Caterpillar Escaped $2.4 Billion Tax With Swiss Maneuver

Caterpillar Inc. (CAT)’s maneuvers to move profits from its parts business to Switzerland were legal and appropriate, an accountant who helped devise the strategy told congressional lawmakers today.

Thomas Quinn, a partner at PricewaterhouseCoopers LLP, defended the global reorganization that his firm designed for the world’s largest maker of construction and mining equipment. Quinn spoke at a hearing of a U.S. Senate investigative subcommittee.

The committee’s chairman, Senator Carl Levin, released a report yesterday showing that the company’s moves saved it $2.4 billion in U.S. taxes. That, Levin said, was a “paper change” that caused the subsidiary’s profits to be subject to a Swiss tax rate as low as 4 percent.

“Caterpillar is an American success story that produces iconic industrial machines,” Levin said today. “But it is also a member of the corporate profit-shifting club that has transferred billions of dollars offshore to avoid paying U.S. taxes.”

The report makes the case 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 focus of previous 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.

‘Significant Fact’

“The Swiss affiliate is performing nothing but a routine function,” Bret Wells, a University of Houston law professor, said at today’s hearing. “When the strategy comes from a tax department and it is divorced from the business itself then that is a significant fact that a judge is going to look at.”

The tax structure saves Caterpillar, which is based in Peoria, Illinois, about $300 million a year, or 7.9 percent of 2013 net income. The moves routed Caterpillar’s foreign sales through Switzerland instead of the U.S., and the company and Levin disagree over whether the income should be considered domestic or foreign.

Caterpillar executives, including Chief Tax Officer Robin Beran, are scheduled to testify today at the hearing of the Senate’s Permanent Subcommittee on Investigations.

‘Pretty Routine’

“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.”

Senator John McCain of Arizona, the top Republican on the committee, isn’t signing onto Levin’s report. He said in a brief interview on 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, which 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.

Retaliation Allegations

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, first reported by Bloomberg News in 2011, was settled in 2012. Schlicksup isn’t scheduled to testify at today’s hearing.

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.

Caterpillar 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.

Swiss Subsidiary

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.

“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.

Virtual Inventory

The company created a virtual inventory so 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 labeled these and other maneuvers the Global Value Enhancement program. 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.

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

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

What’s unclear 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 Mark McQuillan

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