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Elimination of rebates not death blow
By Zhu Boru (Business Weekly)
Updated: 2004-07-27 14:32

Elimination of value-added tax (VAT) rebates for China's chip designers and manufacturers is unlikely to harm the nation's semiconductor industry, which the government intends to foster with other enticements, suggest experts.

China and the United States recently signed, in Geneva, a memorandum of understanding (MOU) involving the VAT on Chinese-made semiconductors.

Under the MOU, China will, beginning on April 1, 2005, adjust its VAT rebate policy, and stop giving existing firms preferential treatment.

"The move will not deal a death blow to China's semiconductor sector," said Li Ke, director of China Semiconductor Industry Association (CSIA)'s information exchange department.

The decision is of greater symbolic significance, he said.

In fact, few Chinese firms are eligible to receive VAT rebates, said Yu Zhongyu, CSIA's president.

The United States has complained China imposes a 17-per-cent VAT on imported chips, and only 3 per cent on domestic chips.

Despite reaching the agreement, the Ministry of Commerce has rebuffed the US' accusation. Ministry officials argue the United States has made a "groundless" accusation because it has confused tax rates with tax burdens.

China's semiconductor makers and designers will receive tax rebates if their tax burdens -- determined by dividing the actual VAT by the company's total sales, rather than tax rates -- exceed 3 per cent.

"Only those firms producing and designing low-end chips, a small proportion, are heavily burdened ... and have received such rebates," said Yu.

Moreover, China's semiconductor industry will still be attractive to investors after the move, as the preferential tax policy is just one reason why they prefer the market, Yu stressed.

It is commonly accepted that many manufacturing companies in developed countries transfer their production bases to developing countries, because they are lured by the rich labour resources and lower operating costs, he explained.

"This is what is happening in China's semiconductor industry," Yu said.

China already has several production lines for the advanced eight-inch wafer, and "foreign firms feel they must enter the market to follow that technology," Yu added.

The Chinese Government has attracted foreign investment to promote its semiconductor industry.

Meanwhile, most domestic chip makers and designers are optimistic about their prospects despite the elimination of the VAT rebates.

"Our sales will not decline, and, as an export-oriented company, we will be able to hold onto our competitive edge globally," said Jimmy Lai, an official with SMIC (Semiconductor Manufacturing International Co), the country's largest semiconductor manufacturer.

Domestic sales account for 3 per cent of SMIC's total revenues.

That means the limited VAT rebates for domestic sales will have little effect on the firm's global competitiveness, Lai said.

However, the move, in the short term, will decrease Chinese companies' profit margins, said Li.

Zhang Rujing, SMIC's chief executive officer, was quoted by 21st Century Economic Herald as saying the company's profit margins will drop US$1.7 million yuan (US$204 million) annually.

In response to the tax adjustment, Shanghai Belling Co Ltd, a domestic chip maker and designer, will commit itself to research and development to offset the fallout, said Wang Longhai, the company's chief engineer.

The Chinese Government is pondering other means to promote the industry.

"The government will stick to its principle of encouraging the domestic semiconductor industry, and it will take measures under the World Trade Organization's rules," said Yu.

He declined to elaborate.

Wang said the government could support companies by offering bank loans with below-market interest rates.

Meanwhile, the National Development and Reform Commission (NDRC), China's top planner, is expected to invest 1 billion yuan (US$120 million) in the semiconductor industry annually to offset the negative effects of the elimination of the VAT rebates, Li Ke, vice-general manager of domestic leading market research house CCID Consulting Co Ltd, was quoted by the Economic Observer as saying.

By 2010, the government's investment in the semiconductor industry will amount to 10 billion yuan (US$1.2 billion), at least 10 times the current total investment, CCID's Li said.

China is the world's third-largest semiconductor market, after the United States and Japan.

With a growth rate almost double the global average in the coming decade, the value of China's semiconductor market is expected to reach US$46 billion, nearly two times greater compared with this year, by 2007, indicate statistics from market research firm Gartner Dataquest.

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