Financial & tax considerations when liquidating
[ By Edward Ma, Manager, and Jessica Hou, Associate, Beijing office, Lynn Liu, Manager, Shanghai office, and Helen Liu, Senior Manager, Shenzhen office, Dezan Shira & Associates ]
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 tax liabilities
Clearance of outstanding Foreign Enterprise Income Tax (FEIT) liabilities
As regular readers will know, many foreign enterprises currently receive various incentives, which may include “tax holidays” such as a two year exemption and three year 50% reduction of FEIT. Such “tax holidays” normally only apply to companies on the assumption that they are expected to operate for at least ten years. Enterprises which are granted with this tax relief, but actually operate for less than ten years, are required to repay the amount of tax exempted or reduced.
Note, of course, that these “tax holidays” arrangements are expected to change when the new Enterprise Income Tax Law takes effect.
Enterprise income tax refund for reinvestment of profits
Article 10 of the Income Tax Law of the PRC on Enterprises with Foreign Investment and Foreign Enterprises states that a foreign investor that directly reinvests its share of the profits distributable from a foreign investment enterprise, by either increasing the registered capital of that foreign investment enterprise before the profits were distributed or establishing another foreign investment if the profits were distributed, may obtain a refund of 40% of the tax paid on the reinvested amount, subject to approval of the tax authorities. In addition, if profits shall be reinvested for at least five years, and if the investor withdraws the reinvested profits within five years, the tax refunded shall be returned to the tax authorities.
Therefore, if a foreign investor reinvests its share of the profits distributable from a foreign investment to non-taxable project, and its operation period is less than five years, then 40% refundable tax amount or whole tax amount should be remitted back. The formula is :
Tax refund = A/[1 - (B + C)] x B x D
where
A = reinvested amount
B = original foreign enterprise income tax rate applicable to the enterprise
C = local income tax rate applicable to the enterprise
D = refund rate
If the operation period for foreign enterprise enjoying preferential treatment is less than ten years, then the tax refund should be remitted back to the local government when liquidating.
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