Elimination of tax rebate pressures Chinese chip makers

China’s decision to lift a value-added tax (VAT) rebate on some domestically manufactured semiconductors will increase the competitive pressure on Chinese chip makers that have benefitted from the protective tax policy, chip makers said Friday.

China levies a 17 per cent VAT on semiconductors but has offered a rebate for some chips made in China, effectively lowering the VAT on these products to around three per cent. The tax policy has helped spur the development of China’s domestic chip-manufacturing industry but has been the center of a lingering trade dispute between China and the U.S., which has argued that the rebate violates World Trade Organization (WTO) guidelines.

On Thursday, the Office of the U.S. Trade Representative (OTR) announced that China has agreed to eliminate the VAT rebate for domestically produced chips. Effective immediately, China will no longer certify domestic chip makers as eligible to receive the VAT rebate and will phase the rebate out entirely by April 1, 2005, OTR said in a statement.

Taiwanese chip manufacturers were pleased with the announcement.

“It’s just levelling the playing field for the chip-manufacturing business,” said Alex Hinnawi, a spokesman for United Microelectronics Corp. (UMC) in Taipei. “It means companies will be competing based on their manufacturing competitiveness and not on their location, and I’d say that’s a good move.”

Taiwan Semiconductor Manufacturing Co. Ltd. (TSMC) in Hsinchu, Taiwan, also welcomed the news, said J.H, Tzeng, a company spokesman.

The Semiconductor Industry Association (SIA), a U.S. trade group that had lobbied for the Chinese government to eliminate the VAT rebate or reduce the VAT on all chips to three per cent, also welcomed the OTR announcement. Elimination of the discriminatory features of China’s VAT regime will assure a level playing field for all competitors, the SIA said in a statement.

Chinese chip makers greeted the news cautiously and generally declined to comment on the agreement, noting that the Chinese government had yet to officially announce plans to eliminate the VAT rebate.

“Only the U.S. has made an announcement about this. The Chinese government has so far not announced anything. We are waiting for the Chinese government to make an announcement before we comment,” said Sarina Huang, a spokeswoman for Semiconductor Manufacturing International Corp. (SMIC), China’s largest chip maker, in Shanghai.

While China’s Ministry of Commerce (MOFCOM) had not released a statement on its Web site Friday, the OTR announcement was reported by China’s official media, including the Web sites of the People’s Daily and China Daily newspapers and the Xinhua News Agency. MOFCOM officials could not be reached for comment.

In a prospectus filed with the U.S. Securities and Exchange Commission (SEC) ahead of SMIC’s initial public offering in March, the company noted that the Chinese government provides incentives, including tax rebates, for Chinese chip makers to encourage the development of the domestic chip industry and warned of the impact on its business if these incentives were removed.

“Any such reduction or elimination of incentives currently provided to us could adversely affect our business and operating results,” the prospectus said.

And SMIC is not alone.

“To some extent it will (affect our business plans) but on this issue we have no comment,” said Stephan Chen, vice-president of Nanotech Corp., a start-up company that recently signed a deal with Intel Corp. to acquire chip-manufacturing technology and equipment for a wafer fabrication plant that it plans to construct in Changzhou, China.

The elimination of the VAT rebate could make it more difficult for some Chinese chip makers, who have drawn business from customers looking to move some production to China in order to take advantage of the preferential tax policy imposed by the government.

“For some of these competing companies in China it’s possible they’ve been getting some of their business for this reason,” UMC’s Hinnawi said. “Now it really comes down to who can make the best product.”