Ensuring Compliance: Key Issues and Solutions for WFOE Tax Deregistration

by Mei Zhang, Tianjun Ma, Xuanye Wang, Yuehan Ren and Siyuan Qiu

In recent years, as the global landscape and China’s market environment continue to evolve, foreign companies are considering closing – or have already closed – their Wholly Foreign-Owned Companies (“WFOE”) in China. During this process, tax deregistration is the most important and time-consuming step.

Tax deregistration is not just a necessary administrative procedure – it is the core issue that determines whether a company can exit the China market in a compliant manner. A mishandled tax deregistration can lead to a series of legal risks, including but not limited to the collection of unpaid taxes, late fees, and fines, and in some cases, even criminal liability. Therefore, grasping the key points of tax deregistration in advance is critical for companies to ensure compliance with PRC law.

In this article, our tax team introduces the tax deregistration procedure, analyzes the key points to pay attention to and challenges WFOEs may encounter when conducting their tax deregistration, and shares solutions and strategies for these potential hurdles.

1. Basic procedures for tax deregistration

In China's tax deregistration procedure, the one-stop online processing known as “e-deregistration” has been implemented in most regions. In the Chinese electronic tax system (i.e., “e-tax”), companies usually follow a set process to apply for tax deregistration:

pre-check for tax deregistration → liquidation filing → tax filling → submission of tax deregistration.

The specific contents of each step are as follows:

a) Pre-check for tax deregistration: Before a company applies for tax deregistration, it must first complete the pre-check for tax deregistration to ensure that all pending tax matters have been properly solved.

At this stage, the tax authority will issue a Notification of Pending Tax Matters, listing the company’s pending tax matters as of the time of issuance. According to our practical experience, common pending tax matters include, but are not limited to, unfinished declarations of various taxes, unreturned blank paper invoices and fiscal processors (electronic devices such as USB keys that are used for issuing invoices), uncancelled social insurance registration information for employees, various unsettled taxes, late fees, and fines.

b) Liquidation filing: Whether the company is going through self-dissolution or bankruptcy liquidation, once it enters the liquidation stage, it must file liquidation matters with the competent tax authority and fill in the necessary liquidation forms. After completing the liquidation filing, the tax registration status of the company will be adjusted to “liquidation” status, during which the company may only carry out business activities related to liquidation, such as clearing inventories, fixed assets, and accounts receivable and payable.

c) Tax filling: Before the tax deregistration process is formally completed, the company must continue to fulfill its regular tax declaration obligations for all types of taxes. Even if there is no actual business activity, the company must file taxes. This means that the company must continue to complete all tax declarations until the tax deregistration is complete, which not only includes tax declarations during the normal operation period, but also liquidation income tax declarations during the liquidation period and the annual filing of the Corporate Income Tax (“CIT”) during the liquidation period. During the liquidation period, the taxes that the companies must declare normally include:

• Value Added Tax (“VAT”) and Surtaxes
• CIT
• Individual Income Tax (“IIT”)
• Other relevant taxes, such as the Disabled Persons’ Employment Security Fund

d) Submission of tax deregistration: After completing all the matters above, the company can apply for tax deregistration with the competent tax authority and obtain a tax deregistration certificate, which is necessary to complete the tax deregistration procedures.

2) Audits

Generally, after a company has filed liquidation matters with the competent tax authority, the authority will comprehensively review the company’s tax compliance and may conduct an audit if any abnormality is found, regardless of whether the company has completed the tax deregistration. In recent years, it’s common for companies to be audited by the tax authorities for various tax issues before and after deregistration, including issuing false invoices, tax evasion, abuse of preferential tax policies, and fraudulent export tax refunds. Some of the common tax audit risks are as follows:

a) Tax audit risks before deregistration

China’s tax supervision has been continuously strengthened in recent years thanks to the big data verification system known as the Golden Tax System Phase IV. In practice, the tax authorities generally audit a company’s tax and financial situation from the following aspects:

• Contracts: The tax authorities will check the specific contents of the contracts, identify abnormal transactions, and compare them with both parties’ tax declaration records.
• Invoices: The tax authorities will review whether the company has issued VAT fapiao that do not comply with regulations to offset taxable income, and whether it has used false invoices to increase costs and expenses.
• Financial data: The tax authorities will conduct horizontal and vertical comparisons to monitor and verify the reasons for significant changes in the company’s financial data.
• Fund flow: The tax authorities will investigate the company’s fund flow and look for abnormal fund returns, inconsistent flow of funds between the two parties of transactions, and whether there is any lack of real transactions.
• Consistency of invoices, business, and funds: The tax authorities will confirm whether the invoices, business, and funds of the Company are consistent.

Audit point 1: Tax evasion

During a tax audit, the tax authorities will strictly review the declaration records and comprehensively verify whether the company has declared all the income it has obtained in accordance with the law, as well as whether there are any falsely issued invoices or overstated costs and expenses.

In recent years, the State Administration of Taxation and its branches have increased their efforts to crack down on tax evasion and have made public several administrative penalty cases for tax evasion of public figures, reflecting the zero-tolerance attitude of the tax authorities towards tax evasion.

Audit Point 2: Abuse of preferential tax policies

Abuse of preferential tax policies refers to companies or individuals using improper means, such as forging or modifying relevant documents or declaring inaccurate revenues or costs to enjoy tax reductions and exemptions, and thus reducing their taxable amounts.

During a tax audit, the tax authorities will review the tax compliance of the company before the deregistration and verify whether the business transactions and financial data are suspected of false transactions, illegal invoicing, falsification of relevant documents, or falsification of financial data to further determine whether the company has met the conditions for enjoying tax preferences by illegal means. Upon verification of these conditions, the company may be liable to pay unpaid taxes, late fees, and fines.

Audit Point 3: Falsely-issued invoices

Based on Article 21 of the Administrative Measures of the People's Republic of China for Invoices, no organization or individual may commit any of the following acts: (a) issuing for themselves or for others invoices that are not consistent with actual business details; (b) causing others to issue invoices that are not consistent with actual business details; or (c) causing others to issue invoices that are not consistent with actual business details.

In practice, falsely issuing invoices also includes – but is not limited to – issuing invoices without a real transaction, issuing invoices that are inconsistent with the sale of goods or services, and having sales amounts that are inconsistent with the amounts on the actual invoices issued. If a company uses illegally obtained invoices for the purpose of reducing their taxable amount by increasing costs and expenses, the tax authorities will confiscate the illegal income and impose fines. Going even further, if the act constitutes Article 205 of the Criminal Law of the People's Republic of China, falsely issuing VAT fapiao (Special) or any other invoices to defraud a tax refund for exports or to offset taxable incomes, the persons who are directly in charge and the other persons who are directly responsible for the crime will be sentenced to imprisonment.

b) Tax audit risks after tax deregistration

Many companies believe that they can evade relevant tax risks and responsibilities if they just complete their tax deregistration before the competent tax authority discovers their tax violations or formally imposes tax penalties. However, this view is incorrect.

In fact, it is not uncommon for companies to be audited by tax authorities after their deregistration due to unsettled tax issues. If the competent tax authority finds suspicious tax activity by the company in the follow-up supervision, even if the company has completed the deregistration procedures, the competent tax authority still has the power to audit the company and make administrative penalties.

Audit Case Study:

Company A is engaged in the leasing business, incorrectly calculated and paid VAT at the rate of 3%, and under-reported its income, resulting in a cumulative underpayment of VAT and surtax of more than RMB 300,000. Company A subsequently completed its tax deregistration. When the tax authority discovered this, it issued a tax disposal decision to Shareholder B, the major shareholder of Company A, ordering B to pay the unpaid VAT and surtax and late fees according to its investment ratio.

In this case, although the tax authority confirmed Company A's tax evasion after the completion of the tax deregistration, they still had the right to order the shareholders to pay the unpaid tax.

3) Recommendations on tax deregistration in the context of digital tax supervision

Given the increased supervision of tax deregistration by the tax authorities, we suggest WFOEs to continue to pay attention to the changes in China’s tax laws and regulations, to ensure that they complete their tax deregistration in compliance with the current regulations. Our suggestions are as follows:

a) Plan and prepare in advance

WFOEs should plan a liquidation schedule and determine the relevant liquidation timeline before initiating tax deregistration procedures. The company can learn the relevant laws and regulations in advance and ensure that all financial and tax documents are prepared and ensure that all taxes payable have been filed and settled. This planning can help the company quickly complete the pre-check for tax deregistration and avoid delays in the liquidation schedule.

b) Hire a professional tax consultant

An experienced and professional tax consultant can help ensure that the entire tax deregistration process is smooth and compliant with PRC laws and regulations, and provide one-stop services to minimize tax risks that may arise from the company’s unfamiliarity of the tax deregistration process.

c) Stay in communication with the competent tax authority

Consider assigning or appointing a liquidator in-charge to maintain communication with the competent tax authority to understand their position and attitude towards tax deregistration and obtain the latest tax policies. This will go a long way to quickly solve any questions and problems that arise during the tax deregistration process.

Conclusion

Tax deregistration is the most important step in shutting down a WFOE. This process requires compliance with complex laws and regulations, as well as multi-step tax deregistration. Through careful preliminary planning, guidance from a professional tax consultant team, and effective communication with the competent tax authority, WFOEs can more efficiently deal with the challenges and difficulties they face, avoid penalties, and ensure compliance with tax laws to minimize tax and legal risks during tax deregistration.