IBM probed for tax evasion

The tax office is seeking to determine whether IBM Corp. improperly avoided taxes in Britain by having its British unit pay artificially high royalties to the parent company, according to people familiar with the matter.

The Inland Revenue has been examining IBM's books for about two years, these people said. The inquiry has centred on fluctuations in royalty payments between about 1991 and about 1996, these people said. The inquiry was sparked by allegations made to Inland Revenue by a former IBM U.K. employee, Gerard M. Churchhouse.

Churchhouse, who had been a manager in sales and marketing, alleged that IBM avoided paying as much as about $500m (£304m) in British taxes between 1991 and 1996 by raising to 12% from 8% the royalties paid to the U.S. parent on goods and services sold here.

Such an allegation, if true, would lower the operating profit of the British unit, thereby lowering British taxes. It would also have improved operating results at IBM's American unit. However, IBM did not pay taxes on its U.S. operations between 1991 and 1993 because the company was posting losses. U.S. operations returned to profitability in 1994.

IBM confirmed that the computer maker is being audited by Inland Revenue. IBM spokesman Rob Wilson called the audit "normal and routine," adding that the company is "cooperating fully with the tax authorities."

Churchhouse was dismissed by IBM in 1995. His allegations on British taxes were also outlined in a lawsuit he subsequently filed against the company in New York's Supreme Court, alleging, among other things, that his dismissal was in retaliation for his unearthing of corruption. The suit was dismissed earlier this year on grounds that Churchhouse had already reached a dismissal settlement with IBM in Britain in 1995. The court did not specifically address the merits of his tax allegations.

Churchhouse alleged that IBM's British unit was ordered by the parent company to boost its royalty payments in 1991. He said the four-percentage-point increase in 1991 translated into £160m in extra transfer payments.

Churchhouse said the royalty remained at 12% through 1993, then dipped, only to bounce back around 1995. He estimated that the total amount of royalty increases between 1991 and 1996 reached about 900 million, and that IBM thus avoided paying roughly £300m of taxes over the period. Wilson, the IBM spokesman, declined to comment on the allegations, the level of royalty payments or any reason they might have increased.

In 1991, the corporate tax rate in Britain was about 35%, and has declined since then to its current rate of about 31%. According to IBM's annual reports, its U.S. tax provision as a proportion of U.S operating profit was 18% in 1994, 27% in 1995 and 37.5% in 1996. (IBM paid no U.S. income taxes from 1991 to 1993 because of the losses.)

Churchhouse alleged that he approached Inland Revenue after he was fired, because of tax issues related to his severance payment. Around this time, Churchhouse said he also began to look into the alleged royalty scheme, conducting interviews with IBM officials and pulling IBM corporate filings in Britain. He said he compiled a report laying out the alleged royalty deviations, which he said he submitted to Inland Revenue in 1997.

Analysts have generally lauded IBM's chairman and chief executive officer, Louis V. Gerstner, for lowering the company's tax rate since he took over in 1993. They have said Gerstner accomplished this by moving production to areas with more attractive tax regimes such as Mexico and Singapore.

In 1994, for instance, IBM's overall tax rate was 41.4%. Since then, it has fallen each year, reaching about 30% last year. Analysts estimate that the tax rate will drop to about 29.8% this year.

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