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PRE-LIQUIDATION AUDIT OF COMPANY ACTIVITY: PROCEDURE, TIPS, AND RISKS

The liquidation of a company is a legal process of terminating a legal entity, which may be initiated either by the business owners or on the grounds stipulated by law. Reasons for liquidation may include the completion of business operations, internal restructuring of a business group, economic impracticality of further operations, or changes in the owners' strategic vision. Although liquidation formally signifies the “end” of a business, in practice, it requires thorough preparation, particularly in analyzing the company’s financial, tax, and legal aspects over previous periods.

This is why a pre-liquidation audit becomes a key instrument at this stage - a comprehensive internal review involving lawyers and accountants that help identify and address potential risks in a timely manner. These risks may not only include outstanding debts or unsettled obligations with counterparties but also deficiencies in reporting, errors in HR or commercial documentation, and unfulfilled obligations to regulatory authorities, which may not be immediately apparent. Conducting such an audit allows the company to avoid unforeseen delays, prepare for inspections, and mitigate legal and financial risks for the shareholders and the director.

How should a pre-liquidation audit be organized, and what should be considered?

  • Liquidation vs Bankruptcy. If it is discovered that the company lacks sufficient assets and funds to cover creditors’ claims, voluntary liquidation cannot be applied. In such cases, the company falls under insolvency legislation. This significantly complicates and increases the cost of the process, as it requires filing with the court (by the company itself or by its creditors), the involvement of an insolvency practitioner, and compliance with specific stages under bankruptcy law. The owners and management lose control over the company, which effectively comes under external administration. Moreover, bankruptcy may carry risks of joint or subsidiary liability for the owners and management if their actions contributed to the company’s insolvency. Therefore, before initiating liquidation, solvency shall be assessed, and debts restructured if necessary.

  • Debt Management. If problematic or overdue debts are identified, the owners may restructure them. Possible tools include set-off of mutual homogeneous claims, debt forgiveness, or debt-to-equity swap (transforming debt into charter capital). Each option carries its own legal and tax consequences, so a careful assessment is essential before making a final decision. For instance, in the case of debt forgiveness, the forgiven amount is considered income for the debtor and affects the profit tax base. If restructuring involves increasing the company’s charter capital, this requires state registration of the changes, appropriate legal support, and correct accounting entries.

  • Preparation for Inspections by State Social Insurance Authorities. During liquidation preparations, it is important to consider inspections by bodies responsible for mandatory state social insurance. Specifically, the Pension Fund of Ukraine inspects the period from January 1, 2007, and evaluates the accuracy of wage calculations and pension contributions. Given the long period covered, the company shall ensure availability of employment orders, timesheets, payroll documents, civil law agreements (and related acts), as well as copies of employee passports and tax identification numbers confirming employment and payment amounts.

    • If the company operated before 2010, additional documentation inspections may be conducted by the Employment Center, assessing the calculation and payment of unemployment insurance contributions. Therefore, it is advisable to proactively verify the completeness of records confirming the correctness and timeliness of such payments. Lack of documentation may result in back-payment demands or fines, complicating or increasing the cost of liquidation.

  • Preparation for Tax Inspections. Before liquidation, the company should assess the risk of additional tax assessments, focusing particularly on the presence of primary documents supporting each business transaction. These are the basis for accounting records, and in their absence, any expenses, income, or other transactions may be deemed fictitious or unjustified by the tax authorities, leading to assessments and penalties. To streamline data, summarized accounting records may be used, but they shall be based on actual primary documents. Having complete and reliable documentation of all transactions ensures accurate financial statements and minimizes the risk of additional assessments or fines.

    • If the company was a VAT payer, in some cases it may be advisable to preemptively cancel VAT registration to speed up the liquidation. However, it shall be noted that once cancelled, the company loses the right to file VAT returns and thus to recover any remaining VAT credit from the last return. Therefore, before submitting a VAT deregistration application, the company should analyze the VAT credit situation and, if there is a balance, consider claiming budget reimbursement.

    Additionally, the balance of the VAT electronic administration account should be reviewed and, if negative, the outstanding amount should be settled in advance.

    For example, if the VAT credit in the last return exceeds tax liabilities, and certain conditions are met, the company may claim reimbursement. The three key conditions are:

  • The VAT was actually paid in cash (barter or set-offs are not eligible);

  • The reimbursement does not exceed the electronic invoice registration limit;

  • The taxpayer has no outstanding VAT liabilities.

    • If these conditions are met, the company may submit a reimbursement claim with its final VAT return. However, the tax authority has 30 calendar days to conduct a desk audit, and if there are doubts about the validity of the declared amounts, a documentary (unscheduled) audit may be initiated.

    In today’s environment, where tax authorities frequently issue additional assessments, recovering VAT can be practically valuable. These funds can cover potential assessments or penalties, allowing the liquidation to be completed without further financial losses. If a reimbursement claim is not filed, the remaining VAT credit will be permanently lost.

    If the company does not pursue reimbursement or does not meet the above criteria, it may opt for a so-called “deemed sale” before deregistering for VAT. This involves charging VAT on all remaining goods, services, or non-current assets not used in economic activities but for which VAT credit was claimed, based on their fair market value.

    In any case, this stage requires careful analysis of asset balances, reporting, and financial capacity, and it is recommended to engage a tax specialist or accountant.

  • Communication with Staff and Top Management. In liquidation, dismissals are usually carried out due to organizational changes. This requires personal notification of each employee at least two months in advance. In case of mass layoffs, the Employment Center shall also be notified in advance, and consultations with the trade union (if any) shall be held. Violations of the procedure may result in labor disputes or block liquidation due to unresolved employee claims.

    • The law requires severance pay (at least one average monthly salary), compensation for unused vacation, and full settlement on the termination day. In some cases, such as socially protected categories, additional guarantees apply. Alternatively, employment may be terminated by mutual agreement, provided the terms are balanced and clearly defined for both parties.

    Special attention should be given to employees with additional social protection (minors, single parents, pregnant women, etc.). Termination without observing procedures or offering alternative employment may be ruled unlawful. Thus, an internal audit of personnel matters is advisable before initiating liquidation to ensure compliance with all legal requirements.

    In conclusion, a pre-liquidation audit is a strategic entry point into a safe and controlled closure of business operations. It enables early identification of hidden legal, financial, and tax risks, helps eliminate barriers to liquidation, and aligns the process with the company’s actual condition. Such an audit ensures a transparent closure process, protects the interests of owners and management, and helps avoid conflicts with employees and claims from regulatory authorities. Today, state authorities increasingly recognize and support this approach. With proper preparation and accurate documentation, liquidation can proceed swiftly and without complications. Therefore, a professional pre-liquidation audit should be seen not as an expense, but as an investment in predictability, safety, and the company’s reputation even at its final stage.

    Authors:

  • Oleksandr Melnyk, Partner, Head of Corporate Law and M&A practice at GOLAW, Attorney at law

  • Oles Riabchuk, Senior Associate at Corporate Law and M&A practice at GOLAW, Attorney at Law

    • Content supplied by GOLAW