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Will China's Telecoms Dodge a Major Tax Bullet?

Eric Johnson

BEIJING (TheStreet) -- Between the lines of an otherwise dull announcement about building mobile phone towers was an assurance for investors that China's telecom operators expect to weather the storm of a new tax regime.

That assurance in the face of a tough VAT regime announced this week by the government helped China Mobile , China Telecom and China Unicom survive a tumultuous trading session Friday on the Hong Kong Stock Exchange.

Shares in each of the state-run carriers opened sharply lower following the May 1 holiday after the Beijing government unveiled the tax plan late Wednesday. Telecom services will be taxed starting June 1 in a way that, according to the companies, could slash annual earnings up to 36%.

On the tax announcement, telecom share prices slipped as much as 3.5% during the trading day before rebounding. China Mobile closed 0.8% lower at HK$73.10 per share, China Unicom finished down 1.8% at HK$11.68, and China Telecom ended the day unchanged at HK$3.98.

Investors apparently found solace in separate China Mobile and state media announcements Friday that the three carriers had formed a joint venture to build towers nationwide -- perhaps 750,000 units this year alone -- to carry fourth-generation (4G) Internet and mobile phone signals.

The investment project is expected to offset at least some of the higher taxes because, according to VAT rules imposed by the government's State Administration of Taxation, capital expenditures will be deductible under the new regime.

And the joint venture, tentatively named "State Tower," has a massive and expensive job ahead.

This year alone China Mobile plans to add 500,000 towers to accommodate 4G customers, state media said Friday, while China Telecom could install up to 250,000 towers. Similar building plans have yet to be announced at China Unicom, which got regulatory permission to offer 4G services only last month.

The new 11% VAT on basic telecom services and 6% on value-added services will replace the current 3% business tax, the government said.

China has been slowly phasing out its business tax industry by industry and phasing in the VAT, which is easier to levy and, officials say, fairer for taxpayers. A VAT for the cargo and logistics industries came into full force last September, and railroad services are slated to be added by 2015.

The telecom operators had apparently hoped to keep the VAT at bay for their industry at least through 2014. State media earlier reported that the companies had complained about massive cuts to this year's earnings unless the business tax was retained.

Ratings agency Fitch this week said China's VAT on the telecom sector "will not simply be a neutral pass-through tax to be borne by the consumer. We think that Chinese telecom operators will find it difficult to pass on the additional tax burden to customers through higher tariffs."

Telecom profits may not fully recover from the switch to VAT for three or four years, Fitch said.

But capital expenditures for China Mobile and China Telecom -- estimated at 225 billion yuan and at least 90 billion yuan this year, respectively -- will mean the new tax "will not materially impact" those companies, the agency said. It did not mention China Unicom's spending plans.

Writing this week in the Communist Party magazine Qiushi, Prime Minister Li Keqiang said the central government favors the new VAT system "to eliminate double taxation, reduce the burden on enterprises, and promote industrial restructuring, development  and business innovation."

At the time of publication, the author held no positions in any of the stocks mentioned.

This article represents the opinion of a contributor and not necessarily that of TheStreet or its editorial staff.



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