How to Use Reserve Funds to Offset Losses of a China Company?
According to the latest revised Company Law of the PRC (effective from 1 July 2024), a company's reserve funds can be used to offset its losses. However, the discretionary reserve funds and statutory reserve funds shall be used to offset the losses of the company first. If the foregoing funds are not sufficient to offset the losses, then the capital reserve funds may be used to offset losses in accordance with laws and regulations. Prior to the revision of the Company Law, it was not allowed to use capital reserve funds to offset company losses.
To clarify issues related to the use of reserve funds to offset company losses, the Ministry of Finance of the PRC issued the Notice on Financial Treatment Issues Following the Implementation of the Company Law and Foreign Investment Law (Caizi [2025] No. 101) on 9 June 2025. According to the Notice:
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When using reserve funds to offset losses, the amount of losses shall be determined based on the company’s audited financial statements of the previous year (not earlier than 2024). The reserve funds may only be used to offset losses until the negative undistributed profits at the end of the period reaches zero. The discretionary reserve funds shall be used to offset losses first and then the statutory reserve funds. The capital reserve funds can be used only when the foregoing funds are not sufficient to offset the losses. The capital reserve funds can only be used to offset losses up to the limit of the net increase in capital reserve funds by the following actions:
(1) Accepting capital contributions in the form of currency or non-monetary property such as physical objects, intellectual property rights, land use rights, equity, and debt rights that can be valued in currency and transferred according to law.
(2) Accepting capital investments in the form of debt repayment, debt exemption, or donations of currency, physical objects, intellectual property rights, and land use rights.
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Capital reserve funds restricted for specific shareholders or special purposes cannot be used unless the rightful owner agrees.
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Capital reserve funds that are conditional or subject to change cannot be used until the conditions are resolved and the amount is fixed.
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When using reserve funds to offset losses, the company shall formulate a plan to explain the situation of the losses, the reasons for offsetting the losses, and the sources, amount, and method of the reserve funds to be used to offset the losses, and so on. A resolution of board of directors shall be made and submitted to the shareholders’ meeting for approval.
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When using capital reserve funds to offset losses, the company shall either notify creditors or announce to the public within 30 days upon the adoption of the shareholders’ resolution.
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While fulfilling the relevant information disclosure obligations, the company shall also separately disclose the amount of losses that are offset using the capital reserve funds under the “undistributed profits” item in the notes to its financial statements.
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Companies that have used reserve funds to offset losses since 1 July 2024 shall make adjustments accordingly if their action did not meet the requirements set out in the Notice (Caizi [2025] No. 101).
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