Swatch Faces Complaint Over Taxes

By Leslie Lopez and John D. McKinnon

Swatch Group has evaded taxes and customs duties totaling millions of dollars through extensive use of transfer pricing in its Asian- Pacific operations, two former Swatch managers allege in a complaint filed with the U.S. Labor Department. The complaint -- filed June 25 under the U.S. Sarbanes-Oxley statute, which offers various protections for workers who blow the whistle on corporate wrongdoing -- charges that the big Swiss watchmaker used its British Virgin Islands subsidiary, Swatch Group Asia Inc., to evade taxes and duties in several countries, including the U.S.

The complaint also alleges that Swatch Group's senior management attempted to cover up the purported tax-evasion activities in April, after the two employees complained to their superiors about the practice. The alleged coverup attempt entailed Swatch's incorporating new companies in Hong Kong and Taiwan to take over the role played by the group's wholly owned unit, Swatch Group Asia. The Internal Revenue Service has become increasingly worried that some big companies are using transfer-pricing schemes to shave their tax bills. The basic concern is that companies are manipulating the prices they charge between subsidiaries in different countries in order to funnel profits out of high-tax countries and park them in low-tax ones. This week, in a transfer-pricing dispute, Motorola Inc. said tax authorities believe the telecommunications-equipment company owes as much as $500 million more in taxes from earnings they think were incorrectly booked within its global operations. Motorola says it intends to dispute the findings. The IRS has rules designed to prevent transfer-pricing abuses. But the rules have proved porous. One problem is that big corporations engage in so many transactions between their international subsidiaries that IRS agents have trouble keeping up. The complaint against Swatch was filed by Joseph Ede and Matthieu Phanthala, two Asia-based executives before they left the company earlier this year. The two men served as financial controllers for Swatch in the Asian-Pacific region whose responsibilities included conducting internal audits of the watchmaker's operations there. In a letter dated June 8 to Swatch Group Chief Executive George Nicolas Hayek Jr., New York-based law firm Kaiser, Saurborn & Mair, whose attorneys represent the two men, alleged "the entire purpose for Swatch Group Asia Inc.'s existence . . . was to move profit from other Swatch Group companies located in various countries around the world, including the U.S., so as to evade taxes in the particular host nations." The allegations in the letter, together with attached copies of internal Swatch documents, formed the basis of the complaint to the Labor Department. In their complaint, Messrs. Ede and Phanthala also charged that they have been subjected to a "pattern of harassment" by Swatch Group because of their allegations. The two men say they are taking the complaint to the U.S. Labor Department because the Swiss company does substantial business in the U.S., and its stock is traded over the counter there. The complaint alleges that Swatch Group Asia was used to move profits out of the U.S., "resulting in cumulatively well more than $1 million in U.S. tax evasion." The amounts were far more in Asia and Australia, the whistle-blowers allege. In an interview, Mr. Ede, who lives in Singapore, estimated that Swatch evaded taxes and duties amounting to more than $180 million in Asia and Australia over the past six years. Hanspeter Rentsch, Swatch Group's senior vice president and general counsel in Switzerland, said lawyers for Swatch are in contact with the Labor Department over the complaint. "We are taking the allegation seriously and started our own internal investigation" on the matter, he said. So far, Swatch's own "internal investigation shows that the allegations have no basis," he added. A Labor Department official acknowledged that the complaint is being investigated. "It is an open investigation and we have asked [the complainants] for more information," said Richard Porteus, a regional investigator for the department. He added that his department "is only investigating the employee-protection aspect of the complaint, but not the fraud." Swatch Group has annual sales of more than $3 billion, second only to Citizen Watch Co. of Japan. It was created in 1983 when Lebanon- born management consultant Nicholas Hayek merged two heavily indebted Swiss companies that made Longines, Rado, Tissot and Omega brand watches. Mr. Hayek turned the merged company around by creating and aggressively marketing the inexpensive, colorful Swatch watch. With assets of more than $4.4 billion, Swatch posted a profit of $393 million on revenue of $3.1 billion for 2003.