US Economy
US Corporate Tax: Caterpillar paid PwC $55m to move $8bn in profits to Switzerland
By Michael Hennigan, Finfacts founder and editor
Apr 1, 2014 - 8:40 AM

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US Corporate Tax: Caterpillar Inc., the giant American equipment manufacturing firm, used a wholly owned Swiss affiliate to shift $8bn in profits from the United States to Switzerland to take advantage of a special 4 to 6% corporate tax rate it negotiated with the Swiss government and defer or avoid paying $2.4bn in US taxes to date, a new report from Senator Carl Levin, the chairman of the US Senate Permanent Subcommittee on Investigations shows. PwC (PricewaterhouseCoopers) earned $55m for its advice on the move.

Caterpillar said it has set up a "standard multinational business structure entirely consistent with the letter and spirit of US tax law." The company said its effective tax rate averages 29% and is three percentage points higher than the average for US corporations.

“Caterpillar is an American success story that produces phenomenal industrial machines, but it is also a member of the corporate profit-shifting club that has shifted billions of dollars in profits offshore to avoid paying US taxes,” Levin said. “Caterpillar paid over $55m for a Swiss tax strategy that has so far enabled it to avoid paying $2.4bn in US taxes. That tax strategy depends on the company making the case that its parts business is run out of Switzerland instead of the US so it can justify sending 85% or more of the parts profits to Geneva. Well, I’m not buying that story.

Caterpillar’s offshore tax strategy will be the subject of a Tuesday hearing, the latest in a series of subcommittee probes into tax avoidance by multinational corporations. Previous hearings examined offshore tax avoidance by Apple, Microsoft, and Hewlett-Packard, among others.

The Wall Street Journal says that Senator John McCain, the ranking Republican on the subcommittee, declined to endorse the report. A spokesman for McCain said last week that the Arizona senator didn't think Caterpillar's practices were as "egregious" as Senator Levin did. The spokesman said Senator McCain would elaborate at a hearing Tuesday morning.

As both Caterpillar's auditor and tax consultant, PwC "audited and approved the very tax strategy sold by the firm to Caterpillar," the report said. This dual role created possible conflicts of interest, it added. Caterpillar said that the dual role "violated no law, regulation, or ethical standard" - -  it possibly didn't as the system is riddled with conflict of interest situations.

Starting in 1999, Caterpillar paid PricewaterhouseCoopers, acting as both its tax consultant and auditor, over $55m to develop and implement a tax strategy built around redirecting to Switzerland taxable profits from sales of Caterpillar branded replacement parts manufactured by third parties under contract with the company.

Under the Swiss tax strategy, in exchange for a small royalty, Caterpillar transferred rights to the profits from its profitable international parts distribution business to a wholly controlled Swiss affiliate called CSARL. Caterpillar essentially redirected the profits by simply replacing its name with CSARL on its invoices. No personnel or business activities were moved from the United States to Switzerland, and most of the parts business remains in the US.

Prior to issuing the license, Caterpillar had booked 85% or more of its non-US parts profits in the United States, where 70% of those parts are made and warehoused and where its global parts operation was created and is managed. The license allowed CSARL to sell the parts to Caterpillar’s non-US dealers and pay Caterpillar a royalty equal to only about 15% of the parts profits, while keeping the remaining 85% on its books in Switzerland. From 2000 to 2012, Caterpillar directed so much of its parts profits to CSARL in Switzerland that it avoided paying US taxes totaling $2.4bn on parts profits of $8bn.

“Caterpillar gave its Swiss sub $1 dollar of profits in exchange for 15 cents, a deal no reasonable business would offer,” Levin said. “It didn’t even ask to be compensated for turning over a profitable parts business that Caterpillar took decades to develop. It wasn’t a real business transaction; it was a tax deal pure and simple to shift profits between related parties.”

The report says Caterpillar sent the vast majority of its profits to Switzerland even though only about 65 of the 8,300 Caterpillar employees who handle parts work in Switzerland. That contrasts with the nearly 5,000 US employees who handle parts. None of the manufacturing, warehousing, or distribution activities – the heart of the parts business – exists in Switzerland. Because it lacks the personnel, infrastructure, and expertise to run the company’s parts business, CSARL pays Caterpillar to keep doing the work, reimbursing it for its costs plus a small service fee.

Caterpillar told the subcommittee that sending the lion’s share of the parts profits to Switzerland is justified because its Swiss affiliate performs valuable intangible services. But the report points out that a company executive, under oath, acknowledged that there was no business advantage to the Swiss arrangement other than tax avoidance. The report also shows how Caterpillar, when evaluating the same type of intangible services at another time, found their value to be negligible.

“When Caterpillar and its tax advisers launched this tax avoidance scheme, almost nothing changed in the real world,” Levin said. “The manufacturing workers who make world-class parts, the managers who operate its parts operations, the warehouses where they are stored – none of that changed. But in the fantasy land that is international tax law, tax lawyers waved a magic wand to make millions of dollars in US taxes disappear.”

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