With investments already poised to climb because of 4G mobile deployments, the profitability of the mainland's "big three" telecommunications network operators could take a hit once Beijing introduces a value-added tax (VAT) for their industry.
The senior management at China Mobile, China Unicom and China Telecom have suggested that the domestic telecommunications industry "will most likely start recognising VAT from the beginning of 2014", says a Barclays research note.
"We view VAT reform as a confusing transition, given that many of the specifics are still unknown," said Anand Ramachandran, lead author of the Barclays report and the firm's head of telecommunications, internet and media equity research for Asia, excluding Japan. "We believe there is potential downside risk to the entire sector's profitability."
The State Council implemented the VAT programme, which started as a province-by-province pilot scheme last year, to boost productivity in various industries and lessen their tax burden. Post and telecommunications, financial services and insurance, and construction and real estate are among those yet to transition to VAT.
The telecommunications operators currently pay a 3 per cent business tax net of revenue. This will be replaced by a VAT on gross revenue at 6 per cent or 11 per cent, the specific rates of which are yet to be finalised, from next year. The tax rates for different services - voice, equipment sales and value-added offerings - are expected to be different.
Assuming an 8.5 per cent VAT rate, Barclays estimates that China Mobile's net revenue next year would reach 651.69 billion yuan, down 5.1 per cent from its current forecast of 686.49 billion yuan. Following VAT adjustment, profit before tax would total 141.81 billion yuan rather than the forecast 160.21 billion yuan.
The ability to pass the additional cost on to the consumer may alleviate the tax burden, but higher tariffs on telecommunications services would not be acceptable to the government, or feasible in a competitive market, according to Barclays.
"All three operators are currently negotiating with the government on some concessions, which could potentially minimise this adverse impact to profitability," Ramachandran said. "The timeline to implementation could be phased out, which then allows the operators more time to rework systems … to maximise cost offsets."
In a June report, KPMG said the increased tax burden would be short term.
"It is expected that after an initial settling-in period, customers will become more accustomed to the VAT being passed on and providers will generate input VAT credits as part of their normal capital replacement and new investment activities."