Caterpillar’s $2 billion tax fight with the IRS – could this change how US companies do business?

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Caterpillar is an American success story. The world’s largest manufacturer of construction equipment ranks #59 in the Fortune 500 list in 2016. A 92-year-old behemoth, Caterpillar, is headquartered in Peoria, Illinois with over 52,000 US employees and facilities located across the country.

Caterpillar’s tax fight started with IRS when Daniel Schlicksup, former accounts executive blew the whistle on the illegal overseas tax arrangement of the company, which in his reckoning had helped it avoid more than $1 billion in taxes.

How Caterpillar’s tax fight is going to change the operations?

Caterpillar is not the only one that has used tax havens like Ireland, Bermuda, and the Cayman Islands to evade taxes. The likes of Google, Apple and Pfizer have loads of cash stashed in these tax havens.

Caterpillar-s-offshore-tax-strategy

Before the new tax reforms for any profit that was earned overseas, the US companies need to pay corporate income taxes at the rate of 35 percent. However, there was a caveat; the companies can defer the taxes on the profits they had generated offshore until they bring it back to the States.

The corporate giants exploited the caveat to keep their money overseas.

 

What was Caterpillar’s strategy for tax evasion?

The overseas tax arrangement was designed by Pricewaterhouse Coopers (PWC), one of the largest accounting firms in the world and Caterpillar’s long-time auditor, with an objective to significantly reduce the company’s tax burden. The tax policy of the company was structured around the corporate tax rate of the country: losses in high tax-rate countries and profits in low.

In the year, Caterpillar designated CSARL, a new Swiss affiliate as its “global parts purchaser” and it licensed CSARL to sell Caterpillar third-party manufactured parts to Caterpillar’s non-US dealers.

From 2000 to 2012, Caterpillar accumulated taxable income more than $8 billion from its non-US parts through CSARL in Switzerland and avoided paying US taxes of about 2.4 billion.

Caterpillar executed profit shift without making a real change in the ground reality. The U.S operations continued to play a larger role than its Swiss operations. Of its 125 manufacturing facilities worldwide, 54 are in the United States, while none are located in Switzerland. Of the $2 billion Caterpillar spent on research, 80 percent was spent in the U.S and only 10 percent was spent in Switzerland.

Since PWC acted as both the auditor and the tax consultant, it audited and approved at the same time the tax strategy it had sold to the firm, which is quite difficult to digest.

 

How has this tax evasion impacted the US economy?

For the IRS, it was increasingly difficult to determine appropriate allocations of taxable income of US Corporations between US parents and their overseas subsidiaries. According to a report by Congress:

A 2013 analysis found that during the late 1960s and early 1970s, large U.S. companies listed on the current Dow 30 index routinely cited U.S. federal tax expenses that were 25% to 50% of their worldwide profits. By 2013, however, most were reporting less than half of that percentage.

However, over that same period, the percentage of corporate profits earned overseas increased.

With the new tax reform, the corporate tax rate has been slashed down to 20 percent from 35 percent, which should incentivise $2.6 trillion parked abroad by the giants to be brought back. The current tax bill taxes profits invested in liquid assets like stocks bonds at 15.5 percent and profits invested in harder-to-sell assets at 8 percent.

The new tax reforms are going to make it attractive for the companies to bring back their monies from abroad to the US, but the IRS is watching all of them closely. The tax reforms are complicated and understanding them is not going to be easy.

Reach out to us at tax@mytaxfiler.com for a free 30-minute consultation and find out for yourself!

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