Apr 11, 2022

China Signals Intention of Implementing Framework of “Dormant” Companies

Under the legal system in China, previously, no framework of “dormant” or “inactive” companies, as in a variety of other jurisdictions, existed. Thus, any company incorporated in mainland China has been required to satisfy several burdensome requirements, including maintenance of a physical address and employees, making it somewhat costly to maintain a company even while it is not engaged in business activities. Additionally, companies are generally also subject to intermittent inspections from regulatory authorities. On the other hand, shutting down a company in China is time consuming and laborious, including de-registration, liquidation and tax clearance processes, which are often time consuming, particularly for companies that have been operating for a long time.

Recently, China introduced a framework of “business suspension”, through the issuance of the Administrative Regulations of the People’s Republic of China on the Registration of Market Entities together with related implementing rules (collectively, “Administrative Regulations”), both having come into effect on 1 March 2022. The framework is to allow companies in China to remain in good standing without most of the regulatory formalities otherwise required, and thus rather more like “inactive” or “dormant” companies in other jurisdictions. The Administrative Regulations appear to have been issued on the premise that many companies are facing business difficulties due to the epidemic and the “business suspension” system was to provide a “buffer zone” to help companies with such difficulties. Since this March, an increasing number of cities, such as Beijing, have launched a series of supporting measures, specifying further rules or guidance for companies to make use of “business suspension”.

A company may apply to enter the status of “dormant” with a regulatory filing, for a term that may last up to three years. The Administrative Regulations aim to alleviate the burden of companies to continue existing without operations, for which they have brought about (and may continue to usher in) new changes, of which the most representative and significant areas are as follows:

  • Registered Address: Previously, companies were required to maintain an actual office address (usually requiring a lease). The Administrative Regulations stipulate that during the period of “business suspension”, an address where legal documents may be served can be used in lieu of a domicile or main premises. Thus, companies no longer need to maintain an actual office address while remaining “dormant”.
  • Maintenance of Employees: Under PRC employment law, not having business operations does not constitute a legal ground for terminating employees, and a company without business operations must continue to pay local minimum wages to its employees, and also pay social insurance contributions for them. The Administrative Regulations provide that companies shall negotiate with their employees on labor relation treatment and other related matters prior to the suspension of business. It is not clear whether the labor authorities will recognize “business suspension” as a ground to lawfully terminate employees, place them on unpaid leave or any other arrangement different from the rules under PRC employment law hitherto.
  • Tax Filing: At present, China’s State Taxation Administration has not released any supporting policy on tax treatment in relation to “business suspension”. Thus, “dormant” companies are still obligated to file the standard annual tax report and fulfill other established tax filing obligations under current laws and regulations. The Beijing local branch of the State Administration for Market Regulation (“SAMR”) issued the Filings Management Methods for Business Suspension (for Trial Implementation), stipulating that companies in Beijing do not have to report to tax authorities when applying to become “dormant”. It remains to be seen whether tax filing obligations of “dormant” companies will be reduced.

This framework still has certain preconditions and limitations generally not found in most other jurisdictions. Most notably, companies cannot take advantage of “business suspension” from the time of their incorporation (thus inhibiting the shelf-company trade found in some other jurisdictions) nor for any (or no) reason; instead, they have to be suffering certain “operational difficulties”. Furthermore, they cannot remain in “business suspension” indefinitely, but rather only for a total period of three years. That said, the other aspects of companies in “business suspension” in China should resemble those of “inactive” and “dormant” companies elsewhere. In particular, companies need to make preparations concerning payroll, ongoing contractual obligations, bank accounts, etc., before entering “business suspension”, and ensure they do not conduct any transactions; otherwise, they will be considered active and subject to all the corresponding requirements (and possibly to penalties). Likewise, as in most jurisdictions, companies may exit “business suspension” simply by resuming operations and then giving prompt notification of the same.

In a nutshell, the Administrative Regulations appear to represent a substantial amendment to the current operating framework for companies. Amongst all the updates, the introduction of “business suspension” for companies signifies the most prominent institutional innovation drawing on the experience of the “dormant” system in other jurisdictions. During the first month of implementation, regional SAMRs are more lenient in approving applications for “business suspension”. It is likely that more regulations or other forms of guidance will be released to consummate the Administrative Regulations and the newly introduced framework of “business suspension”.

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