IRS Probing Caterpillar Parts Deals Examined by Senators

The Internal Revenue Service is challenging Caterpillar Inc. (CAT) on overseas transactions involving its spare-parts business, the company disclosed yesterday in a regulatory filing.

The transactions were the focus of a congressional hearing last month at which Senator Carl Levin, a Michigan Democrat, said Caterpillar had made a “paper change” to book U.S. profits in Switzerland that saved the company $2.4 billion in U.S. taxes from 2000 to 2012.

“We disagree with these proposed adjustments, which the IRS did not propose in previous audits of U.S. tax returns in which the same tax positions were taken,” Caterpillar said in its quarterly filing, using different and more specific language to describe the inquiry than it did in February.

In the filing, Caterpillar said it would “vigorously contest” the IRS challenge in appeals. The inquiry covers the Peoria, Illinois-based company’s tax returns for 2007, 2008 and 2009.

Rachel Potts, a Caterpillar spokeswoman, said in an e-mail that such notices from the IRS are a routine part of the audit process. The IRS is prohibited from commenting on individual taxpayers.

Levin, chairman of the Senate’s Permanent Subcommittee on Investigations, issued a report detailing how Caterpillar took its profitable U.S.-based spare parts business, changed little if anything about how it operated and moved it to Switzerland.

Wider Look

The report is part of broader scrutiny by the U.S. and other governments of profit shifting, in which companies locate their earnings in low-tax jurisdictions. Levin had previously investigated companies including Microsoft Corp. (MSFT) and Apple Inc.

Under U.S. law, companies pay a 35 percent corporate income tax rate 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.

The 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.

Caterpillar’s Restructuring

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

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. 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.

Executives from Caterpillar and PricewaterhouseCoopers defended themselves at last month’s hearing.

“Americans pay the taxes they owe, but not more,” said Julie Lagacy, who overseas Caterpillar’s tax operations. “And as an American company, we pay the taxes we owe, not more.”

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 Don Frederick

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