Profits Parking

Carl Levin: Caterpillar used Swiss unit to skirt U.S. taxes

By KELSEY SNELL

Heavy equipment manufacturer Caterpillar used complicated corporate maneuvers to avoid $2.4 billion in U.S. taxes by parking profits in a unit in Switzerland, Sen. Carl Levin charged in a report released on Monday.

The report is the latest in a series of probes by the chairman of the Permanent Subcommittee on Investigations into corporations shifting profits overseas to skirt U.S. income taxes. Panel investigators found that over about a decade, Caterpillar restructured operations to shift $8 billion in profits of a parts unit, and take advantage of a tax rate between 4 and 6 percent, well below Switzerland’s 8.5 percent rate and a far cry from the 35 percent rate in the United States.

“Prior to 1999 [when] Caterpillar booked over 85 percent of the profits from its international sales of parts, they were booked here in the United States,” Levin (D-Mich.) told reporters. “Then in 1999 Caterpillar flipped that profit split, sending 85 percent or more of its parts’ profits to Switzerland and keeping 15 percent or less here in the United States. Nothing changed in the real world after that except Caterpillar’s tax bill.”

The 91-page report is the result of nearly a nearly nine-month investigation into the corporate structure and tax practices employed by Caterpillar and devised by advisers at PricewaterhouseCoopers. It is the first time that Levin has focused on a domestic manufacturer primarily engaged in large-equipment sales rather than intellectual property-heavy technology firms like Apple, HP or Microsoft.

But like the tech firms that preceded Caterpillar, executive Julie Legacy and company tax advisers will testify at a Tuesday hearing on the report that the tax planning they did was responsible and entirely legal.

“Caterpillar takes very seriously its obligation to follow tax law and pay what it owes,” Legacy, the financial services division vice president, will say, according to prepared testimony. “We comply with the tax laws enacted by Congress, by the states and by all of the many jurisdictions in which we conduct business.”

The complicated tax strategy removed Caterpillar from the legal chain of selling parts outside of the U.S. so that existing third-party suppliers could sell Caterpillar-branded parts directly to the subsidiary in Switzerland. That company, known as CSARL, took care of the sales. Over 70 percent of the parts they sold were manufactured in the United States.

Caterpillar received royalty payments of 15 percent or less of the profits and CSARL pocketed 85 percent of the cash. CSARL also remained on Caterpillar’s consolidated financial statement.

Levin said that is a system that no company would ever agree to with an outside distributor, thus violating the so-called arms-length standard that requires such transactions be made at fair market value to mimic real world deals with third parties.

Levin said the restructuring also violated the economic substance doctrine, which requires all transactions to have a real-world economic purpose beyond avoiding taxes.

“No business would trade an 85 percent share of the profits that it has for a 15 percent share with no buy-in payment while at the same time doing the work and continuing to bear the economic risk,” he said.

“Caterpillar only did the deal because it was transferring its crown jewels to a wholly owned part of the company.”

But the company said its Swiss unit is “no mere shell” but a unit with hundreds of employees making marketing, pricing and discounting decisions, calling the division an “entrepreneur for sales.”

“The removal of Caterpillar Inc. from the transactional flow has produced a simpler supply chain that better reflects the reality that CSARL is a true entrepreneur for sales of machines, engines, and parts in its territories,” company executives wrote in joint written testimony. “Many sales of replacement parts into non-U.S. markets are made by a Caterpillar affiliate based in Geneva, Switzerland, known as Caterpillar Sarl, or CSARL. CSARL and its predecessor entity have had a large marketing and sales presence in Geneva for more than 50 years.”

Caterpillar has about 119,000 employees throughout the world, with about half working in the U.S. About 400 work in Switzerland, according to the report.

That type of planning falls into a kind of legal gray area, according to Rebecca Wilkins, a senior policy analyst at the left-leaning Citizens for Tax Justice.

“It is not clear that everything they’re doing is completely legal,” she said. “It certainly violates the spirit if not the letter of the law. If the IRS had enough resources and enough motivation to go after these transactions they might not stand up.”

The IRS did not respond to a request for comment by the time of publication.

The report calls on the IRS to clarify when a transaction violates the economic substance doctrine and to require parent companies to identify and value the function of related parties in structures like that set up by Caterpillar.

Sen. John McCain, (R-Ariz.), the top Republican on the committee, said the tax planning Caterpillar did does not measure up to the kind of profit-shifting and avoidance that big tech firms have used to cut their tax bills nearly to zero.

“I don’t agree with the conclusions of the investigation.” McCain said. “We don’t think that they’ve committed the same kind of egregious abuse that has been in the past.”

Some critics of the report said that not only was Caterpillar acting legally, it didn’t even cut its tax bill very much. Ken Keis, a former chief of staff at the Joint Committee on Taxation who now represents Caterpillar on unrelated tax issues, noted that the company still pays a relatively high 29 percent effective tax rate.

“I’ve seen a lot of corporate tax-planning over the years and with all due respect to the Levin staff, I wouldn’t describe this as aggressive, I would describe this as fairly routine tax-planning,” he said. “It is perfectly appropriate for companies to structure themselves to minimize the amount of tax they pay the federal government.”

Levin said he’s not concerned with the level of avoidance or how successful a company is at gaming the system.

“Whether or not these tax strategies are appropriate, that’s the question for the public,” he said. “The question is, is it tolerable. And I don’t think it is.”

Levin’s panel discovered the tax strategy as a result of a lawsuit from a former Caterpillar tax executive who had complained internally.