Company Statutory Reserves in China
Companies investing in China can distribute dividends to their shareholders after paying taxes, allocating reserves and an audit.
Statutory Common Reserve
According to the PRC Company Law Article 166, 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.
Such reserve should reach an amount equal to 50% of the registered capital. When such cap has been reached, the company is allowed to distribute the whole after-tax profits with no allocation to reserves.
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.
Allocation of Common Reserves
In financial statements, common reserves include Capital Reserve (used for capital increase) and Surplus Reserve, including the statutory allocation of 10% of after-tax profit. Other surplus reserves can be related to Staff Reward and Welfare Fund, Business Development Reserve, and others.
With reference to the use of a reserve, it shall be considered that a common reserve can be used to cover losses from previous years and expand business, while a capital reserve cannot be used to cover losses.
Moreover, it is possible to convert a statutory common reserve into capital (art. 168) [common reserve → capital reserve → 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.