Overview
To facilitate the effective implementation of the new PRC Company Law (revised on 29 December 2023 and effective from 1 July 2024) and the PRC Foreign Investment Law (effective from 1 January 2020), the PRC Ministry of Finance issued the circular Cai Zi [2025] No. 101 (“Circular 101”) on 9 June 2025. Circular 101 entered into effect on the same day. Circular 101 provides clarifications on the financial treatments of certain issues which the public has been paying attention to and which had been newly introduced by the two laws mentioned above.
Key issues include (i) the use of company reserves for loss recovery, (ii) capital contributions in the form of non-monetary assets and (iii) how to deal with the balances of those funds which were required under the former, now abolished, special laws and regulations for foreign-invested enterprises (“FIEs”).
Summary of the Key Contents
1. Use of company reserves for loss recovery
Company reserves, from accounting perspectives, include both the “capital reserve” and the “surplus reserve”. “Capital reserve”, from accounting perspectives, normally comes from the shareholders’ investment premium, donation from the affiliated companies, etc., but it is not converted from the net profits earned by the company. “Surplus reserve”, from accounting perspectives, is an account that recognizes the accumulated net profits of the company that are retained in the company without distribution as dividends.
According to Article 210 of the PRC Company Law, when a company distributes its after-tax profits for the current year, it shall set aside 10% of the profits to be included in the company's statutory reserve. A company may elect not to do so if its aggregate statutory reserve reaches 50% or more of its registered capital. The company can decide to set aside more profits as the reserve without distribution and the reserve contributed over the threshold for the statutory reserve is called “discretionary reserve”. Both the “statutory reserve” and the “discretionary reserve” are recorded as part of the “surplus reserve” from accounting perspectives.
The mapping of the various types of company reserves between the concept under the PRC Company Law and the concept under the PRC accounting standards is summarized as follows:
Article 214 of the PRC Company Law further provides that a company's reserves shall be used to cover its losses, expand its production and business, or increase its registered capital. When using a company’s reserves to cover its losses, any discretionary reserve and statutory reserve balances shall be used first to cover such losses; if there is still a shortfall, the capital reserve may be used in accordance with regulations. When converting statutory reserve into an increase in registered capital, the remaining balance of such reserve shall not be less than 25% of the company's registered capital before the conversion.
It is a longstanding common understanding that the surplus reserve, which is formed from the net profits earned by a company, can be used for loss recovery. Also, the PRC Company Law has never prevented that the capital reserve is used to recover losses. In this context, Circular 101 confirms and clarifies the sequence of the utilization of the reserves for loss recovery. First, the discretionary surplus reserve should be used, then the statutory surplus reserve, and then lastly the capital reserve.
The following points are further clarified by Circular 101 in terms of the implementation of using the capital reserve for loss recovery:
• Scope of the qualified capital reserve for utilization
The qualified incremental capital reserve should be formed from
a) the capital contribution in form of cash or non-monetary properties such as tangible assets, intellectual property rights, land use rights, shares and credit rights which can be appraised and transferred in a legal manner; or
b) the capital investment in form of debt repayment on the company’s behalf or debt waiver or donation of cash, tangible assets, intellectual property rights or land use rights.
The incremental capital reserve used for loss recovery should neither belong to specific shareholder(s) nor be subject to restrictions in use. Further, an incremental capital reserve, the amount of which may vary due to certain conditions, can only be used for loss recovery after the amount of the incremental capital reserve has been fixed.
• Procedures for using reserve funds for loss recovery
According to Circular 101, the use of reserve funds for loss recovery shall generally be decided by the Board of Directors and then be finally approved by the Shareholders' Meeting of the company. The loss recovery plan for resolution should describe the loss situation, the reasons for loss recovery and the source, amount and manner of the reserve funds used for loss recovery.
In the case of loss recovery by capital reserve, the company must notify the creditors or make a public announcement within thirty days from the date on which the related resolution of the Shareholders' Meeting was made. This allows the creditors to reasonably evaluate the credit risk. Companies using the capital reserve for loss recovery should also disclose the amount used for loss recovery under the item of "undistributed profits" in the notes to the financial statements.
2. Capital contributions with non-monetary assets
According to Article 48 of the PRC Company Law, shareholders may contribute capital in cash, in kind, or with intellectual property rights, land use rights, equity, debt claims, or other non-monetary assets which can be valued in monetary terms and legally transferred, except for assets not eligible for capital contribution under any other law or administrative regulations. The value of any non-monetary asset used for capital contribution shall be appraised and verified, and shall not be overestimated or underestimated. Where any law or administrative regulations provide for the appraisal of values, such provisions shall apply.
Circular 101 further clarifies in this regard that
• the non-monetary assets used for capital contribution should be subject to asset appraisal and internal decision-making procedures relating to relevant corporate matters such as company set-up, capital increase, merger and spin-off; and
• the companies should carefully evaluate the factors that may affect the realization of asset-related rights and interests (e.g., ownership clarity, liquidity, potential legal risks) and seek legal opinions, where necessary.
These measures aim at preventing the risk of inadequate contributions and ensuring the authenticity and quality of the capital of the company, thereby enhancing the overall corporate governance level.
3. Treatment of balances of those funds which were required under the former, now abolished, special laws and regulations for FIEs
Prior to the entry into effect of the PRC Foreign Investment Law on 1 January 2020, there were special laws and regulations for FIEs, i.e. the PRC Law on Sino-foreign Equity Joint Ventures, the PRC Law on Sino-foreign Cooperative Joint Ventures and the PRC Law on Wholly Foreign-owned Enterprises together with respective implementing regulations. Concurrently with the entry into effect of the PRC Foreign Investment Law, those special laws and regulations have been abolished. Under the former regime of those special laws and regulations for FIEs, FIEs should make allocations to a reserve fund (i.e., the statutory reserve), an enterprise development fund and an employees' bonus and welfare fund (collectively referred to as the "Three Funds"). The Three Funds had been abolished by the revised PRC Company Law and the PRC Foreign Investment Law and have been replaced by the uniform statutory reserve and discretionary reserve which shall be accrued from the after-tax profits of the FIEs.
Circular 101 provides for a smooth shift of the accounting treatment of the Three Funds already accrued by FIEs to meet the requirements under the new regime:
• The balance of reserve fund shall be shifted to the statutory surplus reserve for management.
• The balance of the enterprise development fund shall be shifted to the discretionary surplus reserve for management.
• The accrued employees' bonus and welfare fund shall be used according to the requirements at the time when they were accrued. At the time of liquidation of the company, unless treated as liabilities for management under the accounting standards, the remaining balance of the accrued employees' bonus and welfare fund shall be treated in accordance with the long-standing financial circular Cai Gong Zi [1995] No. 222.
• It is clear that the Three Funds should no longer be accrued since 1 January 2025 and any accrued Three Funds after 1 January 2025 should be reversed as described above.
These provisions provide clear guidance for FIEs to adapt themselves to the new legal framework in dealing with the Three Funds accrued under the superseded regime.
Recommended Actions
» Companies intending to use their capital reserve for loss recovery under the revised PRC Company Law should be familiar with the priority and sequence of the reserve funds used for loss recovery, the scope of the capital reserve for loss recovery as well as the statutory formalities.
» Companies accepting non-monetary assets for capital contributions should pay attention to the requirements of asset appraisal and risk assessment.
FIEs should stop the accrual of the Three Funds from 2025 onwards and properly deal with the balance of the Three Funds accrued under the superseded regime according to Circular 101.
