18 August 2019

VAT reform, cheap 4G fees add up to China telco profit challenge

Tax reform and government-ordered cuts to the price of 4G services could cost the three Hong Kong-listed mainland state-owned telecoms operators a large chunk of their earnings in the near future.

Premier Li Keqiang said in his government work report that Beijing will test a new value-added tax for telecommunications service providers as a replacement for business tax. Li did not go into details about the tax changes but analysts said the switch could hit the companies’ profit lines.

Value-added tax is benefiting the manufacturing sector because it cuts down on double taxation. But service providers like telecoms operators may end up paying more under a new tax regime given the higher rates of value-added taxes.

Telecoms operators now pay 3 percent business tax but VAT rates are expected to be anywhere up to 11 percent, depending on whether they are in voice, equipment sales or other value-added areas. Everything else being equal, the new tax scheme is almost certain to hurt telco profits.

And operators don’t have much room to maneuver.

Consultancy firm KPMG said operators could bundle free handsets into its service contract to avoid the high tax rate on the sale of goods but they will then incur the handset cost.

Nevertheless, they probably wouldn’t be allowed to pass the extra costs onto subscribers because the government has told operators to cut 4G mobile service fees to lure more users.

Market sources said telecoms operators are negotiating with the government to minimize the fallout from the new tax scheme. The best outcome could be for the VAT rate to be set at 6 percent.

While in the long term telcos could benefit from cheaper 4G fees by attracting a bigger user base, short-term pain seems unavoidable. Shareholders may even have to brace for dividend cuts.

Eventually, mobile operators may have to refine their business models and shake up their corporate structure to trim expenses to offset the tax bill.

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EJ Insight writer

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