July 8, 2004 12:01 PM PDT

China, U.S. resolve chip tax issues

China has agreed to phase out an oft-criticized tax that U.S. companies complained discriminated against foreign semiconductor makers, the latest step in improving relations.

The Office of the United States Trade Representative announced on Thursday that the two nations have agreed to resolve their differences over China's value-added tax for semiconductors over the next nine months. The agreement settles a case filed in March by the United States.

The agreement will in all likelihood lead to increasing imports into the fast-growing Chinese markets. Under the system now being phased out, China places a 17 percent tax on semiconductors but gives local manufacturers rebates, thereby providing them with a substantial advantage.

"It worked the same as a tariff," Daryl Hatano, vice president of public policy at the Semiconductor Industry Association, said in March. "We're pleased with the results."

The old system also had the effect of encouraging foreign manufacturers to build facilities in China to take advantage of the rebates, according to U.S. executives and trade groups.

European companies were also affected by the VAT rules, but the United States has been more active in trying to eliminate the tax. For instance, the United States filed the complaint about the VAT with the World Trade Organization that was resolved by Thursday's agreement.

Ultimately, the elimination of the tax will probably lead to more chip exports from around the world. U.S. manufacturers sold $2 billion worth of integrated circuits into China in 2003. Overall, China consumed $19 billion worth of semiconductors last year, according to the United States Trade Representative.

China could also begin to gain more credibility as a stable trading partner. Since it joined the WTO in 2001, many have wondered whether it would live up to all of the obligations of membership, which include opening markets once reserved for local providers.

So far, the country appears to be honoring many of the obligations, albeit after open disputes. In April, the country agreed to drop wireless regulations that western companies said were designed to favor local chipmakers. China has also agreed to remain neutral with regard to 3G mobile phone standards, according to the USTR, another breakthrough.

The USTR noted that the agreement resolves the first WTO case ever filed against China by a fellow WTO member.

Chinese companies such as Shanda Interactive and SMIC have also increasingly been listing their stocks on U.S. exchanges.

Whether the change in regulations will prompt U.S. and European manufacturers to slow down their plant expansions remains to be seen. Hatano said the VAT policy provided an additional incentive to build facilities in China rather than in other nations encouraging chip industries. Personnel can be a relatively small expense in chip manufacturing, so nations such as Israel, Malaysia, the United States and Ireland remain competitive with developing nations in many regards.

Many chip executives, however, have said that China has other attractions: a large pool of engineers, a growing local market, and tax breaks and other incentives that are permissible under WTO rules.

Under the agreement, China will no longer certify new semiconductor products and manufacturers for VAT refunds and will no longer offer VAT refunds that favor chips designed in China, according to the USTR. Starting in April 2005, China will stop providing VAT refunds to current beneficiaries.

Although the VAT was one of the more testy trade issues between China and the United States, other issues remain. China is currently trying to promote homegrown standards for DVD players, and the nation still remains one of the hot spots for piracy.

 

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