WASHINGTON -- Caterpillar executives defended a tax strategy Tuesday that has saved the manufacturing giant billions in U.S. taxes. They got support from Republican senators, including one who said the company deserves an award.
Caterpillar (CAT) has avoided paying $2.4 billion in U.S. taxes since 2000 by shifting profits to a wholly-controlled affiliate in Switzerland, according to a report released by Sen. Carl Levin, D-Mich.
Levin chairs the Senate investigations subcommittee. On Tuesday, Levin grilled Caterpillar executives and their accountants at a hearing on the company's tax strategy.
"Caterpillar is an American success story that produces iconic industrial machines," Levin said. "But it is also a member of the corporate profit-shifting club that has transferred billions of dollars offshore to avoid paying U.S. taxes."
Julie Lagacy, a Caterpillar vice president, was adamant that the Peoria, Ill.-based manufacturer follows all tax laws.
"We pay everything we owe," she told the subcommittee.
Caterpillar got support from Sen. Rand Paul, R-Ky., who questioned why the subcommittee was even holding the hearing.
"I think rather than having an inquisition, we should probably bring Caterpillar here and give them an award," Paul said. "You know, they've been in business for over 100 years. It's not easy to stay in business."
Paul said Caterpillar and its accountants have an obligation to shareholders to minimize their taxes.
"It is a requirement that you try to minimize your costs.
Caterpillar is the world's leading manufacturer of construction and mining equipment, with sales and revenues last year of nearly $56 billion. The company says it has increased U.S. employment by 13,000 jobs since 1999, growing to nearly 52,000 workers last year.
The company says it has 118,000 employees in 21 countries. In the U.S., it has 69 manufacturing and logistics facilities in 23 states, and dealers from coast to coast.
The subcommittee's Democratic staff spent nine months investigating Caterpillar's taxes, generating a report released Monday. The investigation focused on Caterpillar's lucrative international parts distribution business.
The report says Caterpillar paid PricewaterhouseCoopers $55 million to develop the tax strategy. Under the strategy, Caterpillar transferred the rights to profits from its parts business to a wholly-controlled Swiss affiliate called CSARL, even though no employees or business activities were moved to Switzerland, the report said.
In exchange, CSARL paid a small royalty, and the income was taxed at a special rate of 4 percent to 6 percent that Caterpillar negotiated with the Swiss government, the report said.
Before the 1999 arrangement, 85 percent of the profits from the parts business were taxed in the U.S., the report said. Afterward, only 15 percent of the profits were taxed in the U.S. The rest was taxed at the special rate in Switzerland, the report said.
Levin grilled Thomas Quinn, a tax partner at PricewaterhouseCoopers, on whether the arrangement was appropriate.
"My question is, is there any way that they would make this deal with a nonrelated company?" Levin asked.
"I'm sorry, I can't answer that. I don't know," Quinn answered.
"You can't or you won't?" Levin shot back. "You have an opinion on that, don't you? After all your years of experience?"
Quinn: "I see companies that dispose of business operations all the time. Caterpillar's done it as well."
In general, federal tax law prevents companies from shifting profits among affiliates simply to reduce their taxes. The transactions must provide economic benefit -- or substance -- beyond tax savings.
Quinn said the accounting changes reflected Caterpillar's growing international business.
Sen. John McCain of Arizona, the top Republican on the subcommittee, seemed to agree. McCain, who did not endorse Levin's report, said Caterpillar appears to manage important operations from Switzerland, which could justify the tax strategy.
"In this case, an important factor in Caterpillar's overseas sales seems to be its independent dealer network, which is overseen and managed by Caterpillar's subsidiary in Switzerland," McCain said.
Robin Beran, Caterpillar's chief tax officer, testified that the Internal Revenue Service audits Caterpillar every year, and has not proposed any adjustments to its tax bill.
"We're under continuous examination," Beran said. "The IRS literally sits right outside my office."
Beran said IRS examinations are complete for 1999 through 2006. He said reviews are ongoing for more recent years.
Levin's subcommittee has examined the tax practices of various U.S.-based corporations, including Apple (AAPL), Microsoft (MSFT) and Hewlett-Packard (HPQ). Levin said he chose to examine Caterpillar because it was a clear example of tax avoidance.
Levin has introduced legislation to restrict the ability of U.S.-based corporations to shift profits overseas to avoid U.S. taxes. But the bill has stalled in the Senate.