By Andrew Tangel and Michael Rapoport
More than a decade before federal agents arrived at Caterpillar
Inc. in March with search warrants, an anonymous employee claimed
in a letter to its chief executive that something was wrong about
how the heavy-machinery maker used a subsidiary in Switzerland to
shrink its tax bill.
When customers outside the U.S., need parts for a bulldozer or
mining truck, their order often is shipped from a Caterpillar
warehouse in Morton, Ill. Nearly all the sales and profits flow
through a company subsidiary in Geneva, where the company has paid
an effective tax rate as low as 4%. Caterpillar began the practice
in 1999 and has never stopped.
The employee accused Caterpillar of violating U.S. tax law and
threatened to tip off the Internal Revenue Service. The company's
tax director replied to the CEO and other officials that there was
no doubt the strategy was legal.
"The company didn't just make this up," says someone who was a
Caterpillar executive at the time.
Two CEOs and at least four investigations later, Caterpillar
faces a potential tax bill of $2 billion from the IRS, which is
challenging the amounts paid on profits from parts sales made
through the Swiss unit, called Caterpillar SARL. The raids in
March, led by the Commerce Department, were a sign of an
intensifying criminal investigation into the company's taxes and
exports.
No civil or criminal charges have been filed against Caterpillar
or anyone at the company. A company spokeswoman says it "believes
its tax position is right" and is "in the process of responding to
the government's concerns."
"We're a values-based company," says Caterpillar Chief Executive
Jim Umpleby, who moved into the top job at the start of 2017.
"We're cooperating, and we're hopeful that that issue will be
resolved in an expeditious manner."
The tax troubles clash with Caterpillar's history as an American
manufacturing icon. Caterpillar machinery helped build the Hoover
Dam, Golden Gate Bridge and U.S. interstate highway system. The
company supplied equipment for the Allied effort in World War II
and the Apollo 11 moon mission.
They also are a distraction from efforts to boost profit margins
following four consecutive years of declining revenue, waves of
layoffs and factory closings. Caterpillar was hurt by turmoil in
construction and mining markets around the world, many of which are
now rebounding.
The outcome could influence how U.S. companies structure their
businesses to lower tax bills. The use of tax-avoidance strategies
has been widespread since the late 1990s, including shell
corporations and so-called tax inversions. American companies are
keeping more than $2 trillion of profits overseas rather than at
home, where they would be required to pay 21% under the new tax law
signed by President Donald Trump in December.
The new law cuts the U.S. corporate tax rate from 35% and
provides companies with a one-time tax cut on earnings and cash
held outside the U.S. The aim is to persuade companies to bring
back those profits.
Even with those changes, companies still have an incentive to
book profits in lower-tax foreign countries and keep the money
there, says Elise Bean, who oversaw a Senate subcommittee's
investigation of the Swiss subsidiary.
"The tax bill won't cause Caterpillar to close up shop in
Switzerland, just the opposite," she says.
The Caterpillar spokeswoman declined to comment, but the company
has said the tax changes would help American manufacturers compete
in foreign countries and gain more access to cash there.
Caterpillar's own regulatory filings indicate it shaved more
than $1 billion from its taxes from 2012 to 2016, due in large part
to the Swiss subsidiary. The total is roughly equal to
Caterpillar's net income in the third quarter.
Under federal law, any tax shelter must have "economic
substance," or a legitimate business purpose for entering into it,
and can't simply be to avoid taxes. Caterpillar has never wavered
from its position that the Swiss subsidiary is perfectly legal,
even though some employees raised doubts internally.
A senior person in Caterpillar's management in the early 2000s
recalls asking colleagues at the time how it planned to bring
profits that were piling up in Switzerland back home without paying
U.S. taxes on them. He says he didn't get any clear answers.
"It was pretty obviously just a tax initiative," he says.
Caterpillar wouldn't comment on his recollections.
The anonymous letter arrived in May 2004. It was from someone
who claimed to work in Caterpillar's tax department. "If there is
no independent investigation or if there is any retribution, I will
go to the Internal Revenue Service," the writer told James Owens,
then Caterpillar's chief executive.
Robin Beran, Caterpillar's director of taxation at the time,
responded in a memo to Mr. Owens that the allegations were "simply
untrue," adding that the letter writer was "very misinformed."
"The basic operations of Caterpillar SARL are no different than
any other valid and legal partnership operating anywhere in the
world," Mr. Beran added. "Great care has been taken to ensure
Caterpillar's operations are consistent with Switzerland's laws and
any applicable U.S. and international tax laws."
The letter and memo were publicly disclosed in 2014 by the U.S.
Senate's Permanent Subcommittee on Investigations, which examined
the Swiss subsidiary and tax arrangements at numerous companies.
Caterpillar declined to comment on the memo. Mr. Owens retired in
2010.
More than 50 years ago, Caterpillar began using its Geneva
office to help expand the company's international dealer
network.
After Caterpillar SARL was formed in 1999, the subsidiary took
legal title over replacement parts made by outside companies,
eliminating the U.S.-based parent company from the supply chain.
Caterpillar has said the company was an unnecessary link in that
supply chain.
By 2005, Caterpillar's cash level in Switzerland was growing by
about $70 million a month, according to an email written by Mr.
Beran and released by Senate investigators.
In 2008, Caterpillar tax-department employee Daniel Schlicksup,
who had worked in Geneva, questioned in an internal memo whether
the Swiss strategy complied with federal case law or requirements
of the Sarbanes-Oxley Act, enacted after accounting scandals at
Enron Corp. and WorldCom Inc.
According to documents in a lawsuit Mr. Schlicksup filed against
Caterpillar in 2009, he also told Mr. Beran in a memo that the
Swiss tax plan lacked economic substance and was "the pink elephant
issue worth a billion dollars on the balance sheet." Mr. Schlicksup
said he got no response.
He alleged that he was demoted and reassigned as retribution for
speaking up about Caterpillar SARL. Caterpillar denied the
allegations and settled the suit in 2012 for an undisclosed amount.
Through his lawyers, Mr. Schlicksup declined to comment.
In 2014, a report issued by the Senate subcommittee said
Caterpillar deferred or avoided paying $2.4 billion of taxes as a
result of the restructuring.
At a subcommittee hearing, Caterpillar and longtime auditor
PricewaterhouseCoopers LLP, which helped put the Swiss tax plan in
place, defended their work to cut Caterpillar's tax bill. But they
were confronted with some embarrassing emails.
PwC tax partner Thomas Quinn wrote in 2008 that tax consultants
at PwC would have to "do some dancing" to comply with looming IRS
rule changes related to U.S. tax exemption.
Steven Williams, a PwC managing director, replied: " What the
heck. We'll all be retired when this comes up on audit."
At the hearing, Mr. Quinn told lawmakers he had used a "poor
choice of words." Mr. Williams said his reply was an "inappropriate
use of words in an attempt at humor." Mr. Williams declined to
comment for this article, and Mr. Quinn didn't respond to requests
for comment.
The subcommittee's report concluded PwC had a potential conflict
of interest as Caterpillar's auditor because PwC was essentially
auditing its own tax advice. A PwC spokeswoman says it has
"maintained its independence with respect to Caterpillar at all
times" and has complied with all applicable auditing rules. PwC
still is Caterpillar's auditor.
Senate investigators said Caterpillar had allocated more than $8
billion in profits from parts sales outside the U.S. to the Swiss
subsidiary. Documents released by the subcommittee cite an IRS
letter to Caterpillar in 2013 that denounced the use of Caterpillar
SARL as an "abusive corporate tax shelter."
Caterpillar was as adamant about its innocence then as it is
now. "We pay everything we owe," Julie Lagacy, Caterpillar's vice
president for financial services, told lawmakers. She is now the
company's chief information officer.
The tax strategy also has been examined by the Securities and
Exchange Commission, which sought records about loans and product
shipments between the Swiss unit and the parent company, according
to documents obtained by The Wall Street Journal through a
public-records request. The SEC also sought information about cash
repatriation, the documents show.
The SEC accumulated two boxes of documents and 1.9 gigabytes of
electronic records but ended its investigation in 2015 without
pursuing enforcement action, according to the documents.
The Public Company Accounting Oversight Board has examined
whether PwC's dual role as auditor and tax adviser was a conflict
of interest. The audit regulator declined to comment on the status
or outcome of its inquiry.
Caterpillar also got a subpoena from a federal grand jury in
Illinois seeking financial information about its U.S. and foreign
subsidiaries, according to securities filings by the company.
On March 2, agents from the Commerce Department's Office of
Export Enforcement, the IRS's criminal division and the Federal
Deposit Insurance Corp.'s inspector general's office raided
Caterpillar's headquarters in Peoria, Ill., its parts warehouse in
nearby Morton and a data center. Caterpillar has since moved its
headquarters to Deerfield, Ill., a suburb of Chicago.
The searches lasted all night and into the next day. Agents were
looking for information related to export data Caterpillar is
required to submit to the government when it ships outside the
U.S.
People familiar with the matter say investigators identified
before the raid numerous instances in which they believe
Caterpillar might have failed to file the required data. Search
warrants reviewed by the Journal indicate the raid was focused
largely on the Swiss unit.
Agents also seized documents from PwC's work site at the former
headquarters in Peoria, according to a person familiar with the
situation.
"I'm sorry that we had to experience this today," Mr. Umpleby,
Caterpillar's chief executive, said in an internal memo to
employees. He called Caterpillar an "honorable company."
As part of its investigation, the FDIC's inspector general
commissioned a report by Dartmouth College professor Leslie
Robinson, who concluded Caterpillar had engaged in tax and
accounting fraud, according to a person familiar with the report.
It hasn't been publicly released.
The report was based on publicly available financial information
and nonpublic wire transfers, and it examined whether Caterpillar
restructured Swiss cash into loans between its foreign subsidiaries
and U.S. operations to offset a cash-flow deficit in the U.S., the
person familiar with the report says.
Caterpillar wouldn't comment on the report but has privately
criticized its assumptions and conclusions, according to people
familiar with the matter. Caterpillar also has hired Obama
administration tax official Stephen Shay and at least one other
expert to defend the company's position.
The Dartmouth professor "misunderstands some amazingly basic
things," says one of those people familiar with the company's
opinion. A spokesman for the FDIC's inspector general's office
referred questions to a spokeswoman for the U.S. attorney's office
in Springfield, Ill. She declined to comment.
An analysis of securities filings by the Journal shows that
manufacturing operations at Caterpillar sometimes have been boosted
by loans from the company's financial unit.
Such loans increased cash flow in Caterpillar's heavy-machinery
business in seven of the 14 years from 1998 to 2011. The Journal's
analysis is consistent with the Dartmouth professor's findings,
according to the person familiar with the report.
The federal government hasn't examined the full trove of data
and documents agents seized in March because Caterpillar has argued
that many of the materials are subject to attorney-client
privilege, according to people familiar with the investigation.
--Richard Rubin and Aruna Viswanatha contributed to this
article.
(END) Dow Jones Newswires
January 01, 2018 14:37 ET (19:37 GMT)
Copyright (c) 2018 Dow Jones & Company, Inc.
Caterpillar (NYSE:CAT)
Historical Stock Chart
Von Sep 2024 bis Okt 2024
Caterpillar (NYSE:CAT)
Historical Stock Chart
Von Okt 2023 bis Okt 2024