Closing a company with debts: strategy or risk?

When a business stops generating profit and debts only grow, its owners often wish to "close down" the company and stop incurring maintenance costs. However, companies often have previously accumulated obligations (to banks, government agencies, employees, and their own participants). In such a situation, terminating a legal entity's activities is not always possible and is most often a risky option. The method of "closing" a company determines the timelines and costs, the likelihood of additional tax assessments, the risks of claims being made (e.g., by the Federal Tax Service of Russia), and exposure to liability.

Most often, a business can cease operations in three main ways:

• Simplified liquidation;
• General liquidation procedure;
• Exclusion from the USRLE due to inaccurate company information.

Below, we will examine each of these methods.

Simplified Liquidation

As of July 1, 2023, small or medium-sized businesses can be excluded from the USRLE based on a decision by their participants to cease operations, i.e., simplified liquidation (Article 21.3 of Federal Law No. 129-FZ of August 8, 2001, "On State Registration of Legal Entities and Individual Entrepreneurs"). However, this simplified liquidation does not mean that a legal entity can terminate its activities regardless of existing debts.

For instance, before the procedure is completed, the Federal Tax Service of Russia may initiate an audit, during which requests for documents and explanations are sent. Ignoring such requests or failing to provide all required documents will result in a refusal to dissolve the company. If, during the audit, the Federal Tax Service of Russia determines that the company has outstanding settlements with creditors, the simplified liquidation procedure may be halted, and the identified debts will lead to additional tax assessments and penalties.

Simplified liquidation is possible by submitting an application using form P19001 and only if the following conditions are met simultaneously:

• The company is a small/medium-sized business;
• The company is not a VAT payer / is exempt from its calculation and payment;
• The Federal Tax Service of Russia has no information about outstanding settlements with creditors;
• The USRLE does not contain a mark indicating inaccurate company information;
• The company has no unfulfilled obligation to pay taxes, fees, or other mandatory payments;
• The company does not own real estate / vehicles;
• The company is not undergoing liquidation, reorganization, or exclusion from the USRLE by decision of the Federal Tax Service of Russia;
• Bankruptcy proceedings have not been initiated against the company.

The decision on the upcoming exclusion of the company is published in the USRLE and the journal "Vestnik Gosudarstvennoy Registratsii" (Bulletin of State Registration). This grants the company's creditors the right to file objections within 3 months from the date of publication of the decision on the upcoming exclusion. Upon expiration of the objection period, the company must not have any outstanding debt to creditors who could subsequently claim such debt. In other words, if the company is aware that creditors do not intend to contact the Federal Tax Service of Russia to report the legal entity's debt to them, the company can cease operations in the specified manner. Otherwise, the Federal Tax Service of Russia will refuse the company's simplified liquidation.

Duration: from 3 months and 5 business days.

‍

Voluntary Liquidation

Voluntary liquidation is the most transparent way to terminate a company's operations, involving settlement with all creditors. However, if there are outstanding debts, this option almost inevitably leads to increased scrutiny from the Federal Tax Service (FTS) of Russia, including the possibility of audits and the identification of additional liabilities. If unpaid debts or accounting irregularities are discovered during liquidation, this could result in a refusal to liquidate, additional tax assessments and penalties, and in some cases, the initiation of bankruptcy proceedings for the company and subsequent liability for controlling persons.

To carry out this procedure, the company's participants must submit an application for the liquidation of a legal entity to the FTS of Russia using form P15016 (Article 57.3 of Federal Law No. 14-FZ of February 8, 1998, "On Limited Liability Companies"). It is important to note that the application is submitted not once, but three times throughout the procedure, and a state fee (800 rubles) must be paid for each application. Additionally, the liquidation process requires the publication of notices in the Unified Federal Register of Information on the Facts of Legal Entities' Activities, the "Bulletin of State Registration" journal, actions by the liquidator/liquidation commission, and interaction with a notary (if the application is submitted through a notary). All these actions involve additional costs.

Duration: from 3 to 12 months.

Exclusion from the USRLE due to unreliable information

The Federal Tax Service (FTS) of Russia plays a key role in the procedure for excluding a company from the USRLE due to unreliable information: it initiates and conducts the process, makes key decisions, and determines the timing and scope of audits. The company itself cannot fully control the timing and progress of the process, nor can it predict which specific audits will be initiated.

The procedure can be initiated either by an application from a participant / general director of the company (using form P34001) or by an application from any interested party, such as a landlord/counterparty (using form P34002), so its initiation does not always depend on the conscious choice of the participants. After the relevant entry is made, the FTS of Russia decides to exclude the company from the USRLE.

It should be noted that this mechanism is not an independent method for terminating a company's operations but rather a tool for state control and response to violations. Thus, while its application can lead to the termination of a legal entity's activities, such a "closure" of the business does not automatically write off debts and does not preclude the possibility of claims being made against the company.

Given that such an exclusion of a legal entity from the USRLE is the FTS of Russia's response to improper business conduct by the company, its general director may face administrative liability in the form of a fine ranging from 5,000 to 10,000 rubles (Part 4, Article 14.25 of the Code of Administrative Offenses of the Russian Federation), and in case of a repeated violation, disqualification for 1–3 years is possible (Part 5, Article 14.25 of the Code of Administrative Offenses of the Russian Federation). When an LLC is "closed" this way, any participant who owned at least 50% of the votes at the time of the company's exclusion from the USRLE cannot be a participant in other companies for three years from the date of the LLC's termination (Subparagraph "f", Paragraph 1, Article 23 of Federal Law No. 129-FZ of August 8, 2001, "On State Registration of Legal Entities and Individual Entrepreneurs").

Duration: from 14 months (in practice, the term can significantly increase due to the FTS of Russia, meaning full control over the procedure is not possible).

Conclusion

All available methods for terminating a company's operations differ significantly in terms of procedure, duration, and costs, but with any of them, there is a risk of uncovering outstanding debts.

The method of terminating a company's operations due to unreliable information is not always manageable, and if a company liquidation procedure is initiated (regardless of its type), there is a high risk of a tax audit and the subsequent discovery of outstanding debts to creditors. Such debt could likely lead to the FTS of Russia refusing to liquidate the company or result in additional corporate income tax assessments and penalties.

Potential Consequences and Risks

According to legal requirements, a legal entity is obliged to repay existing debts or file for bankruptcy. Therefore, terminating operations with debts can lead to the following consequences:

Tax reassessments: Unpaid debt may be classified as non-operating income subject to corporate profit tax (Article 250 of the Tax Code of the Russian Federation). Inaccurate determination of the tax base, in turn, can lead not only to additional tax assessments but also to penalties (20% / 40% of the unpaid tax amount) (Article 122 of the Tax Code of the Russian Federation).

Refusal to terminate company operations: The existence of debt may lead to the Russian Federal Tax Service (FTS) refusing to complete the company's "liquidation" procedure.

Initiation of bankruptcy: If debts cannot be repaid, the company's counterparties may file for the company's bankruptcy. The company itself can also initiate this procedure, but its implementation requires significantly more time and financial resources than the methods analyzed above.

Tax audits: Audits are almost inevitable during liquidation, which carries the risk of uncovering other debts (including tax payments), additional tax assessments, or violations.

Administrative liability: The exclusion of a company from the Unified State Register of Legal Entities due to inaccurate information may result in a fine for the general director or a temporary inability to hold the position of general director in other companies.

‍

C Cases Recommendations

Considering the identified risks, the C Cases team recommends the following:

• Conduct a preliminary legal and tax audit to identify the actual scope of obligations and assess the risks of their classification;
• Repay the debt or settle it otherwise, for example, by creditors forgiving the debt (if possible);

Important: when creditors forgive a debt, the company incurs a tax liability on the amount of the forgiven debt.

• Choose a method for terminating operations based on the company's financial condition and other factors;
• Evaluate the feasibility of bankruptcy, as in some cases, it is the only possible way to cease operations when there is no possibility to repay the debt.

If you need to terminate a legal entity's operations and wish to minimize risks during its "liquidation," the C Cases team is ready to conduct a comprehensive legal review, propose the optimal solution tailored to your goals, and guide the proper termination process for your company, which will not entail negative consequences for business owners, executives, and creditors.

‍

Sources

• Tax Code of the Russian Federation;
• Code of Administrative Offenses of the Russian Federation;
• Federal Law No. 129-FZ of August 8, 2001, "On State Registration of Legal Entities and Individual Entrepreneurs";
• Federal Law No. 14-FZ of February 8, 1998, "On Limited Liability Companies."