When can foreign companies distribute profits in China?
Companies with a profitable business in China will want at some point to repatriate profits. However, dividends can be distributed among shareholders only after paying taxes, allocating reserves and doing an audit.
There are important considerations that need to be addressed before deciding the optimal repatriation strategy.
In China, article 166 of the Company Law establishes that 10% of the after-tax profits at the time of distribution of dividends must be allocated to a statutory common reserve up to the cap of 50% of the registered capital.
Once the 50% is reached, no further contributions are needed, and the company is permitted to distribute the whole after-tax profits with no allocation to reserves.
The ratios of contribution to reserve funds, enterprise development funds, staff incentives and welfare funds are determined by the board of directors. Among these, reserve funds must account for at least 10% of an enterprise's after-tax profits.
It is not mandatory for a company to set aside an enterprise development fund.
Reserve funds are intended primarily to make up for operating losses. Development funds are usually used for expanding the company’s scale of production or operation; and upon approval by the original authority, such funds may also be used to increase investment.
Company Law Article 166
Where a company distributes its after-tax profits for the current financial year, it shall draw 10% of its profits as the company's statutory common reserve, provided that a company with an aggregate common reserve of more than 50% of the company's registered capital may elect not to draw any statutory common reserve anymore.
Where the aggregate balance of the company's statutory common reserve is insufficient to cover any loss the company made in the previous financial year, the current financial year's profits shall first be used to cover the loss before any statutory common reserve is drawn therefrom in accordance with the provisions of the preceding paragraph.
Where any company has drawn a statutory common reserve from its after-tax profits, it may, subject to a resolution of the shareholders' meeting or the general meeting of shareholders, draw a discretionary common reserve from its after-tax profits.
Where losses have been covered and the statutory and discretionary common reserves have been drawn, any remaining after-tax profits shall be distributed to shareholders in accordance with Article 34 of the Law in case of a limited liability company or on a pro rata basis in case of a joint stock limited company, unless its articles of association provide distribution shall not be made on a pro rata basis.
Where the shareholders' meeting, general meeting of shareholders or board of directors distributes profits in violation of the provisions of the preceding paragraph before losses are covered and the statutory common reserve is drawn, the profits distributed must be returned to the company.
No profit may be distributed for shares held by the company itself.
Common reserves are specified in financial statements and include Capital Reserve (used for capital increase) and Surplus Reserve, including the statutory allocation of 10% of after-tax profit.
Staff Reward and Welfare Fund, and Business Development Reserve are some of the other possible surplus reserve funds that a company may have.
A capital reserve cannot be used to cover losses, while a common reserve can be used to cover losses from previous years and expand business.
It is possible to convert a statutory common reserve into capital but the value of reserve after the conversion shall be not lower than the 25% of the registered capital prior the conversion.
Company Law Article 168
A company's common reserves shall be used to cover losses made in past years, to enhance the company's productivity and expand its business or to increase its registered capital; however, a company's capital reserve shall not be used to cover the company's losses.
Where the statutory common reserve is converted into capital, the value of the remaining common reserve shall be no less than 25% of the company's registered capital prior to the conversion.
There is a specific order of priority for profit distribution. After paying income tax on the profits earned in accordance with the law, companies can distribute profits in the following order:
1. Paying all fines such as breach-of-contract fines, late charges, later interest charges and other penalties;
2. Making up for previous years' losses;
3. Contribution to reserve funds, enterprise development funds, staff incentives and welfare funds;
4. Profit distribution to investors.
Equity JVs should distribute profits according to the actual proportion of capital contribution by the respective investors; cooperative JVs should follow the terms as stated in their contracts; whereas foreign enterprises should do so according to their articles of association.
Unless otherwise stated in the contract or articles of association, profit to be distributed in cash is in the currency of the income from the enterprise's operation. Investors may convert their profit in renminbi into foreign currencies, absorbing possible losses in currency exchange.
Foreign investors may remit their profit overseas, or they may reinvest it in China. A Chinese bank will only process dividend payments with a completed audit report and tax receipt confirming the amount of profit distribution and tax payment.
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DISCLAIMER: All information in this article is verified to the best of our ability and is assumed to be correct at time of release; however, Woodburn Accountants & Advisors does not accept responsibility for any losses arising from reliance on the information provided within. The information provided is for general guidance and does not replace specialized advice.