Senate and Caterpillar Prepare to Face Off Over Tax Avoidence Strategy

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The Senate’s Permanent Subcommittee on Investigations is scheduled to release its report on Caterpillar’s (NYSE:CAT) tax practices on Monday ahead of its April 1 hearing on the construction and mining equipment manufacturer’s strategies to mitigate its tax burden.

This investigation into Caterpillar dates back to 2009, when Daniel Schlicksup — a Caterpillar employee who worked on tax strategy — testified in federal court that the company used what is known as a “Swiss structure” to shift profits to offshore companies, thereby avoiding more than $2 billion in United States taxes. He further alleged that Caterpillar employed a “Bermuda structure,” which allows shell companies to return profits to the U.S. without paying required taxes. According to Schlicksup complaint, obtained by Bloomberg, the Swiss structure involved “many shell corporations with no business operations,” in which the management of profitable businesses was technically shifted to Switzerland even though it actually remained in the U.S. Specifically he called the company’s strategy a “tax dodge.”

Schlicksup’s lawsuit was eventually settled in 2012, with Caterpillar denying allegations that company executives had retailed against him. He claimed that his superiors limited his career opportunities because he complained that the “Swiss structure” ran afoul of U.S. tax rules.

But the Senate’s examination of the company’s tax strategies is by no means an isolated inquiry. Broadly, the Senate subcommittee — which is headed by Democrat Carl Levin of Michigan — has been investigating tax avoidance by multinational companies like Microsoft (NASDAQ:MSFT), Hewlett-Packard (NYSE:HPQ, AND APPLE (NASDAQ:AAPL), which have been the subjects of previous congressional hearings. Senate lawmakers discovered in 2013 that Apple owned a subsidiary that had earned $30 million over four years and had no home for tax purposes, while in 2012, Microsoft was found to have transferred nearly half of its net revenue from U.S. retail sales to a Puerto Rican subsidiary between 2009 and 2011, saving the company $4.5 billion in U.S. taxes. In essence, these companies have been case study for congressional lawmakers, who want to show that even though multinational corporations may be taking advantage of legal loopholes in the tax code, these loopholes are hurting the United States economy.

“When powerful large U.S. corporations avoid their fair share of taxes, they undermine U.S. competitiveness, contribute to the national debt and shift more of the tax burden to domestic businesses, especially small businesses that create most of the new jobs,” wrote a coalition of small business groups in a letter included in an October 2011 report from the Senate’s Permanent Subcommittee on Investigations regarding repatriating offshore funds from large multinational companies. “A transparent corporate tax system that assures all companies — large and small — pay for the services upon which our businesses, our customers, our workforce and our communities depend, would help restore the economic vitality and domestic job creation we all seek.”

That reported noted that companies like International Business Machines (NYSE:IBM), Caterpillar, and United Technologies (NYSE:UTX) “expressed a lack of support for a new repatriation effort,” and called the current system of repatriation, which was put into place by the 2004 America Jobs Creation Act in hopes of encouraging companies to return cash to the United States. Proponents of the measure argued that cash would finance expansion of payrolls and domestic investments. Many current tax regulations were written at a time when business was primarily domestic and tax-avoidance techniques were much simpler. In part, these congressional hearings are looking to find fairer and more effective methods to tax global companies.

Levin has long spoke out against the ability of corporations to avoid taxes through what he has called “complex structures, dubious transactions and legal fiction.” In his February 26 opening statement before the subcommittee hearing entitled: “Offshore Tax Evasion: The Effort to Collect Unpaid Taxes On Billions in Hidden Offshore Accounts,” the senator made a similar point. “The American public is angry about offshore tax abuse — efforts by well-off Americans to evade their U.S. tax obligations by hiding money offshore,” he stated. As ranking minority member of the committee, Senator John McCain of Arizona, explained in his opening statement, that February investigation focused on Credit Suisse (NYSE:CS). The bipartisan investigation into tax haven banks “revealed another unfortunate example of a foreign bank succumbing to the charms of compensation over compliance and uncovered how, for years, Credit Suisse greatly profited by helping U.S clients hide billions of dollars of taxable assets from the U.S. Treasury,” noted McCain.

Repatriating offshore is legal; companies based in the United States can defer U.S. taxes on their foreign income until they bring profits home. At 35 percent, the United States has the highest tax rate of the industrialized world, while profits brought home from abroad are taxed at a 5.25 percent rate. This means that companies have an incentive to book profits overseas. Caterpillar, for example, had accumulated $17 billion in overseas profits as of the end of last year, profits that have not be taxed by the U.S. government. This is an increase from the $11 billion that was held overseas three years ago. Together the largest companies in the United States have amassed $1.95 trillion abroad, a jump from 2012’s $206 billion, according to a Bloomberg News analysis.

In 2013, Caterpillar reported that 62.2 percent of its pretax income was earned outside the United States. Revenue for the past year totaled $55.7 billion.

In a filing made with the Securities and Exchange Commission in February, the company reported that a notice from the Internal Revenue Service informing Caterpillar it owed more in federal taxes. “We disagree with these proposed adjustments, and to the extent that adjustments are assessed upon completion of the field examination relating to these matters, we would vigorously contest the adjustments in appeals,” Caterpillar said in the filing.

Caterpillar is among the most active companies lobbying for more favorable U.S. tax rules for handling foreign companies. In 2011 testimony before the House Ways and Means Committee, Ed Rapp — who was then company’s chief financial officer — said that Congress should do a “foreign tax code tear down” and replace the current system with a “territorial” system that wouldn’t include the residual U.S. tax upon repatriation of profits. “I am not asking for special treatment, but am simply asking for a level playing field versus our foreign competitors,” he said. Now, Caterpillar must defend a late 1990s corporate restructuring that helped ruduce the company’s U.S. taxes; before that corporate change, the company’s U.S. operations bought parts from suppliers and then sold them to overseas customers, which meant those sales were immediately subject to U.S. tax. Then after the restructure, a Swiss subsidiary was in put charge of purchasing and reselling parts, removing U.S. operations from the process and therefore reducing tax liabilities.

Congress has been debating international taxation rules for many years, but lawmakers are divided over whether international companies should pay more taxes and whether the overall United States tax burden should be higher. At the subcommittee level, opinions are split, primarily along partisan lines, on whether the questioning of corporate-tax planners is in anyway beneficial; according to his spokesman McCain does not think Caterpillar’s tax practices are as “egregious” as Levin argues. But nonetheless, Harvard Law School professor Stephen Shay — who has worked as a senior Treasury tax official, told The Wall Street Journal that the information drawn out by the Senate hearings should “cause policy makers to sit back and ask, ‘Are the rules that we have really sensible?’”

Comparatively, Dorothy Coleman, a vice president at the National Association of Manufacturers, a trade group whose current chairman is Caterpillar Chief Executive Doug Oberhelman, said Congress should fix the tax code rather the spending time investigating individual firms. “We have an antiquated tax code,” Coleman told the Journal. “It’s out of sync with the rest of the world, and it’s holding us back.” Jennifer Blouin, an associate professor of accounting at the University of Pennsylvania’s Wharton School, went so far as to tell the publication that it was unfair for the Senate to put individual companies under the microscope for finding legal means to reduce tax burdens. This is sort of rational behavior if you’re competing in a global market,” she said.

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