal operations;
- Or label the WOFE as an enterprise seriously violating the Law. In this case, the legal representative, directors or the person in charge of the WOFE will be deemed unable to hold a similar or identical position in any other company during three years.
Furthermore, there are other obligations from different legal perspectives which are also necessary to be analyzed.
Thus, since the WFOE has not been liquidated it shall yet comply with all its tax obligations as provided by Chinese Tax Regulations, applicable to any company incorporated in China. However, as we know in practice the WFOE would have been “abandoned” and its operations stopped, so it will be likely not to meet its tax obligations. As a result it may face fines and mandatory enforcement measures from Chinese tax authorities.
More specifically, such circumstances may lead the WFOE to be included by the Chinese Tax Authorities in an internal list as a company with abnormal operations. Moreover, if the company does not regularize its fiscal situation after it has been required to do so, Chinese Tax Authorities will include it in the list of enterprises with serious violations of the Law, making this information available to the general public through the enterprise credit information disclosure system.
We need to remark at this point how serious and harmful consequences the disclosure of this kind of information usually represents for any international company nowadays. Reputational damage and its related consequences are in play when talking about these issues. Therefore, the company may find itself obligated to invest a great deal of resources to clean up its image and convince clients, distributor or suppliers that those are not regular practices within the entity.
Additionally, if after those sanctions the company does not remedy the situation, further enforcement measures will be taken by Chinese Tax Authorities, including freeze or block of its bank accounts, seal up or sell by auction its commodities, goods or other properties.
In conclusion, it is quite advisable and definitely worthy to legally liquidate and dissolve a WFOE when any international company finishes its operations in China or merely change its business model. As seen, the benefits to take the appropriate steps to do it are incomparable to the harmful consequences that inaction at this point may cause.