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Caterpillar Escaped $2.4 Billion Tax With Swiss Maneuver

By Richard Rubin
March 31, 2014 5:00 PM EDT 287 Comments
An attendee examines a Caterpillar Inc. backhoe loader at the National Farm Machinery Show in Louisville, Kentucky, on Feb. 13, 2014.
Photographer: Luke Sharrett/Bloomberg
An attendee examines a Caterpillar Inc. backhoe loader at the National Farm Machinery Show in Louisville, Kentucky, on Feb. 13, 2014.

Caterpillar Inc. (CAT) avoided paying $2.4 billion in U.S. taxes by shifting profits from a parts business to a subsidiary in Switzerland, according to a report released today by a Senate investigative committee.

The world’s largest maker of construction and mining equipment made a “paper change” starting in 1999 that made the profits of the subsidiary subject to a Swiss tax rate as low as 4 percent, said Senator Carl Levin, a Michigan Democrat who will question company executives at a hearing tomorrow.

“Nothing changed in the real world after that except Caterpillar’s tax bill,” Levin told reporters today. “Caterpillar waved a magic wand to make billions of dollars in U.S. taxes disappear.”

The report makes the point that offshore profit-shifting by U.S. corporations goes beyond the intellectual property maneuvers of technology companies such as Apple Inc. (AAPL) and Microsoft Corp. (MSFT) that have been the subjects of past hearings by Levin and scrutiny from governments in Europe.

According to the report, Caterpillar was able to take a profitable U.S.-based business, change little if anything about its operations and locate it in Switzerland for tax purposes.

The tax structure saves Caterpillar, which is based in Peoria, Illinois, about $300 million a year, or 7.9 percent of 2013 net income.

Senate Hearing

Caterpillar executives, including Chief Tax Officer Robin Beran, are scheduled to testify at tomorrow’s hearing of the Senate’s Permanent Subcommittee on Investigations, of which Levin is chairman. Executives from PricewaterhouseCoopers LLP, which aided Caterpillar, also are set to testify.

“What Caterpillar did here is pretty routine U.S. multinational tax planning,” said Kenneth Kies, a Washington tax lobbyist who represents Caterpillar. “This is not radical cutting-edge tax planning. This is pretty normal stuff.”

Julie Lagacy, Caterpillar’s vice president for finance services, said in prepared testimony that the company complied with U.S. tax law.

The Swiss subsidiary, she said, “is no mere shell, but rather a major operating company employing hundreds of personnel in Geneva, including many of the people who perform the strategically critical work of interfacing with dealers in non-U.S. markets.”

PricewaterhouseCoopers said in an e-mailed statement today that it stands by its work for Caterpillar.

“Our advice was founded on years of extensive work overseas and in the United States and included detailed analyses of Caterpillar’s global operations,” the company said in the statement.

McCain’s ‘Disagreement’

Senator John McCain of Arizona, the top Republican on the committee, isn’t signing onto Levin’s report. He told Bloomberg News in a brief interview March 28 that Caterpillar’s actions weren’t “on the level” of Apple’s and that he and Levin “have a disagreement about the degree of the violations.”

Under U.S. tax law, companies pay a 35 percent corporate income tax on profits they earn around the world. They receive tax credits for payments to foreign governments and don’t have to pay U.S. taxes on profits they earn outside the country until they bring home the money.

That system gives companies an incentive to book profits outside the U.S. and leave them there, often using tax havens to minimize foreign taxes.

2013 Report

Such profit shifting costs the government between $30 billion and $90 billion a year, according to academic estimates cited in a 2013 Congressional Research Service report. The tax practice has become a focus for the Organization for Economic Cooperation and Development and the Group of 20 nations, who are trying to develop coordinated rules that could be adopted by multiple governments.

The largest U.S. companies have accumulated $1.95 trillion in profits outside the country that haven’t been taxed by the U.S., according to data compiled by Bloomberg News. Caterpillar has $17 billion, up from $11 billion three years earlier, according to company securities filings.

Levin’s investigation began focusing on Caterpillar following a lawsuit filed by former employee Daniel Schlicksup, who alleged that company executives retaliated against him when he raised concerns about the international tax strategies.

That case was settled in 2012. Schlicksup isn’t scheduled to testify.

The parts business is significant for Caterpillar because it provides a steady stream of income at high profit margins as customers replace parts of equipment, according to the report.

‘Profit Machine’

The company tries to ensure that specialized parts are available around the world when needed and the report says the company has called the parts business a “perpetual profit machine” that is steady even as new machine sales slow in an economic downturn.

Levin’s report focuses on a 1999 decision by Caterpillar to restructure its international parts business, acting on advice for which it paid PricewaterhouseCoopers more than $55 million.

Caterpillar and its Swiss subsidiary entered into an agreement that let the Swiss company purchase parts from third-party suppliers and sell them to dealers outside the U.S., removing Caterpillar itself from the “legal title chain” of the transactions.

That move didn’t change any of the “operational details” of how Caterpillar ran its parts business.

‘Paper Owner’

“Instead,” the report said, “it focused on changing the legal entity that served as the paper owner of Caterpillar’s replacement parts and the recipient of the non-U.S. parts profits.”

As a result, profits could be booked in Switzerland, where Caterpillar negotiated a tax rate as low as 4 percent. A PricewaterhouseCoopers document cited in the report said the maneuvers were “effectively more than doubling the profit on parts.”

In her prepared testimony, Lagacy said the changes created a “simpler supply chain” and eliminated unnecessary transactions.

The company created a virtual inventory so that it could track which parts in the U.S. were owned by the Swiss subsidiary and which were owned by Caterpillar, though they were commingled in U.S. warehouses.

Caterpillar called these and other maneuvers the Global Value Enhancement program, and from 2000 to 2012 the company shifted more than $8 billion in profits to Switzerland, resulting in the $2.4 billion tax advantage during those years, according to the report.

Minimal Presence

Levin’s report emphasizes Caterpillar’s minimal presence in Switzerland to suggest that Caterpillar’s parts operation is still run from the U.S. According to the report, the company has about 8,300 employees who specialize in parts -- 4,900 in the U.S. and 65 in Switzerland.

The company’s parts warehouses, inventory tracking and forecasting are operated in the U.S., the report says.

Nevertheless, the Swiss subsidiary received about 85 percent of the profits from non-U.S. parts sales while Caterpillar received about 15 percent. That’s about the reverse of the split that had been in place before 1999, Levin said.

In a deposition from Schlicksup’s lawsuit, Rodney Perkins, a senior international tax manager for Caterpillar, said the transactions had no business advantage other than tax reduction. U.S. tax law prohibits companies from making transactions that have no economic substance other than tax avoidance.

Perkins, who is retired from Caterpillar, will testify tomorrow.

Unrelated Companies

Under tax laws, the transaction was supposed to be treated for tax purposes as if it were made by two unrelated companies. Levin said Caterpillar wouldn’t have engaged in such a transaction with an outside company. Caterpillar retained the ultimate economic risk and received little in return for a valuable business it had spent years building.

“The structure complies with existing law and offends no U.S. tax policy,” Lagacy said in her testimony. “Caterpillar stands by this structure.”

The report cites concerns within PricewaterhouseCoopers and Caterpillar that the strategy was legally risky. In December 2008, Perkins wrote in an e-mail that proposed U.S. tax rules would put the benefits at risk unless Caterpillar added “sufficient entrepreneurial substance” in Geneva.

In his lawsuit, Schlicksup alleged that Caterpillar used a subsidiary in Bermuda to return money to the U.S. without paying the required taxes.

The report doesn’t address these allegations, though it says Caterpillar’s Swiss subsidiary made some prepayments for goods, alleviating some of the cash crunch caused by the buildup of offshore profits.

What’s not clear from the report or from securities filings is how the Internal Revenue Service has responded to the transactions. The tax agency is prohibited by law from discussing matters involving any taxpayers.

To contact the reporter on this story: Richard Rubin in Washington at rrubin12@bloomberg.net

To contact the editors responsible for this story: Jodi Schneider at jschneider50@bloomberg.net Laurie Asseo

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