US Economy
Corporate Tax: Caterpillar case shows lucrative market for US tax dodges sold by PwC
By Michael Hennigan, Finfacts founder and editor
Apr 2, 2014 - 10:22 AM

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Corporate Tax: Hearings by the US Senate Permanent Subcommittee on Investigations Tuesday, on the Caterpillar scheme that was devised by PwC (PricewaterhouseCoopers), showed how easy US corporate taxes can be dodged and the huge money-making incentive the Big 4 accounting firm has in maintaining the status quo.

Julie Lagacy, vice president of Caterpillar's finance services division, told the subcommittee, "Caterpillar complies with US tax laws and we pay everything we owe."

Senator Rand Paul, Republican of Kentucky, said “We’ve got the wrong people on trial here. The tax code should be on trial.”

He added that Caterpillar, the giant construction and mining equipment manufacturer, deserved an apology for the “inquisition” and should be given a reward for keeping jobs in the US instead of moving them overseas.

Up to 1999, Caterpillar's US operations bought CAT-branded parts from mostly US suppliers and sold them to dealers overseas. Those sales incurred US corporate income taxes and PwC earned $55m for proposing in September 1998 to Caterpillar that a Swiss unit should buy the parts and then sell them on to dealers, leaving Caterpillar's US operations out of the transaction and greatly reducing the US tax bill.

The subcommittee found that Caterpillar has been saving as much as $300m a year in US taxes.

Reuven S. Avi-Yonah, a professor of law and director of the International Tax Master of Law Program at the University of Michigan Law School, on Tuesday in testimony [pdf] described to the panel how the dodge worked. 

Prof Avi-Yonah said in respect of the logistics, "physically nothing was changed. The parts were still shipped by the suppliers to Morton (Illinois) and shipped by Caterpillar from Morton to the independent dealers, without any involvement by CSARL (the Swiss tax avoidance unit). Caterpillar still ran the logistics business as it did before, except that it did so as an agent for CSARL, the owner of the parts destined for foreign markets."

Prof Avi-Yonah also noted that shifting profits to Switzerland, must have economic "substance," or a valid business rationale, as opposed to merely reducing tax liability. He said the IRS (Internal Revenue Service) could argue that Caterpillar didn't meet that test because most of the value in the parts business was created in the U.S., not Switzerland.

On the level of royalties paid, Prof Avi-Yonah said the IRS could argue that the royalties paid by the Swiss subsidiary are too low, but noted that "the IRS has not generally been successful in transfer-pricing litigation and…the Caterpillar business restructuring follows a common model" used by many other global companies.

In a 2008 email, Thomas F. Quinn, a PwC tax partner, warned the company that it could lose tax benefits if some Swiss-based product managers relocated to the US. The managers' presence in Switzerland was part of Caterpillar's justification for recording the bulk of the profits from the overseas sales of replacement parts there rather than in the US, cutting tax liabilities.

"We are going to have to create a story that will put some distance between them [the managers] and the parts…to retain the benefit," Quinn wrote to Steven R. Williams, a managing director at PwC. "Get ready to do some dancing."

Williams replied: "What the heck. We'll all be retired when this comes up on audit."

Asked by Senator Carl Levin, the panel chairman, to explain the emails, PwC's Quinn said, "Senator, that was a very poor choice of words."

Robin Beran, Caterpillar’s chief tax officer, agreed with the panel that there are no warehouses or manufacturing facilities in Switzerland for the parts business, but noted that Caterpillar is carefully examined by US tax officials, who sit outside his office. They have cleared the company’s taxes through 2006 and are working on later years.

Senate panel hearings written testimony

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