A Caterpillar Inc. (CAT) executive defended her company’s tax maneuvers, telling a Senate panel that moving profits from its parts business to Switzerland from the U.S. was a legal and appropriate way to eliminate unnecessary expenses.
Julie Lagacy, who oversees Caterpillar’s tax operations, said the company engaged in standard, prudent business transactions.
“We cannot remain competitive, we cannot create jobs and we cannot increase exports by incurring unnecessary expenses,” Lagacy said at a hearing of a U.S. Senate investigative committee. “Americans pay the taxes they owe, but not more. And as an American company, we pay the taxes we owe, not more.”
The committee’s chairman, Senator Carl Levin, released a report yesterday showing that Caterpillar’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.
“No reasonable business would have transferred its crown jewels to an unrelated party for less than nothing, keep doing all the work and continue to bear all the economic risk,” Levin said today as he concluded a five-hour hearing. “If Caterpillar’s right, our laws need even more strengthening than I think they do.”
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.
“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, testified today at the hearing of the Senate’s Permanent Subcommittee on Investigations.
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 also spoke at the hearing.
Senator John McCain of Arizona, the panel’s top Republican, 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.”
Other Republican senators, included Ron Johnson of Wisconsin and Rand Paul of Kentucky, defended the company and blamed the U.S. tax system. None of the committee’s Democrats, other than Levin, attended the hearing.
“Rather than having an inquisition, we should probably bring Caterpillar here and give them an award,” Paul said. “Money is said to go where it’s welcome, so money is going overseas.”
Under U.S. law, companies pay a 35 percent corporate income tax on profits they earn around the world. They receive 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.
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 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 American 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, first reported by Bloomberg News in 2011, was settled in 2012. Schlicksup didn’t 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.
Caterpillar and its Swiss subsidiary entered 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.”
Levin pressed PricewaterhouseCoopers executives on the economic assumptions they made to justify the transactions and pointed to an e-mail saying they might have to do some “dancing” to justify that the profits were earned in Switzerland.
Lagacy said the moves “correctly identified in 1999 where the profits were earned” and realigned the corporate structure to fit that reality and eliminate Caterpillar itself as a middleman.
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.
Beran said the company’s audits through 2006 are closed and that auditors haven’t challenged the transactions.
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