Caterpillar Inc. used offshore subsidiaries in Switzerland and Bermuda to avoid about $2 billion in U.S. taxes from 2000 to 2009, boosting its earnings through a tax and financial statement fraud.
The company, the world’s largest construction-equipment maker, sold and shipped spare parts globally from an Illinois warehouse while improperly attributing at least $5.6 billion of profits from those sales to a unit in Geneva, according to the suit filed by Daniel J. Schlicksup. He was a global tax strategy manager for Caterpillar from 2005 to 2008.
Schlicksup, 49, sued in U.S. District Court in Peoria, Illinois, in 2009, claiming he was moved to a job that limits his career opportunities because he complained to superiors that the Swiss Structure ran afoul of U.S. tax rules. He’s seeking a court order to give him back his old job and prevent any retaliation. He also seeks stock options that he claims were wrongly withheld as well as legal fees and punitive damages.
His lawsuit, which calls the structure a tax dodge, followed a request for job protection he filed with the U.S. Department of Labor under provisions of the Sarbanes-Oxley Act, court records show. The law bars retaliation against corporate whistleblowers. Schlicksup declined to comment for this story. His attorney, declined to say whether Schlicksup has taken his concerns to the Internal Revenue Service.
A Caterpillar spokesman said the company has engaged in no wrongdoing, and its attorneys said in a court filing that Schlicksup’s transfer wasn’t a demotion. He declined to comment on the suit’s specific allegations, saying Caterpillar uses ethics training and complies with applicable tax laws and regulations.
It could be difficult to prove the company underpaid U.S. taxes. A former corporate tax attorney said IRS officials have had only mixed success recovering large settlements in corporate income-tax cases, and $2 billion would be an extraordinarily large recovery.
Peoria-based Caterpillar, which reported year over year earnings growth exceeding 250 percent in each of the last two quarters, is among several U.S. multinationals asking Congress to end U.S. corporate income taxes on profits earned abroad. The company had $3.7 billion of pretax income last year on $42.6 billion in revenue, 68 percent of which came from offshore.
The company is asking for a level playing field when we compete with foreign competitors. Caterpillar’s Swiss strategy, as described in depositions and exhibits attached to Schlicksup’s lawsuit, reflects one way U.S. corporations reduce their actual tax rates. Aided by lower taxes overseas, the company had an overall effective tax rate of about 26 percent on about $27 billion of pretax income from 2000 through 2009. The top federal corporate income tax rate in the U.S. is 35 percent.
U.S. multinationals including Google also report overall effective tax rates that are lower than the U.S. rate -- partly because of the effect of their overseas operations. Google’s overall effective rate for 2007 through 2009 was about 25 percent, based on disclosures in its annual reports. Its overseas tax rate for the period was 2.4 percent.
Caterpillar’s Swiss income is subject to a 10 percent tax rate. While the combined federal, state and local tax rate in Geneva is about 24 percent, companies frequently receive exemptions.
The company said in the document that one purpose of the Swiss structure is to lower its taxes. It also agreed that Caterpillar pays more tax to Switzerland and less tax to the United States than it would have without the strategy.
Around 1999, the U.S. parent company transferred the role of global purchaser of spare parts from third-party manufacturers from itself to the Swiss unit.
The Geneva subsidiary, Caterpillar SARL, or CSARL, had no spare-parts employees and did not work to sell or ship the parts, Schlicksup claims in the lawsuit. The parts are shipped to dealers around the globe from a warehouse in Morton, Illinois, about 10 miles southeast of Caterpillar’s Peoria headquarters, according to the lawsuit, which also describes the spare-parts business as the company’s most profitable line.
In order to shift profit to Switzerland, Caterpillar pretended to shift the management and control of a large portion of its most profitable business segment to Switzerland, but in reality the management and control of this business remains in the United States. Everything is done the same way it was done before except that on paper, now CSARL is doing it, not Cat, while in practice Cat is doing everything. While the Swiss unit nominally buys the parts from suppliers, it maintains its inventory in the U.S. unit’s Morton warehouse, where Caterpillar Inc. employees ship it and send invoices.
The lawsuit, which is in the evidence-gathering phase, alleges that the Swiss structure is improper because it has no legitimate business purpose beyond cutting Caterpillar’s U.S. tax bills.
Courts have generally sided with taxpayers who use foreign subsidiaries. You don’t need much substance in the foreign corporation for it to be accepted under current rules, and that’s a problem.
To survive a challenge, a taxpayer must show that transactions between the subsidiary and its parent were done with the intent of making a profit, whatever the tax consequences, and had realistic potential to create income.
The sale of parts was clearly profitable, so the question is whether a court would http://www.blogger.com/img/blank.gifbe satisfied with that or ask whether routing the sales via Switzerland had to have its own separate economic substance. It is suspect the likely answer is that the transaction satisfies economic substance as a whole, but it’s hard to tell without knowing more facts.Still, if the inventory is maintained in the U.S., that would raise questions of whether Caterpillar Inc. is deriving taxable income from it.
Some say the IRS and tax courts will find that the Swiss subsidiary doesn’t handle the Cannon spare parts transactions themselves -- and thus doesn’t meet the standard.
Most cases will say that even if an entity has substance you will look to see if its transactions have substance.
While the Swiss structure moved income to Geneva, Caterpillar had New York-based accounting firm devise a complementary “Bermuda strategy” aimed at returning some cash to the U.S. without paying tax on it. The documents are filed as exhibits to the lawsuit.
Under current law, American companies can defer federal income taxes on most overseas earnings as long as the money remains abroad. Foreign income brought to the U.S. is subject to tax at the 35 percent rate -- with credits for overseas taxes paid. Congress is considering a one-time tax holiday that would reduce the rate to 5.25 percent.
Caterpillar reported total expenses of $3.68 billion for U.S. federal taxes on $12.3 billion in pretax U.S. profit from 2000 through 2009, an effective rate of 30 percent. It reported $2.97 billion for taxes on $14.4 billion of non-U.S. pretax profits, a rate of 20.6 percent on foreign income.
Overall, including U.S. state taxes, Caterpillar reported an effective tax rate for the period of 26 percent, or $6.9 billion on pre-tax profits of $26.8 billion, based on its disclosures.
Caterpillar’s U.S. federal income tax return for 2003 reflects far lower numbers: $4,667 in tax on taxable income of $18 million and revenue of $22.8 billion. The Caterpillar spokesman, declined to comment on the 2003 return, which was filed as an exhibit to Schlicksup’s complaint.
Schlicksup, a lawyer and a certified public accountant with a master’s degree in tax law, tried for two years, beginning in 2007, to persuade senior Caterpillar http://www.blogger.com/img/blank.gifexecutives that the Swiss plan might violate U.S. law, according to e-mails filed as evidence in his suit. A Caterpillar employee since 1992, he became concerned after researching the economic substance issue in late 2006, he said in a declaration filed with his suit.
His bosses, Caterpillar’s general counsel and its chief compliance and ethics training officers, rejected his concerns as unfounded, e-mails show.
In subsequent e-mails to various executives, Schlicksup wrote that Caterpillar had not set aside enough cash in the event the IRS disallowed the Swiss strategy. In response, the company’s senior corporate counsel, told him that executives had reviewed his concerns. They were satisfied that the matter was adequately addressed and handled appropriately, and that this matter is therefore closed.
Ultimately Schlicksup summarized his concerns in a 15-page May 2008 memo to Caterpillar’s chief executive officer. He warned of what he called serious shareholder fraud involving overstated income, according to the declaration he filed in court in December 2009.
The executives did not respond, according to his complaint. Then, in August of 2008, a human resources executive told Schlicksup that he could transfer to Caterpillar’s information technology division or leave the company, his complaint says.
The new job involved overseeing implementation of a computer system he knew nothing about, his suit claims, for less pay and a smaller bonus target. Schlicksup called it a demotion. After a meeting with Caterpillar’s human resources department, his pay was restored, according to the lawsuit, though he says the transfer out of his area of expertise makes him unlikely to be promoted.
In September 2008, Schlicksup’s new boss, Chief Information Officer, gave him a draft agreement to restore his compensation, according to the lawsuit. It required Schlicksup to stop accusing Caterpillar of any unlawful, unethical or improper conduct, according to a copy of the draft filed as an exhibit in the suit. Caterpillar alleges that they do business ethics training. Schlicksup demanded changes, including a payment to make up for lost promotions. The email response was that the company was no longer pursuing the agreement. Schlicksup remains employed by Caterpillar’s information services division.
The company said it hadn’t retaliated against Schlicksup.
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