China's Ambassador to the WTO Sun Zhenyu and Deputy US Trade Representative Linnet Deily have signed a Memorandum of Understanding on the value-added tax on semiconductors. The agreement, inked in Geneva on Wednesday, formally puts an end to the first complaint filed against China with the World Trade Organization (WTO).

Under the agreement, effective immediately China will provide no new certifications of eligibility for VAT refunds. By April 1 of next year, it will stop providing VAT refunds on semiconductors made domestically by producers currently benefiting from the policy, and will also drop the tax break for semiconductors that are designed locally, produced outside and then imported into China. The change is to be officially announced before September 1 this year and take effect before October 1.

In return, the US will withdraw its complaint from the WTO.

The complaint, filed on March 18, was the first against China since it joined the WTO in late 2001. Under WTO rules for resolving disputes, the US and China were required to hold consultations for at least two months before a panel began to adjudicate the complaint.

Four rounds of consultation were held from late April to early July. The European Union, Japan and Mexico joined the talks as third parties.

The United States alleged that China collected 17 percent VAT on imported semiconductor products, while the rate for domestic companies was only 3 percent. The commerce ministry claims that the complaint is "incorrect and not based on reality," but is the result of "some people confusing the concepts of tax rate and tax burden."

Local analysts said that the 3 percent tax for domestic companies refers to the rate of tax burden, which is actual VAT divided by the total sales of a company.

Most domestic and foreign semiconductor companies have a tax burden below 3 percent, so only a few businesses benefit from the preferential policy.

The Ministry of Commerce says that the agreement will not divert investment from China's semiconductor industry, as US semiconductor companies have been expecting.

China's huge market potential will remain the biggest factor for foreign investors, even when the VAT rebate policy is adjusted. The country's US$19 billion semiconductor market is the world's third largest and its fastest growing, expected to reach US$30 billion by 2006.

(China Daily July 15, 2004)