[Senate Hearing 113-408]
[From the U.S. Government Publishing Office]


                                                        S. Hrg. 113-408
 
                  CATERPILLAR'S OFFSHORE TAX STRATEGY 

=======================================================================

                                HEARING

                               before the

                PERMANENT SUBCOMMITTEE ON INVESTIGATIONS

                                 of the

                              COMMITTEE ON
               HOMELAND SECURITY AND GOVERNMENTAL AFFAIRS
                          UNITED STATES SENATE

                    ONE HUNDRED THIRTEENTH CONGRESS


                             SECOND SESSION

                               __________

                             APRIL 1, 2014

                               __________

         Available via the World Wide Web: http://www.fdsys.gov

                       Printed for the use of the
        Committee on Homeland Security and Governmental Affairs

                               ----------

                         U.S. GOVERNMENT PRINTING OFFICE 

89-523 PDF                       WASHINGTON : 2014 
-----------------------------------------------------------------------
  For sale by the Superintendent of Documents, U.S. Government Printing 
  Office Internet: bookstore.gpo.gov Phone: toll free (866) 512-1800; 
         DC area (202) 512-1800 Fax: (202) 512-2104 Mail: Stop IDCC, 
                          Washington, DC 20402-0001


        COMMITTEE ON HOMELAND SECURITY AND GOVERNMENTAL AFFAIRS

                  THOMAS R. CARPER, Delaware, Chairman
CARL LEVIN, Michigan                 TOM COBURN, Oklahoma
MARK L. PRYOR, Arkansas              JOHN McCAIN, Arizona
MARY L. LANDRIEU, Louisiana          RON JOHNSON, Wisconsin
CLAIRE McCASKILL, Missouri           ROB PORTMAN, Ohio
JON TESTER, Montana                  RAND PAUL, Kentucky
MARK BEGICH, Alaska                  MICHAEL B. ENZI, Wyoming
TAMMY BALDWIN, Wisconsin             KELLY AYOTTE, New Hampshire
HEIDI HEITKAMP, North Dakota

                   Ricard J. Kessler, Staff Director
               Keith B. Ashdown, Minority Staff Director
                     Laura W. Kilbride, Chief Clerk
                   Lauren M. Corcoran, Hearing Clerk


                PERMANENT SUBCOMMITTEE ON INVESTIGATIONS

                     CARL LEVIN, Michigan, Chairman
MARK L. PRYOR, Arkansas              JOHN McCAIN, Arizona
MARY L. LANDRIEU, Louisiana          RON JOHNSON, Wisconsin
CLAIRE McCASKILL, Missouri           ROB PORTMAN, Ohio
JON TESTER, Montana                  RAND PAUL, Kentucky
TAMMY BALDWIN, Wisconsin             KELLY AYOTTE, New Hampshire
HEIDI HEITKAMP, North Dakota

            Elise J. Bean, Staff Director and Chief Counsel
                     David H. Katz, Senior Counsel
                       Daniel J. Goshorn, Counsel
       Henry J. Kerner, Minority Staff Director and Chief Counsel
                 Jack Thorlin, Counsel to the Minority
             Brad M. Patout, Senior Advisor to the Minority
          Scott D. Wittman, Research Assistant to the Minority
                     Mary D. Robertson, Chief Clerk



                            C O N T E N T S

                                 ------                                
Opening statements:
                                                                   Page
    Senator Levin................................................     1
    Senator McCain...............................................     7
    Senator Johnson..............................................    17
    Senator Paul.................................................    33
    Senator Portman..............................................    34
Prepared statements:
    Senator Levin................................................    93
    Senator McCain...............................................    98

                               WITNESSES
                         Tuesday, April 1, 2014

Bret Wells, Esq., Assistant Professor of Law, University of 
  Houston Law Center, Houston, Texas.............................     8
Reuven S. Avi-Yonah, Esq., Irwin I. Cohn Professor of Law, The 
  University of Michigan School of Law, Ann Arbor, Michigan......    10
Thomas F. Quinn, Tax Partner, PricewaterhouseCoopers LLP, 
  Chicago, Illinois; accompanied by James G. Bowers, Tax Partner, 
  Pricewaterhouse-Coopers LLP, Dallas, Texas and Steven R. 
  Williams, Managing Director, PricewaterhouseCoopers, LLP, 
  McLean, Virginia...............................................    25
Julie A. Lagacy, Vice President, Finance Services Division, 
  Caterpillar Inc., Peoria, Illinois; accompanied by Robin D. 
  Beran, Director, Global Tax and Trade, and Rodney Perkins, 
  Former International Tax Manager, Caterpillar Inc., Peoria, 
  Illinois.......................................................    58

                     Alphabetical List of Witnesses

Avi-Yonah, Reuven S. Esq.:
    Testimony....................................................    10
    Prepared statement...........................................   106
Beran, Robin D.:
    Testimony....................................................    58
    Prepared statement...........................................   129
Bowers, James G.:
    Testimony....................................................    25
    Prepared statement...........................................   116
Lagacy, Julie A.:
    Testimony....................................................    58
    Prepared statement...........................................   129
Perkins, Rodney:
    Testimony....................................................    58
    Prepared statement...........................................   129
Quinn, Thomas F.:
    Testimony....................................................    25
    Prepared statement...........................................   116
Wells, Bret, Esq.:
    Testimony....................................................     8
    Prepared statement...........................................    99
Williams, Steven R.:
    Testimony....................................................    25
    Prepared statement...........................................   116

                                APPENDIX

Report of the Permanent Subcommittee on Investigations' Majority 
  Staff entitled ``Caterpillar's Offshore Tax Strategy,'' April 
  1, 2014........................................................   160

                              EXHIBIT LIST

 1. a. GCaterpillar Ownership of CSARL, chart prepared by the 
  Permanent Subcommittee on Investigations.......................   276
   b. GCSARL Legal Structuring, chart prepared by 
  PricewaterhouseCoopers.........................................   277
   c. GProfit Split: CSARL's Parts Profit versus Caterpillar's 
  Royalty Fee from CSARL, chart prepared by the Permanent 
  Subcommittee on Investigations.................................   278
   d. GCSARL Offshore Replacement Parts Sales, chart prepared by 
  the Permanent Subcommittee on Investigations...................   279
   e. GThe Caterpillar 797, chart prepared by the Permanent 
  Subcommittee on Investigations.................................   280
   f. GCaterpillar Replacement Parts, chart prepared by the 
  Permanent Subcommittee on Investigations.......................   281
   g. GCaterpillar Organizations, Performing Key Functions 
  Related to Parts, chart prepared by the Permanent Subcommittee 
  on Investigations..............................................   282
   h. GCorporate Income Tax as a Percent of Total Revenue, chart 
  prepared by the Permanent Subcommittee on Investigations.......   283

Documents Related to Caterpillar Transfer Pricing:

 2. GPricewaterhouseCoopers tax consulting and audit fees. [PSI-
  PWC-22-000001-003].............................................   284
 3. GHistory of Significant Changes in International Operations 
  (Not Inclusive of Financing Arrangements) 1997-2002. [PSI-TWLF-
  02-000422-436].................................................   287
 4. a. GExcerpts from Caterpillar Inc. Evaluation of Arm's Length 
  Pricing for Intercompany Transactions, Year Ended December 31, 
  1994, Prepared by Price Waterhouse LLP, FINAL REPORT, April 28, 
  1996. (P&SS sells the requisite replacement parts to the 
  marketing company, which then sells to dealers, who in turn 
  sell to the customer. *** Cat Inc. has the largest role with 
  regard to market and dealer development, . . . *** The dealer 
  network and parts distribution are the two keys to after-sales 
  service. . . . Cat Inc., as the designer of the system and 
  owner of the Morton parts center, has the greatest strategic 
  role. *** All companies with marketing responsibilities are 
  actively involved in dealer administration. These include Cat 
  Inc. and the three principal marketing companies.). 
  [PwC_PSI_CAT_00008634, 672-674, 684-687, 698-699]..............   302
   b. GExcerpts from Caterpillar Inc. Evaluation of Arm's Length 
  Pricing for Intercompany Transactions, Year Ended December 31, 
  1995, Prepared by Price Waterhouse LLP, Final Report, December 
  19, 1996 (Cat Inc. has the largest role with regard to market 
  and dealer development . . . *** The dealer network and parts 
  distribution are the two keys to after-sales service. . . . Cat 
  Inc., as the designer of the system and owner of the Morton 
  parts center, has the greatest strategic role. *** All 
  companies with marketing responsibilities are actively involved 
  in dealer administration. These include Cat Inc. and the three 
  principal marketing companies. *** Prime Product Profit Centers 
  Motivate to create machine populations with high degree of 
  proprietary components which have high parts margins ***; P&SS 
  Motivate to: Drive overall parts profit). 
  [PwC_PSI_CAT_00008881, 929-932, 958-959, 963]..................   312
   c. GExcerpts from Caterpillar Inc. Evaluation of Arm's Length 
  Pricing for Intercompany Transactions, Year Ended December 31, 
  1996, Final Draft Report, Prepared by Price Waterhouse LLP, 
  January 26, 1998 (Cat Inc. has the largest role with regard to 
  market and dealer development, . . . *** The dealer network and 
  parts distribution are two keys to after-sales service. The 
  marketing companies have responsibility for the dealer network, 
  while P&SS performs the primary management activity for the 
  parts distribution network. Cat Inc., as the designer of the 
  system and owner of the Morton parts center, has the greatest 
  strategic role.). [PwC_PSI_CAT_00009105, 155-156]..............   320
   d. GExcerpts from Caterpillar Inc. 1997 Documentation Report, 
  Final Report, September 15, 1998, Prepared by 
  PricewaterhouseCoopers LLP (Cat Inc. has the largest role with 
  regard to market and dealer development, . . . *** The dealer 
  network and parts distribution are the two keys to after sales 
  service. . . . Cat Inc., as the designer of the system and 
  owner of the Morton parts center, has the greatest strategic 
  role. *** All companies with marketing responsibilities are 
  actively involved in dealer administration. These include Cat 
  Inc. and the three principal marketing companies. ). 
  [PwC_PSI_CAT_00009339, 392-394]................................   323
 5. GExcerpts from Caterpillar Fiscal Year 2000 U.S. Transfer 
  Pricing Documentation Report, September 17, 2001. (Cat Inc. is 
  the parent company and is the most complex entity. Cat Inc. 
  operates as an entrepreneur, a marketer and an intangible 
  owner. Cat Inc. is the parent company of the global enterprise. 
  Since Cat Inc. is the most complex Cat entity it was not 
  selected as a tested party in this report. *** Although Cat 
  SARL is a complex entity, it is a simpler entity than Cat Inc. 
  . . . we will test Cat SARL's results against the results of a 
  set of independent European manufacturers.). 
  [PwC_PSI_CAT_00004975, 5008-009, 027-033]......................   327
 6. GExcerpts from Caterpillar Inc. Global Tax Optimization Case 
  for Action, September 1998 (Negative Tax Rate Drivers: U.S. 
  `centric' profile . . . U.S. ownership of intangibles . . . 
  Conformity of tax and management books. *** Migrate income from 
  the U.S. to lower-tax jurisdictions; Obtain/maintain U.S. tax 
  deferral *** Description of Idea: Remove Caterpillar Inc. from 
  the chain of title passage for purchased finished parts (from 
  U.S. or foreign sources) sold to foreign markets. The foreign 
  marketers would then buy from and sell to unrelated parties. 
  Benefits/Costs: Eliminates Subpart F character of foreign 
  marketers profits on purchased finished parts sales. Relatively 
  simple re-invoicing requirements.) [PwC_PSI_CAT_00004632, 636, 
  640, 646, 674, 675]............................................   337
 7. GExcerpts from Caterpillar GTOP Summary of Ideas - 
  Pricewaterhouse-Coopers, 1998 (Cat Inc. Out of Chain, 
  Recharacterize Marketing Company Income to Achieve U.S. Tax 
  Deferral Description of Idea: Remove Caterpillar Inc. from the 
  chain of title passage for purchased finished parts (from U.S. 
  or foreign sources) sold to foreign marketers. The foreign 
  marketers would then buy from and sell to unrelated parties. 
  Benefits/Costs: Eliminates subpart F character of foreign 
  marketers profits on purchased finished parts sales. Relatively 
  simple re-invoicing requirements.). [PwC_PSI_CAT_00004566, 618-
  619]...........................................................   343
 8. GCOSA as Entrepreneur: European Sold Parts, High-Level Target 
  Design, charts excerpted from Caterpillar Inc. Operational 
  Feasibility Analysis, High Level Target Designs: Migration/
  Deferral (This will cause the accumulation of parts profit in 
  COSA that was previously accumulated in CAT Inc. ... In 
  addition, the parts profit retained in COSA will be enhanced to 
  better reflect the contributions of the functions, risks and 
  dealer network intangibles controlled by COSA. *** Invoicing 
  from suppliers will be changed from CAT HE and Morton HE to 
  COSA ``HE.'' Supply contracts will be changed to COSA.). 
  [PwC_PSI_CAT_00004548, 550-552]................................   346
 9. GCaterpillar Inc. Global Tax Optimization Risk Adjusted 
  Benefit Analysis, Working Papers - Draft 1, December 1998 
  (Purpose: Increase shareholder value through tax optimization 
  *** Solution Benefits and Costs: Migrate profits from Cat Inc 
  to low-tax marketing companies . . . Risk: change from current 
  intercompany pricing method and documentation. *** We are 
  effectively more than doubling the profit of parts.). 
  [PwC_PSI_CAT_00001336, 338, 341-342, 344-346, 348, 362, 386, 
  408-409, 411-415]..............................................   350
10. GEconomic Analysis of Royalty Rates and Transfer Prices, 
  charts excerpted from Caterpillar Inc. Global Value Enhancement 
  Project, Economic Analysis of SARL, Intercompany Transactions 
  with Cat Inc. in the COSA Territory, Draft October 5, 1999. 
  [PwC_PSI_CAT_00004483, 508-509]................................   367
11. GParts: COSA - Cost Benefit Analysis, chart excerpted from 
  Caterpillar Inc. - Global Value Enhancement - Develop Phase 
  Status Report, May 28, 1999. [PwC_PSI_CAT_00004349, 365].......   370

Documents Related to Marketing Intangibles:

12. GCaterpillar email, dated July 2007, re: Caterpillar: value 
  of marketing intangibles (The point is that CSARL (or its 
  predecessor COSA, or CFEL, or CACO) has spent decades building 
  up the dealer network around the world. And has spent decades 
  building the brand name through advertising. Caveat is that in 
  2001, we said in another transaction that there is no 
  significant marketing intangibles other than workforce in 
  place). [PwC_PSI_CAT_00122483-484].............................   372
13. GExcerpts from Caterpillar Inc. Economic Analysis of 
  Intangible Assets Transferred by Caterpillar Americas CO. to 
  Caterpillar Americas SARL (Based on our analysis of the 
  Intangible Assets Transferred we conclude that they are routine 
  and common to most distribution and marketing companies. These 
  assets have only limited economic life, and could be 
  effectively reproduced by a new start-up company with 
  sufficient investment of time and resources.). 
  [PwC_PSI_CAT_00142353-367].....................................   374
14. GExcerpt from Caterpillar Inc. Summary Meeting Notes, Geneva, 
  March 7-9, 2005. CSARL Profitability and Royalty (Should we 
  expand profit split analysis - additional income to CSARL for 
  parts responsibility, dealers/marketing intangible (but 
  consider agreements in LAD restructuring stating that dealer IP 
  is not very valuable)?). [PwC_PSI_CAT_00150469]................   389

Documents Related to Swiss Tax Rate:

15.  Charts from:
      -- GPresentation to Caterpillar Inc. Audit Committee, June 
  2004:
      -- GPurchased Finished Parts Distribution - Prior to 
  Establishing CSARL;
      -- GPurchased Finished Parts Distribution - Post CSARL;
      -- GTax Exposures Reserved at end of 2003;
      -- GETR - Causes of ``Low-Taxed'' Non-U.S. Earnings 
  (Switzerland provides favorable tax rulings that many U.S. 
  companies utilize.);
      -- GBackground - Pre-2001 (Before Caterpillar S.A.R.L.); 
  and
      -- GBackground - 2002-2004 (Effect of Caterpillar 
  S.A.R.L.). (The CAT S.A.R.L. initiative deferred the U.S. 
  taxation of Purchased Finished Replacement Parts sales outside 
  the U.S., but only if the earnings are not repatriated.). [CAT-
  001899, 905, 906, 912, 920, 934, 935]                             390
16. GExcerpts from Delivering Vision 2020, Value Transformation: 
  An After-tax View (The single largest factor driving 
  Caterpillar's effective tax rate below the U.S. statutory rate 
  is the ability to maintain deferral of earnings outside the 
  U.S. Most of these deferred earnings are located within the 
  Caterpillar S.A.R.L. (``CSARL'') organization. The two primary 
  operational drivers of the CSARL deferral are (1) purchases of 
  replacement parts from supplies directly by CSARL for marketing 
  regions outside the US and (2) product management benefits for 
  assemblies at the Grenoble and Gosselies facilities (i.e., toll 
  manufacturing). [PwC_PSI_CAT_00058419, 429, 449-452]...........   397
17. GExcerpt from Caterpillar Global Finance and Strategic 
  Support, Global Tax & Trade Update, Audit Committee, April 13, 
  2010 (Effective Tax Rate has dropped to lowest in the Dow 30 
  *** 2009 Effective Tax Rate - Drivers: Losses in high-tax rate 
  countries, Profits in low). [PwC_PSI_CAT_00205974-979, 984-985]   403

Documents Related to Parts Business:

18. GCaterpillar Board of Directors Minutes Excerpts. (2/8/12:  
  Mr. Gosselin began by explaining that the ``seed, grow, 
  harvest'' business model ingrained in the organization was a 
  catalyst to aftermarket parts sales and services, creating an 
  annuity continuing long after original equipment sales and 
  generating customer loyalty, PINS and profits. *** 4/7/09: Mr. 
  Larson then noted that the key points regarding the Logistics 
  Division are that it is driving transformational change in the 
  Transportation, Manufacturing Logistics and the Cat parts 
  business that will deliver significant value . . . ). [CAT-
  001855-858, 860, 863-864]......................................   411
19. GCaterpillar email, dated August 2007, re: Caterpillar parts 
  history (This showed that more than 50% of parts sales were for 
  parts originally placed in service more than 10 years prior. 
  And to capture 80% of parts sales, you had to go back 20 years. 
  (ie, in a given year, Cat still sold 20% of replacement parts 
  that were first placed in service more than 20 years 
  prior....). [PwC_PSI_CAT_00024439-440].........................   418
20. GCat Parts Desired State, excerpt from Caterpillar February 
  2012 Board of Directors Meeting, [CAT-001885-889, 891-898].....   420
21. GCaterpillar dealer push may drive some out, Levenick says, 
  Reuters, March 6, 2014.........................................   433

Documents Related to Tax Risk Guardrails:

22. GCaterpillar Audit Committee Presentation, December 13, 2005, 
  Global Tax Management (Audit Committee Risk Guard Rails). [PSI-
  TWLF-16-000167-180]............................................   435
23. GCaterpillar email, dated February 2006, re: Tax Risk 
  Guardrails - audex (Dave, I have a solid draft of the guard 
  rails done. I have not polished it into a presentation because 
  it was not included on the agenda. I feel comfortable that if 
  Gene demanded to see something today and you came and got me, I 
  could present the draft and get the Aud Comm comfortable that 
  we are meeting our commitments.). [PSI-TWLF-04-000078].........   449
24. GCaterpillar email, dated February 2006, re: A/C meeting (We 
  had a two day offsite last week to finalize the guardrails. We 
  have two more days next week to plot the tax positions on the 
  guardrails. This will be done in April if the agenda changes.) 
  [PSI-TWLF-04-000089]...........................................   450
25. a. GTax Risk Guardrails, 03/21/06. [PSI-TWLF-04-000382]......   451
   b. GTax Risk Guardrails, 10/15/07. [PSI-TWLF-04-000383].......   452
    1Ac. GTax Risk Guardrails, 03/18/08. [PSI-TWLF-04-000384]....   453
   d. GTax Risk Guardrails Criteria (draft), 02/08/06. [PSI-TWLF-
  04-000381].....................................................   454
26. GCaterpillar Income Tax Update, June 13, 2006 (Audit 
  Committee - Risk Guard Rails . . . Escalation Triggers - Risk 
  positions clearly outside the guardrails trigger communication 
  to the Audit Committee for guidance and possible remediation). 
  [CAT-001949-952, 954, 956-965].................................   455
27. GCaterpillar email, dated July 2006, re: fyi only - Update to 
  Legal 6S team on regulatory compliance (Provided overview of 
  Tax Risk Guard Rails yesterday to a 6S team from legal working 
  specifically on a deep dive into regulatory compliance risks. . 
  . . They encouraged us to continue with the process and explain 
  our current tax risk profile to the audit committee to get 
  their approval. *** Good work, Dan. . . . Can discuss further, 
  but current chart puts one area at high. Assuming guidance is 
  to stay below high in all areas, how could we utilize?) [PSI-
  TWLF-04-000368]................................................   470
28. GCaterpillar email, dated August 2006, re: Tax Risk Guard 
  Rails (FYI, Tax Council will be meeting in near future to 
  update TRGRs. The pressure/question I am getting is focused on 
  reducing the risk shown on the guard rails. ... I need to 
  understand where you want to go with the TRGRs. Are we going to 
  stop where we are at which is just informing the board about 
  the process we went through to create the guard rails, or are 
  we going to show the board the results and have a meaningful 
  discussion explaining our risk profile and to determine the 
  board's comfort with it?). [PSI-TWLF-04-000127]................   471
29. GCaterpillar Global Finance and Strategic Support, Global Tax 
  Update, April 8, 2008 (High risk areas are actively managed.; 
  Higher Risk Areas; CSARL - Product Management - Operational; 
  CSARL - Parts Distribution - Management & Reputation). [CAT-
  002087, 090-098, 102]..........................................   472

Documents Related to Economic Substance:

30. GP&SS Availability & Inventory Management (85% of worldwide 
  parts inventory is managed from Morton-moving toward 100% *** 
  Morton knows if Grimbergen sold a part, received part, scrapped 
  a part-information goes into Morton global parts forecast calc) 
  [PwC_PSI_CAT_-00179037-038]....................................   483
31. GPurchasing Transportation and Technical Support (P&SS has 
  developed (over 12 years) network of suppliers for non current 
  that is independent of current production suppliers). 
  [PwC_PSI_CAT_00179035-036].....................................   485
32. GExcerpt from The Deposition of Sally A. Stiles, February 24, 
  2011 (Q: Is it fair to say that the driving force behind Glove 
  or CSARL was the tax department and not any business unit? A: 
  Yes.) [PSI-TWLF-11-000008, 113-114]............................   487
33. GExcerpt from The Deposition of Robin Beran, March 15, 2011, 
  (Q: Well, other than paper issues that were caused by the 
  entities that became involved, were there any other changes to 
  the physical flow of purchased finished replacement parts? A: 
  Physical flow, probably not substantially.) [PSI-TWLF-12-
  000008, 177-178]...............................................   490
34. GExcerpt from The Deposition of Rodney Perkins, March 10, 
  2011, (Q: Was there any business advantage to Caterpillar, 
  Inc., to have this arrangement put in place other than the 
  avoidance or deferral of income taxation at higher rates? A: 
  No, there was not.) [PSI-TWLF-10-000004, 113-115]..............   493
35. GExcerpt from The Deposition of Janie Copeland, May 5, 2011, 
  (Do you know if the accounting for purposes of the consolidated 
  books and records of Caterpillar, Inc., is done the same way 
  with respect to Swiss operations now as it was before CSARL? . 
  . . Q: So would operating profit still be the same? A: Yes. Q: 
  But earnings after taxes would be differently? A: Right.) [PSI-
  TWLF-15-000007, 017, 018]......................................   497
36. GCaterpillar email, dated June 2005, re: Authorization to 
  proceed with planning and ABP cost adjustment (Due to the 
  successful planning from prior years, significant low taxed 
  earnings (over $1.5 billion) have accumulated in CSarl. This 
  cash is now increasing at about $70 million per month at tax 
  rates of about 10%. This is resulting in offshore cash balances 
  that can no longer be managed through intercompany loans and 
  purchases without triggering significant additional tax costs, 
  and an increase in CAT's effective tax rate.) [PSI-TWLF-12-
  000315-316]....................................................   500
37. GCaterpillar Sarl - Pop Quiz, chart excerpted from 
  Caterpillar Sarl Overview, July 30, 2008. 
  [PwC_PSI_CAT_00065585, 589]....................................   502
38. GCaterpillar Memorandum, dated May 2004, re: Tax Concerns 
  Raised by an Unnamed Source (Caterpillar's transfer pricing 
  policy is the result of detailed analysis of the functional 
  activities of the various entities in strict accordance with 
  required Treasury Regulations. *** The basic operations of 
  Caterpillar SARL are no different than any other valid and 
  legal partnership operating anywhere in the world. *** I do not 
  believe Caterpillar's transfer pricing practices (past and 
  present) meet the IRS' tests. The Officers and Board of 
  Directors need to examine the transfer pricing issue before 
  Caterpillar ends up in court and in the press.) [PSI-TWLF-02-
  001393-396]....................................................   504
39. GCaterpillar email, dated January 2007, re: 7th Cir. Cases 
  (To my knowledge there is no one in CSARL managing the parts 
  business or managing the sub-contracting of all the activity to 
  Inc.) [PSI-TWLF-02-000349-352].................................   508
40. GCaterpillar email, dated April 2008, re: Pls review again 
  before we sent in AM (With all due respect, the business 
  substance issue related to CSARL Parts Distribution is the pink 
  elephant issue worth a Billion dollars on the balance sheet.) 
  [PSI-TWLF-07-000022]...........................................   512

Documents Related to Substance Added:

41. GCaterpillar slides entitled Product Management Alignment - 
  Recommendation; Product Management Alignment - CSARL Benefits - 
  Based on 2008 Results; Product Management Alignment - Enhance & 
  Optimize (While technically appropriate, creates optics 
  concerns - Taxation in CSARL with minimal business substance); 
  Product Management Alignment - CSARL Benefits - Based on 2009 
  ATS). [PwC_PSI_CAT_000063338-341]..............................   513
42. GCaterpillar email, dated November 2008, re: Exec Office 
  Slides - Business Alignment attaching slides entitled 
  Caterpillar Inc. Machine Business Alignment: Update Briefing, 
  November 11, 2008, Purpose: Leverage business realignment to 
  preserve and enhance CSARL benefits. (Risks & Challenges: 
  Failure to take action weakens current CSARL structure). 
  [PwC_PSI_CAT_00033241-252].....................................   517
43. GCaterpillar Inc CSARL 2009 activities, Report to Audit team, 
  January 2010. (During 2009: . . . ``Worldwide Parts Manager'': 
  establish group in CSARL Geneva with worldwide parts 
  responsibilities Benefit: $300m (``Preserve'')). 
  [PwC_PSI_CAT_00003830-832, 847-848, 855, 871]..................   529
44. GCaterpillar email, dated May 2010, re: WW Parts Manager. 
  [PwC_PSI_CAT_00213059-064].....................................   536
45. GWorldwide Parts Management Group Key Responsibilities, 
  excerpt from Caterpillar Inc. Worldwide Parts Management, Final 
  Closing Book, Draft Version as of March 15, 2010. 
  [PwC_PSI_CAT_00003876, 906-907]................................   542
46. GCaterpillar email, dated November 2008, re: is tomorrow 
  really the only shot with DBB? (PMs in US will put some 
  pressure on the parts profit model. These guys are really 
  bought into the PM is king concept. We are going to have to 
  create a story that will put some distance between them and 
  parts (eg. all the parts that are noncurrent) to retain the 
  benefit. Get ready to do some dancing. *** What the heck. We'll 
  all be retired when this comes up on audit. Bodnam and chris 
  Dunn will have to solve it. Baby boomers have their fun, and 
  leave it to the kids to pay for it.) [PwC_PSI_CAT_00033157-159]   545

Other Miscellaneous Documents:

47. GSummary of Caterpillar Operations and Restructuring of 
  Caterpillar Sarl. [PSI-Caterpillar-04-000002-009]..............   548
48. GCSARL Legal Structuring, CSARL 2009 activities, 
  Pricewaterhouse-Coopers. [PwC_PSI_CAT_00003411]................   556
49. GIntroduction of Caterpillar North America S.A.R.L. (CNAmSARL 
  was created and implemented with the understanding that there 
  be no impact on Caterpillar's accountable profit center 
  reporting systems. While significant changes were made to our 
  legal entity reporting systems, the objective of zero 
  accountable impact was met. [PSI-TWLF-10-000172-174]...........   557
50. a. GExcerpts from November 26, 2013 responses received from 
  Caterpillar Inc. to questions posed by the Permanent 
  Subcommittee on Investigations. [CAT-000267-269]...............   560
   b. GExcerpts from December 3, 2013 responses received from 
  Caterpillar Inc. to questions posed by the Permanent 
  Subcommittee on Investigations. [CAT-000276-277, 279-280, 295-
  298]...........................................................   563
   c. GExcerpts from January 14, 2014 responses received from 
  Caterpillar Inc. to questions posed by the Permanent 
  Subcommittee on Investigations. [CAT-000300-302]...............   571
   d. GExcerpt from March 7, 2014 responses received from 
  Caterpillar Inc. to questions posed by the Permanent 
  Subcommittee on Investigations. [CAT-001866]...................   574
   e. GExcerpts from March 13, 2014 response received from 
  Caterpillar Inc. to questions posed by the Permanent 
  Subcommittee on Investigations. [CAT-0002265]..................   575
51. GLicense Agreement, as of January 1, 2011, between 
  Caterpillar, Inc. and CSARL. [CAT-000306-318]..................   576
52. GFifth Amended and Restated Services Agreement, as of 
  September, 1999, between Caterpillar Inc. and Caterpillar 
  S.A.R.L. [CAT-000653-663]......................................   589
53. GPricewaterhouseCoopers document discussing intangible assets 
  transferred by Cat Inc. to COSARL, undated but likely 1999 
  (Scanning the list, it appears that the following items are 
  relevant to the replacement parts license: Patents, designs, 
  trademarks, contracts, systems, procedures, know-how, methods, 
  forecasts, estimates, and technical data.). 
  [PwC_PSI_CAT_00199858-862].....................................   600
54. GResponses to supplemental questions for the record from 
  Steven Williams, PricewaterhouseCoopers LLP....................   605
55. GResponses to supplemental questions for the record from 
  James Bowers, Caterpillar, Inc.................................   614
56. a. GMemorandum to File from the Permanent Subcommittee on 
  Investigations' Majority Staff, August 28, 2014, regarding 
  Ownership of Caterpillar's Non-U.S. Parts Warehouses...........   628
   b. GMemorandum to File from the Permanent Subcommittee on 
  Investigations' Majority Staff, August 28, 2014, regarding 
  Testimony Related to CSARL's Non-U.S. Parts Employees..........   631
   c. GMemorandum to File from the Permanent Subcommittee on 
  Investigations' Majority Staff, September 11, 2014, regarding 
  False Testimony Related to IRS' Position on Caterpillar's Tax 
  Liability......................................................   633
57. GDocument Locator List and documents cited in footnotes to 
  Caterpillar's Offshore Tax Strategy, the Report released in 
  conjunction with the Subcommittee hearing on April 1, 2014. The 
  Document Locator List provides the bates numbers of the 
  documents cited in the Report and the hearing record page 
  number where the document can be located. Not included are 
  documents related to Subcommittee interviews, which are not 
  available to the public, and widely available public documents.   649
.................................................................


                  CATERPILLAR'S OFFSHORE TAX STRATEGY

                              ----------                              


                         TUESDAY, APRIL 1, 2014

                                   U.S. Senate,    
              Permanent Subcommittee on Investigations,    
                    of the Committee on Homeland Security  
                                  and Governmental Affairs,
                                                    Washington, DC.
    The Subcommittee met, pursuant to notice, at 9:31 a.m., in 
room SD-342, Dirksen Senate Office Building, Hon. Carl Levin, 
Chairman of the Subcommittee, presiding.
    Present: Senators Levin, McCain, Johnson, Portman, and 
Paul.
    Staff present: Elise J. Bean, Staff Director and Chief 
Counsel; Mary D. Robertson, Chief Clerk; David H. Katz, Senior 
Counsel; Daniel J. Goshorn, Senior Counsel; Henry J. Kerner, 
Staff Director and Chief Counsel to the Minority; Jack Thorlin, 
Counsel to the Minority; Brad M. Patout, Senior Advisor to the 
Minority; Scott Wittmann, Research Assistant to the Minority; 
Adam Henderson, Professional Staff Member; Joel Churches, 
Detailee (IRS); Admad Sarsour, Detailee (FDIC); Heidi Keller, 
Congressional Fellow; Samira Ahmed, Law Clerk; Harry 
Baumgarten, Law Clerk; Jacob Rogers, Law Clerk; Tom McDonald, 
Law Clerk; Shannon Kellman and Michael Tash (Sen. Levin); Eamon 
Walsh (Sen. Heitkamp); Ritika Rodrigues (Sen. Johnson); and 
Brandon Brooker (Sen. Paul).

               OPENING STATEMENT OF SENATOR LEVIN

    Senator Levin. Good morning, everybody. The Subcommittee 
for many years has investigated how some of our most profitable 
corporations exploit loopholes in the U.S. tax code to shift 
income and profits to offshore tax havens, thereby denying tax 
revenue to Uncle Sam. Corporate income tax revenue accounts for 
a smaller and smaller share of Federal receipts and today is 
down to about 10 percent of Federal revenue, despite the fact 
that corporate profits are at an all-time high. Tax avoidance 
through the use of dubious tax loopholes costs the treasury 
tens of billions of dollars each year, making it harder for us 
to invest in the education, innovation, and infrastructure that 
promote our prosperity, and to adequately fund our national 
security, while at the same time increasing the tax burden on 
families and businesses who cannot employ an army of tax 
lawyers.
    The subject of our report and the subject of today's 
hearing is Caterpillar Inc. Caterpillar is an American success 
story that produces iconic industrial machines. 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. We will examine Caterpillar's tax strategy at today's 
hearing. But first I want to thank Caterpillar and its 
accounting firm, PricewaterhouseCoopers (PwC), for their 
cooperation with our Subcommittee.
    Headquartered in Peoria, Illinois, Caterpillar designs and 
builds a wide range of heavy construction equipment, power 
generators, and engines, assembling most of them here in the 
United States. On work sites around the world, its bright 
yellow machines are symbols of U.S. manufacturing excellence. 
Its revenues exceeded $120 billion over the last 2 years.
    In addition to manufacturing machines, Caterpillar operates 
a lucrative replacement parts business, selling Caterpillar-
branded parts to customers around the world. It is this aspect 
of their business, specifically its foreign sales of 
replacement parts, on which this hearing will focus.
    Caterpillar machines are known for their durability and 
dependability; they last literally for decades, a testament to 
their quality. To ensure their machines keep running well, 
Caterpillar works to deliver needed parts anywhere in the world 
within 24 hours of an order. This commitment limits the amount 
of time a machine is out of service as well as extending its 
life. Its parts operation helps the company maintain its 
reputation for building equipment that keeps working--a 
reputation that is key to its success.
    The parts operation is also highly profitable. In many 
years, the parts business accounts for a majority of 
Caterpillar's profits despite making up just a fraction of 
sales. Caterpillar maximizes its parts profits by designing 
machines that can be repaired and maintained only with 
Caterpillar parts, ensuring decades of parts sales and profits.
    Caterpillar-branded parts are manufactured primarily by 
independent companies in the United States and shipped by 
Caterpillar around the world. Until 1999, Caterpillar Inc.--or 
Caterpillar U.S., as we sometimes call it--was the initial 
buyer of these parts. When they were shipped to its foreign 
dealers, Caterpillar U.S. typically first passed title to 
marketing companies that it had created, including one in 
Switzerland called Caterpillar Overseas S.A.(COSA). Despite 
taking title, COSA never took physical delivery or even saw the 
parts that it marketed.
    COSA served as Caterpillar's marketing company and parts 
distributor in Europe, Africa, and the Middle East (EAME), 
acting as a liaison between Caterpillar U.S. and the foreign 
dealers, helping those dealers with training, marketing 
campaigns, servicing issues, and parts inventory management. In 
exchange, COSA was allocated about 15 percent of the parts 
foreign sales profits. Until 1999, the vast majority of the 
remaining profits from those offshore sales, usually 85 percent 
or more, were included in Caterpillar Inc.'s U.S. tax returns.
    But starting in 1999, its parts operation assumed a new and 
key role in Caterpillar's tax strategy. That is when 
Caterpillar paid PwC to design and implement a Swiss tax 
strategy, at an eventual cost of more than $55 million. After 
Caterpillar put that strategy in place, it went from reporting 
about 85 percent or more of its foreign parts profits on its 
U.S. tax return to reporting 15 percent or less to Uncle Sam, 
and shifting the remaining profits offshore to its Swiss 
affiliate. In Switzerland, Caterpillar had negotiated a special 
effective Swiss tax rate varying from 4 percent to 6 percent, 
which was below the Swiss statutory rate of 8.5 percent.
    This strategy left the real-world operation of its parts 
business virtually unchanged; in fact, the only significant 
real-world impact of this arrangement was an instant major drop 
in Caterpillar's U.S. tax bill. From 2000 to 2012, the Swiss 
tax strategy shifted $8 billion in profits from Caterpillar 
U.S. to its affiliate in Switzerland. This cut Caterpillar's 
U.S. tax bill by $2.4 billion during that period.
    The law says that transfer pricing agreements between 
related parties must have an economic substance--meaning a 
business purpose other than lowering taxes. But when one of 
Caterpillar's key tax managers responsible for implementing the 
Swiss tax strategy, Rodney Perkins, was asked, under oath, 
whether there was any business advantage to the Swiss 
transaction other than the deferral or avoidance of corporate 
income taxes, he stated: ``No, there was not.''
    Though the lion's share of Caterpillar's international 
parts profits shifted to its Swiss affiliate, the heart and 
soul of Caterpillar's parts business stayed right here in the 
United States. Only a shadow of the parts business took place 
in Switzerland. A few statistics showing the disparity are 
depicted on this chart.\1\
---------------------------------------------------------------------------
    \1\ See Exhibit No. 1f, which appears in the Appendix on page 281.
---------------------------------------------------------------------------
    Of Caterpillar employees who handle parts, 4,900 work in 
the United States; less than 100 work in Switzerland.
    Of the company's 125 manufacturing plants, 54 are in the 
United States; none are in Switzerland.
    Of the company's 19 parts warehouses, 10 are in the United 
States; none are in Switzerland.
    Today there are 1.5 billion parts stored in Caterpillar's 
U.S. warehouses; none are stored in Switzerland.
    Put another way, despite the fact that Caterpillar now 
allocates only a small percentage of its worldwide parts 
profits to the United States, from the moment a part is first 
designed to when that part reaches a customer, Caterpillar U.S. 
is the engine behind the company's parts business:
    Parts design is centered here, with nearly 80 percent of 
the research and development dollars used to design Caterpillar 
machines and parts spent in the United States.
    Once designed, Caterpillar's replacement parts are 
manufactured primarily by third-party suppliers in the United 
States, under the supervision of U.S. Caterpillar personnel. In 
2012, those U.S. suppliers manufactured nearly 70 percent of 
the Caterpillar replacement parts sold offshore.
    Once the parts are built, the technology, expertise, and 
management behind a highly efficient distribution system are 
all here in the United States. Parts are distributed through 
Caterpillar's parts logistics operation, which provides 
Caterpillar with one of its key competitive advantages. That 
operation is managed and run from the United States.
    Caterpillar's Inventory Management Group, located in 
Illinois, uses complicated algorithms to forecast parts demand 
and ensure parts are manufactured in the quantities needed.
    Caterpillar's largest parts warehouse is in Morton, 
Illinois, where it stores and coordinates the movement of parts 
around the world, helping Caterpillar's dealer network maintain 
inventory levels that meet customer demand and delivering even 
hard-to-find parts within 24 hours of an order anywhere in the 
world.
    In short, most of Caterpillar's parts executives are here, 
most of its parts employees are here, most of its parts are 
designed here, most of its parts are built here, most of its 
parts are stored here, most of its orders are filled here, and 
most of its parts are shipped from here. Yet most of its 
international parts profits go to Switzerland.
    Now, in 2012--that is just a year ago--minutes of the 
Caterpillar Board of Directors (BOD) meetings describe the 
company's parts distribution operations as ``U.S. centric.'' So 
if the parts business is U.S. centric, how do most of the 
profits end up at Caterpillar's wholly owned Swiss affiliate? 
Here is how.
    In 1999, PricewaterhouseCoopers provided the company, with 
a list of 49 potential tax strategies to lower its taxes, 
including a plan to avoid or defer U.S. taxes on the foreign 
sales of its parts. The transaction Caterpillar adopted was 
legally complex but straightforward. Caterpillar created a new 
Swiss affiliate called Caterpillar SARL (CSARL). CSARL replaced 
COSA as Caterpillar's leading Swiss affiliate, and Caterpillar 
gave CSARL a license to distribute all of the company's 
replacement parts outside of the United States.
    This arrangement changed nothing in the actual operation of 
the parts business, but caused a massive change in how profits 
on parts sales were split. Because CSARL lacks the personnel, 
infrastructure, or expertise to actually run the parts 
business, it reimburses Caterpillar U.S. its costs and a small 
service fee to continue running the operation. CSARL also pays 
Caterpillar U.S. a so-called royalty payment equal to about 15 
percent of the profits on international parts sales, with CSARL 
keeping the other 85 percent.
    Now, although Caterpillar spent 90 years working to build 
up its international parts business, the license provided 
Caterpillar with no compensation for the assets transferred. 
That license gives CSARL the rights to use Caterpillar's 
patents and trademarks; contracts with suppliers with whom 
Caterpillar had built relationships; it gives CSARL proprietary 
computer systems; and the know-how, methods and data used to 
manage the parts business. Caterpillar U.S. receives only the 
15 percent of future profits from the operation it developed 
and continues to run. So Caterpillar in the United States did 
the lion's share of the work building the business and does 
most of the work of operating the business, while Caterpillar 
in Switzerland gets 85 percent of the profit from the most 
profitable part of Caterpillar's business.
    The law says that transfer pricing agreements between 
related parties must meet an arm's-length transaction standard. 
In an arm's-length transaction, no company would turn over a 
profitable business that took decades to develop without 
receiving compensation. Similarly, in an arm's-length 
transaction, no business would relinquish 85 percent of the 
ongoing profits in exchange for 15 percent of the profits.
    Not only did the arrangement change nothing about the 
actual operation of the parts operation, it changed nothing on 
the financial statements that Caterpillar shows the public and 
investors. That is because Caterpillar and CSARL are related 
companies, with the parent company issuing a consolidated 
financial statement. So Caterpillar still shows the 85 percent 
of the profits sent to CSARL as its own profits on the 
consolidated public financial statement, while telling Uncle 
Sam that those profits belong to its Swiss affiliate CSARL.
    Caterpillar has provided several justifications for this 
change in profit allocation which appear to be inconsistent 
with the economic reality of its operations.
    Caterpillar claims that the company merely cut out a 
redundant middleman--Caterpillar U.S.--and arranged for its 
third-party suppliers to sell directly to its Swiss affiliate. 
The fact is that Caterpillar U.S. is not a redundant middleman 
in its parts business. Caterpillar U.S. continues to play the 
vital role of managing and leading its non-U.S. parts business 
the same way it always had. Caterpillar U.S. is still designing 
parts for Caterpillar machines, forecasting parts demand, 
getting the parts built, and storing and shipping the parts to 
dealers and customers around the world.
    Caterpillar also contends that shifting 85 percent of the 
parts profits to CSARL made sense because its Swiss affiliate 
provided so-called intangible marketing services whose 
substantial value had not been recognized in the past and 
deserves the lion's share of profit.
    But that explanation for sending most of its international 
parts profits to Switzerland is also inconsistent with how 
Caterpillar itself has valued the kind of services that CSARL 
provides. Prior to 1999, COSA, CSARL's predecessor as 
Caterpillar's Swiss affiliate, was one of many marketing 
companies that Caterpillar had around the world, each 
performing essentially the same function of working with 
Caterpillar's foreign dealers to sell and service Caterpillar 
parts and machines. In 1999, as part of the Swiss tax strategy, 
Caterpillar consolidated several of those marketing companies 
into CSARL. Just a few years later, in 2002, Caterpillar merged 
into CSARL another of its marketing companies called CACO, 
which represented Caterpillar with its dealers in Latin 
America, the Caribbean, and Canada. In connection with the CACO 
merger, PwC, the same firm that designed the CSARL transaction, 
evaluated the intangible marketing assets being transferred 
from CACO to CSARL and concluded they had little value. The 
same intangible marketing assets were concluded to have little 
value just 2 years later in 2001.
    So, in other words, when CSARL was the recipient of the 
marketing intangibles from CACO, Caterpillar said the value was 
negligible. But when valuing those same intangibles as provided 
by CSARL, Caterpillar claimed they were so valuable that they 
justified transferring 85 percent of its profits.
    Now, that is not all. For many years, Caterpillar used an 
internal profit allocation system that it called ``accountable 
profits'' to help it decide how to award incentive pay, such as 
bonuses, to employees in its various divisions. Beginning in 
1992, Caterpillar awarded each of its marketing companies an 
accountable profits share totaling about 13 percent of the 
parts profits within their regions. But when CSARL began 
receiving 85 percent or more of the profits related to parts, 
supposedly in recognition of how valuable CSARL's functions 
were, CSARL's employees stayed at the 13 percent profit figure 
internally when it came to allocating bonuses. In other words, 
Caterpillar again told one thing to Uncle Sam and another to 
its employees about the proportionate value of CSARL's work.
    The unreality of Caterpillar's current profits split can be 
illustrated by an example. Caterpillar builds a type of mining 
truck, the 797, shown in the chart we are going to put up 
there, which works in mines around the world, for instance, in 
the Alberta tar sands in Canada.\1\ Major components are 
designed, manufactured, and assembled in the United States. The 
engine is manufactured by Caterpillar in Indiana; the 
transmission is manufactured by Caterpillar in Illinois; the 
axles are manufactured by Caterpillar in North Carolina; the 
tires are manufactured by a third-party supplier in South 
Carolina; the driver's cab is manufactured by a third-party 
supplier in Illinois. When those mining trucks are assembled 
and sold to those mines in Alberta, they are exported from the 
United States, and 100 percent of the profits from those sales 
are reported on its U.S. tax return by Caterpillar. But when an 
order for finished replacement parts comes in to service those 
trucks, again, even though the parts are manufactured in the 
United States, stored at a Caterpillar U.S. warehouse, and 
shipped by Caterpillar U.S. employees to Alberta, the profits 
on those parts go to Switzerland.
---------------------------------------------------------------------------
    \1\ See Exhibit No. 1e, which appears in the Appendix on page 280.
---------------------------------------------------------------------------
    Switzerland has nothing to do with those trucks from start 
to finish. There is no economic basis for allocating those 
parts profits to Switzerland, yet that is where they go.
    And there is more. The unreality of the Swiss strategy can 
also be seen in Caterpillar's so-called virtual inventory 
system. Caterpillar maintains a second set of parts inventory 
books solely for tax purposes. CSARL has $525 million worth of 
parts stored here in the United States. None are stored in 
Switzerland. The parts CSARL purportedly owns here in the 
United States are completely commingled with the parts owned by 
Caterpillar U.S. So when a U.S. warehouse employee fills an 
order for a part, that employee has no way of knowing which 
part is owned by which company. The part is just shipped.
    After the fact, Caterpillar's virtual inventory system 
flags the parts shipped outside of the United States and 
retroactively indicates that they are CSARL-owned. For hundreds 
of thousands of parts shipped abroad each year, however, the 
parts that were shipped actually belonged to Caterpillar U.S. 
When that happens, the virtual inventory system nevertheless 
shows the part as owned by CSARL, indicates it was borrowed 
from Caterpillar U.S. at cost, and later replaces the part when 
new parts are added to the warehouse inventory. This after-the-
fact virtual ownership system is one more sign of how 
transparent the whole Swiss tax strategy is.
    What is real is the U.S. tax revenue that the Swiss 
strategy erases. From 2000 to 2012, Caterpillar shipped--
shifted $8 billion in profits to its Swiss affiliate, reducing 
Caterpillar's U.S. tax bill by $2.4 billion.
    At the bottom, the Caterpillar case study centers on a tax 
strategy purchased by its tax department whose purpose was tax 
avoidance. It used a licensing agreement that no company would 
enter into with an unrelated third party. It relied on a 
virtual inventory system that did not track ownership of parts. 
It allocated profits for tax purposes that bore no relationship 
to the profit allocations made for its own business purposes, 
including bonuses.
    Now, I am about as big a supporter of U.S. manufacturing as 
you will find. But the Caterpillar case study demonstrates that 
offshore profit shifting is not reserved for those high-tech 
companies that transfer intellectual property to themselves 
offshore. Some manufacturers, too, use offshore tax strategies 
to avoid paying taxes. The revenue lost to those strategies 
increases the tax burden on working families here in the United 
States; it reduces our ability to make investments in education 
and training, research and development, trade promotion, 
intellectual property protection, infrastructure, national 
security and more--investments, all of those, on which 
Caterpillar and other U.S. companies depend for their success. 
It is long past time to stop offshore profit shifting and to 
ensure that profitable U.S. multinationals meet their U.S. tax 
obligations.
    Senator McCain.

              OPENING STATEMENT OF SENATOR McCAIN

    Senator McCain. Thank you, Mr. Chairman. After decades of 
growth, Caterpillar has built a global business in which 70 
percent of its sales come from overseas. It is my information 
that at the core of Caterpillar's overseas subsidiaries is an 
independent dealer network that informs the company about local 
demand and keeps it globally competitive. The Majority's Report 
states that many significant functions of Caterpillar's 
overseas parts business are managed from the United States. But 
I think two important questions should be asked before that 
observation can be properly evaluated today: First, what 
activities are most important in generating Caterpillar's 
overseas sales? And, second, where are those activities 
conducted?
    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. I understand that this Subcommittee has many 
important questions to ask about how Caterpillar chose to 
structure itself globally. I look forward to hearing from 
today's witnesses so that we will be better informed as to the 
actual operations of Caterpillar and their policy implications.
    Today, the fact is that the United State of America has the 
highest corporate tax rate of any country in the world. There 
is no doubt that this is a factor in moving operations overseas 
and, as we have seen from previous hearings, parking those 
profits overseas rather than bringing them back to be subjected 
to a 35-percent corporate tax rate.
    This makes a compelling argument for broader tax reform in 
order to ensure our tax code is fair, competitive, and a 
vehicle for economic growth. I want to thank Chairman Levin for 
his continuing passion on this issue, particularly, and on 
others, and I look forward to today's hearing.
    Thank you, Mr. Chairman.
    Senator Levin. Thank you so much, Senator McCain, and I 
want to thank you and your staff for the bipartisan work which 
is the hallmark of this Subcommittee.
    And Senator Johnson, thank you.
    Let me now call upon our first panel of witnesses: 
Professor Bret Wells, Assistant Professor of Law at the 
University of Houston Law Center, Houston, Texas; and Professor 
Reuven Avi-Yonah, the Irwin I. Cohen Professor of Law at the 
University of Michigan Law School in Ann Arbor, Michigan. We 
appreciate both of you being with us this morning. We look 
forward to your testimony. We appreciate your sharing your 
legal expertise today, and we look forward, again, to your 
perspective on the offshore profit shifting.
    Pursuant to Rule 6, all witnesses who testify before the 
Subcommittee are required to be sworn, so at this time I would 
ask both of you to please stand and to raise your right hand. 
Do you swear that the testimony you are about to give before 
this Subcommittee will be the truth, the whole truth, and 
nothing but the truth, so help you, God?
    Mr. Wells. I do.
    Mr. Avi-Yonah. I do.
    Senator Levin. We are using a timing system today, and 
about 1 minute before the red light comes on, you will see the 
lights change from green to yellow, which will give you an 
opportunity to conclude your remarks. Your written testimony 
will be printed in the record in its entirety. We would 
appreciate your limiting your oral testimony to 7 minutes.
    Professor Wells, we are going to have you go first, 
followed by Professor Avi-Yonah, and then we will turn to 
questions about both of you have testified. Professor Wells.

 TESTIMONY OF BRET WELLS,\1\ ESQ., ASSISTANT PROFESSOR OF LAW, 
        UNIVERSITY OF HOUSTON LAW CENTER, HOUSTON, TEXAS

    Mr. Wells. Very good. Thank you. My name is Bret Wells, and 
I am an Assistant Professor of Law at the University of Houston 
Law Center. I have over 20 years of experience in the tax area, 
much of that time in industry but also in academia. And I have 
published repeatedly on the topic of international taxation.
---------------------------------------------------------------------------
    \1\ The prepared statement of Mr. Wells appears in the Appendix on 
page 99.
---------------------------------------------------------------------------
    I would like to thank both Senator Levin and Senator McCain 
for inviting me to testify. I am testifying in my individual 
capacity, and so my testimony does not necessarily reflect the 
views of the University of Houston Law Center or of the 
University of Houston.
    In the interest of time, I want to make a few opening 
remarks.
    First, when we think about Caterpillar, we are thinking 
about a very successful manufacturing business. The U.S. tax 
rules should properly characterize how to think about where the 
economic profits of that business come from.
    When we think about Caterpillar, we also need to recognize 
that it has created a remarkable spare parts business system 
that explains much of its profitability. In this regard, once a 
CAT machine is sold, it represents an annuity for Caterpillar 
because the customer will come back to Caterpillar 
dealerships--for customized replacement parts to keep this 
machine working.
    Caterpillar management treats its proprietary spare parts 
business and the logistics surrounding this spare parts 
business as a core business of the company. Caterpillar's 
integrated business system allows it to sell spare parts to a 
customer within 24 hours anywhere in the world, thus creating a 
sales opportunity at the exact moment when Caterpillar can 
extract substantial profit margins on proprietary spare parts 
sales. Consequently, the sale of a Caterpillar machine creates 
a future captive market for proprietary spare part sales, and 
Caterpillar's logistical capabilities explain its ability to 
generate profitability in that business line.
    Prior to 1999, the profits related to the spare parts 
business were shared between Caterpillar Inc. and the 
independent dealers. A Swiss affiliate earned a routine profit. 
The routine profit earned by the Swiss affiliate was 
appropriate because its minimal profit was commensurate with 
its minimal functional contribution to the supply chain and to 
the factors that were creating the residual profits. In 1999, 
Caterpillar engaged in a supply chain restructuring exercise. 
In this restructuring, a new Swiss affiliate was designated as 
the entity that would now be entitled to reap substantially all 
of the annuity value of the spare parts business that 
Caterpillar and its independent dealers had carefully created.
    After CSARL's formation, Caterpillar claimed that CSARL had 
newly discovered marketing intangibles that justified 
drastically increasing the profits allocable to Switzerland. To 
the extent that these intangibles originated from U.S. 
affiliates at the time of CSARL's formation, CSARL should have 
paid a super royalty every year thereafter under Section 367(d) 
to compensate the U.S. affiliate in an amount commensurate to 
the newfound profitability of that contributed U.S. intangible, 
but the Subcommittee was provided no evidence that this was 
done or is currently being done.
    Caterpillar Inc. remained the creator and developer of the 
equipment designs, and Caterpillar maintained key operational 
control over the spare parts product design, procurements, 
logistics, and inventory management processes. However, 
although nothing in the spare parts business functionally, 
economically, changed from an operational perspective as a 
result of the 1999 tax restructuring exercise, the dominant 
share of residual profits from the spare parts business was 
gratuitously shifted to Caterpillar's Swiss affiliate CSARL.
    The supply chain restructuring implemented by Caterpillar 
is premised on a transfer pricing mistake. The mistaken notion 
is that Caterpillar's residual profits attributable to the 
integrated spare parts business system can be allocated away 
from the functions that economically generate those profits and 
instead simply assign to a Swiss entrepreneur entity whose 
functions did not meaningfully contribute to the annuity value 
of the Caterpillar proprietary spare parts market, nor 
meaningful participated in its ongoing development.
    It is Caterpillar Inc. and the Caterpillar foreign 
dealerships that deserve to share the residual profits because 
the functions that contribute to customer loyalty in the 
foreign marketplace are attributable to Caterpillar Inc.'s 
excellent manufacturing and logistical capabilities developed 
in the United States and to the customer relationships created 
by the Caterpillar independent dealers. CSARL's role is that of 
a minimal risk distributor that possesses no external customer 
contacts and no significant manufacturing intangible. In this 
posture, CSARL's profit margin should approach a cost-plus 
return.
    A court should look through the Caterpillar supply chain 
restructuring exercise and see that CSARL should not receive a 
share of the residual profits of the parts business. But even 
though a court has ample means at its disposal to reach the 
correct substantive transfer pricing result, current law 
provides less guidance than it should because Section 482 does 
not explicitly mandate a specific transfer pricing methodology.
    So Congress should make clear that any allocation of 
residual profits to a foreign affiliate must be justified using 
a residual profit split analysis. Allowing residual profits to 
simply migrate to a tax haven entrepreneur without further 
explanation is a mistake. If all of the non-routine functions 
that create residual profits reside in the United States, then 
all the residual profits should be allocated to the United 
States.
    As a second point, I would like to state that the fact that 
nothing operationally changed as a result of Caterpillar's 1999 
tax restructuring represents a potentially fatal implementation 
flaw because the operational activities among Caterpillar Inc. 
and CSARL appear to have created a de facto U.S. partnership 
that has its own U.S. taxable presence, which in turn creates a 
U.S. taxable presence for CSARL in the United States. In my 
written testimony, I set forth a much more expansive view of 
why that is so.
    Let me conclude by saying that the Subcommittee is to be 
commended for taking the time to understand these international 
profit-shifting practices. Profits attributable to U.S.-created 
intangibles should not end up in a jurisdiction without 
substance, nor should they end up in an entity that did not 
meaningfully contribute to their generation.
    Thank you for allowing me to speak.
    Senator Levin. Thank you so much, Professor Wells.
    Professor Avi-Yonah, welcome back.

   TESTIMONY OF REUVEN S. AVI-YONAH,\1\ ESQ., IRWIN I. COHN 
PROFESSOR OF LAW, THE UNIVERSITY OF MICHIGAN SCHOOL OF LAW, ANN 
                        ARBOR, MICHIGAN

    Mr. Avi-Yonah. Thank you very much. Thank you, Senator 
Levin and Senator McCain, for inviting me to speak here today 
about the Caterpillar tax strategy. I will try to make four 
points briefly.
---------------------------------------------------------------------------
    \1\ The prepared statement of Mr. Avi-Yonah appears in the Appendix 
on page 106.
---------------------------------------------------------------------------
    First is that this is, as the Subcommittee knows, part of a 
more general phenomenon. We have already had a couple of other 
hearings before this. There are $2 trillion more or less of 
profits that are offshore in the case of American 
multinationals, and out of this $2 trillion, a significant 
portion relates to activities that economically take place in 
the United States, either in the form of developing intangibles 
or in this case in the form of developing replacement parts, 
logistical networks, and so on.
    Congress has been aware of this for a long time and has 
tried several times to legislate in order to prevent the 
shifting of profits from the United States overseas. Originally 
Subpart F in 1962 was intended precisely to prevent this kind 
of shifting, and there was a big part of Subpart F that was 
addressed specifically to the shifting from the United States 
to Switzerland. The so-called base company rule was designed to 
address a case in which Dupont shifted significant profits from 
the United States to Switzerland using similar strategies to 
the ones that are used here by Caterpillar.
    Then in 1996, Congress, being aware that the existing laws 
did not work very well, enacted the super royalty rule that 
Professor Wells mentioned, which says that every time you 
transfer an intangible from the United States to a foreign 
jurisdiction, there has to be a royalty paid that is 
``commensurate with the income'' that is attributable to that 
intangible, which was designed to shift all of the profits back 
to the United States. To the extent that what Caterpillar did 
was to shift such an intangible, then it should have paid a 
super royalty.
    Third, I also think that in this case, Caterpillar's 
transaction in 1999 did not have the economic substance that is 
required under the tax law. Under the tax law, as it is now 
codified in Section 7701(o) but was also the law before that, 
an transaction has to have economic substance in order to be 
upheld by the Internal Revenue Service (IRS) and in a court, 
and economic substance requires two things: It requires a 
subjective intent to make a profit and an objective ability to 
make a profit. In this case, we have sworn testimony from 
Caterpillar executives as well as extensive documentation that 
the Subcommittee has discovered in its investigation that we 
have reviewed that indicates that there was no business purpose 
to the transaction other than the shifting of taxable income 
from the United States to Switzerland. And in addition, it is 
hard to see what the objective business purpose of the 
transaction or the objective profit potential could be in a 
transaction in which 85 percent of profit is shifted from the 
United States to Switzerland without any actual change taking 
place on the ground, with everything still being done in the 
United States just like it has been before. So I think that the 
IRS should have attacked this transaction on economic substance 
grounds. It should have also asked itself whether there should 
have been a super royalty paid. It should also have perhaps 
attacked it on assignment of income grounds because if the sale 
of parts represents an annuity out of the sale of the machines, 
then the income from the sale of parts should go to the same 
place the income from the sale of the machine goes. So there 
are all of these opportunities that the IRS had to go after 
this transaction, and unfortunately they didn't.
    So what are my conclusions?
    First of all, I think that the IRS should do a better job 
in addressing these transactions. Of course, we now in this 
case have the advantage of an extensive Subcommittee 
investigation of internal, properly documented, maybe the IRS 
did not have at the time, but it should have, I think, 
addressed itself more to this kind of transaction, which, as we 
heard, shifted $8 billion in profits resulting in $2.4 billion 
less in taxes paid over the years, and, of course, it is still 
going on.
    Second of all, I think that Congress should address the 
issue, and I think the simplest way of addressing this is to 
fix the problem that we already tried fixing in 1962. At the 
moment there is an exercise going on in the Organisation for 
Economic Co-operation and Development (OECD) called the base 
erosion and profit-shifting (BEPS) exercise, under which all of 
these countries, especially the G-20, the largest 20 economies 
in the world, are concerned about this kind of profit shifting. 
None of the G-20 has a tax rate below 20 percent. They all have 
effective tax rates that are similar to that. There is no 
competitive disadvantage that would result from Congress 
reducing the U.S. tax rate and taxing these offshore profits 
currently.
    There certainly can be no competitive disadvantage in 
Congress taxing the $2 trillion that are currently accumulated 
because this income, these profits have already been 
accumulated, and no behavioral incentive or no competitive 
disadvantage can result from taxing them. So, in my opinion, 
Congress should tax this $2 trillion immediately and in the 
future should reduce the corporate rate and tax all offshore 
profits of U.S. multinationals on a current basis.
    Thank you very much.
    Senator Levin. Thank you very much.
    Why don't we start with a 7-minute first round, and we can 
have a number of rounds.
    The tax strategy which we have started to discuss this 
morning was proposed, designed, and implemented over several 
years by tax consultants of PwC working with Caterpillar's Tax 
Department. Caterpillar paid PwC more than $55 million.
    In evaluating the CSARL transaction, my question is: Is it 
relevant that the transaction was initiated and driven by tax 
personnel at Caterpillar rather than by business personnel and 
involved paying a large amount of money for an explicit tax 
strategy to lower the company's taxes? Is that relevant, 
Professor Wells?
    Mr. Wells. I think it is relevant. I do not think it is 
dispositive, but I think it is relevant. And I think what is 
also relevant is the inconsistent stories as it is being 
implemented, where the taxpayer says in more contemporaneous 
documents to the time that there are no marketing intangibles 
in CSARL. Sure, the independent dealers are adding a lot of 
value. They deserve a share of residual profits. But the Swiss 
affiliate is performing nothing but a routine function.
    When the CACO transaction was done, PwC had said that there 
was nothing in Switzerland that could not be easily replicated, 
it had no significant marketing intangibles. In earlier 
transfer pricing reports, they said that CAT played the largest 
role in developing the market and dealer development, it was 
the originator of the basic marketing system designs, and they 
said CAT was the designer of the systems and the owner of the 
Morton spare parts business.
    All of that comes together as far as credibility of the 
witness. A judge is going to look at this case, and the judge 
is going to say, ``Where did the economic profits really come 
from? The person that is testifying to me today seems to be 
making inconsistent statements from everything else that is 
happening. Why did that story come up? Why is the story being 
postulated in front of me?''
    And a judge, a trier of fact, is going to look at the 
overall evidence, and they are going to try to determine what 
are the functions that create residual profits. When the 
strategy comes from a tax department and it is divorced from 
the business itself, then that is a significant fact that a 
judge is going to look at when the judge is charged with trying 
to determine what are the economics consequences, where are the 
economic profits truly being generated.
    Senator Levin. And if the transaction is designed for the 
purpose of lowering taxes, that is a relevant fact to the 
judge?
    Mr. Wells. It should be a relevant fact. Again, it is going 
to be a combination of facts.
    Senator Levin. But that is one relevant fact.
    Mr. Wells. That is a relevant fact.
    Senator Levin. OK. Now, since 1999, Caterpillar has 
allocated about $8 billion in non-U.S. parts sales income to 
Switzerland and so far avoided paying about $2.4 billion in 
U.S. taxes. Is it fair to call that ``profit shifting''?
    Mr. Wells. I think that is a fair thing to say given the 
record that is in front of the Subcommittee today about this 
specific taxpayer and the functions that generated those $8 
billion in profits.
    Senator Levin. Professor Avi-Yonah, we codified the 
economic substance doctrine in 2010 and we stated that the IRS 
can invalidate transactions that create no meaningful change in 
the economic position of the taxpayer and have no ``substantial 
purpose other than to achieve a tax effect.'' Is that right? 
Must there be economic substance in a transfer pricing 
transaction between related parties?
    Mr. Avi-Yonah. So the IRS----
    Senator Levin. Put your mic on, if you would.
    Mr. Avi-Yonah [continuing]. Making sure that you meet both 
prongs--that is, the objective prong and the subjective prong; 
whereas, before, some courts held that you only needed to meet 
one.
    And, in addition, the IRS said that in a true arm's-length 
transaction, they will not apply the economic substance; that 
is, if a transaction meets the arm's-length standard of Section 
482, they will not apply economic substance.
    However, in my judgment, a transaction in which you 
transfer 100 percent of the profit in exchange for 15 percent, 
it is essentially you are transferring 85 percent of the profit 
to a related party, would never have been done on an arm's-
length basis, and, therefore, I do not think the arm's-length 
standard applies here. And I think the economic substance 
doctrine can be applied to this transaction.
    Senator Levin. Now, Caterpillar, in its written statement 
submitted to the Subcommittee, says that even if it were 
stipulated that the changes made in 1999 were motivated 
primarily by tax considerations and generated primarily tax 
effects, the economic substance doctrine would still not apply.
    Now, do you agree with the statement that the economic 
substance doctrine would not apply if the changes in 1999 were 
motivated primarily by tax considerations and generated 
primarily tax effects and the transaction did not meet the 
``arm's-length standard,'' which is a transaction that would 
not be made with an unrelated third party?
    Mr. Avi-Yonah. No, I think in this case the economic 
substance doctrine would apply to invalidate the transaction.
    Senator Levin. Professor Wells, is it true that the law 
requires in every case that a transfer pricing agreement must 
meet the arm's-length standard, it must be a transaction that 
Caterpillar would enter into with an unrelated party?
    Mr. Wells. That is exactly right. In fact, current law 
makes it clear that even if there are multiple transfer pricing 
methodologies, you must choose the best method, and the best 
method under existing Treasury regulations is the one that is 
the most reliable in putting the profits in the functions that 
generated those profits. So even if we have a debate between 
one method or a different method, a court is going to ask the 
question: What would an arm's-length party have done?
    Senator Levin. And would any reasonable business have 
entered into the type of exchange that occurred here?
    Mr. Wells. No, because what occurred here was a failure to 
recognize that there was a captive spare parts market. If we 
use the words of Caterpillar, ``seed,'' ``grow,'' and 
``harvest,'' when they are talking to the stock analyst about 
how to value their company, they said, ``When we sell the 
Caterpillar machine, it is like seed and growing and the 
harvesting is the spare parts, which we get to do once that 
machine breaks down. And nobody would let someone come in at 
harvest time after the crop has been seeded, grown, and is 
ready for harvest, nobody except a related party that does not 
care about the profit shifting.
    Senator Levin. Do you agree with that, Professor?
    Mr. Avi-Yonah. Yes, I agree.
    Senator Levin. Thank you. Senator McCain.
    Senator McCain. Thank you, Mr. Chairman, and I thank the 
witnesses.
    To the witnesses, this restructuring took place, it is my 
understanding, in 1999, and yet no case has been brought 
against them by the government for what you view as a clear 
violation of law. Do you have an explanation for that?
    Mr. Avi-Yonah. I think it is partly because some of the 
information that was provided to the Subcommittee would not 
have been available to the IRS, which relates to internal tax 
planning documents that are privileged. That is not obvious on 
its face from the outside.
    In addition, some of the information was based on a 
whistleblower that also was not available to the IRS at the 
time, who was a senior tax person inside the company. So we, 
today, have much more information to evaluate this transaction 
than was available to the IRS at the time.
    In addition, in my opinion, the IRS is simply overburdened, 
and it has too many companies--even though it audits all the 
large companies, it has too many companies. These transactions 
are very complicated. They are extensively documented. The IRS 
has to go through thousands of pages of data. They just have a 
hard job to do. Nevertheless, I do think that they should have 
done a better job in this particular case.
    Senator McCain. So the IRS looked at this restructuring, 
reached a conclusion that was a failure of the IRS to gather 
all the sufficient information or did not hear from a 
whistleblower. Wouldn't that be a reason for the IRS to reopen 
the case?
    Mr. Avi-Yonah. I suspect that by the time the whistleblower 
case became public, these years have been closed already in the 
IRS----
    Senator McCain. Well, nothing prevents them from reopening 
it.
    Mr. Avi-Yonah. No. If a year is closed, that is, if the 
statute of limitations had run on a year, then they cannot 
reopen the year. They have settled with the company.
    Senator McCain. They are operating today under a scheme 
that you view as illegal. Since when does the statute of 
limitations affect that?
    Mr. Avi-Yonah. I mean, there are two arguments here. There 
is the economic substance argument that relies to the original 
transaction. The original transaction, I believe, is closed, 
and they cannot go after that. There are other arguments. There 
is Professor Wells' partnership argument. There is the question 
of whether there should be a super royalty under the transfer 
pricing rules. There is a question of whether there was an 
assignment of income. All those theories are still available to 
the IRS, and I would encourage the IRS to closely examine what 
is going on now between the company and CSARL and see whether 
they cannot criticize them on the basis of one of those 
theories.
    Senator McCain. Did you have an additional comment, 
Professor?
    Mr. Wells. I think it is an important public service to 
show the IRS, in hearings like this, the results of a thorough 
investigation of a factual record like this. At a time when 
companies are concerned and taxpayers are concerned about base 
erosion and profit shifting, one thing I would hope the Senate 
could all agree on is the following: Whatever reform needs to 
be made, currently law needs to make sure that the transfer 
pricing rules allow taxpayers and the government to be 
confident that taxes are paid on the profits that are 
economically earned in the United States. There may be other 
reform measures that the Senate may not be able to agree on, 
but I think Congress needs to agree on at least this goal. And 
I think the IRS needs to think about what do they need to do in 
order to do a better job of getting the facts in a detailed way 
like this Subcommittee has done.
    Senator McCain. So when there is something this egregious 
going on, it requires a congressional hearing to get the IRS to 
carry out their responsibilities. It is my information that the 
IRS received an anonymous letter with allegations in 2004, 5 
years after the restructuring, looked into it, and brought no 
charges. So the American people and I do not have a lot of 
confidence in the IRS, but now we have less.
    Mr. Wells. I think that is an important point, and I think 
it is hard to come up with good legislative reforms, Senator 
McCain, if we do not have detailed case studies like this. 
Congress needs to develop legislation in light of the current 
reality, not divorced from the current reality. So I think that 
is an important point.
    Senator McCain. And, Professor, I think you would agree 
that there is at least--am I correct--$1.5 trillion that is 
parked overseas at this time?
    Mr. Wells. My knowledge on that is only from publicly 
available information, but that is consistent with what I have 
read in the public.
    Senator McCain. And some years ago, we did kind of a, 
whatever you call it, repatriation in the hopes that it would 
create more jobs and boost our economy, and I think the 
evidence shows that basically it went to pay salaries and 
stockholders.
    Mr. Wells. I think that is a fair characterization of the 
empirical data.
    Senator McCain. So any reform that we make or steps we may 
take in order to try to repatriate some of this money, this 
time maybe we should have requirements for job creation and how 
that--on funds that are returned. But also isn't the larger 
question here, as I mentioned in my opening statement, if you 
are going to bring money home and pay 35 percent corporate tax, 
which is the highest in the world, you are going to try to find 
ways not to have to pay taxes on it, legally you are going to 
have to try and find a way, or in a gray area, or in violation 
of at least the spirit if not the letter of the law.
    So if you had a recommendation to Congress to address this 
issue and prevent future--no matter how you feel about this 
particular case or not--what would you recommend that Congress 
do to try to make sure that there is adequate taxation and a 
disincentive for this kind of activity that this Subcommittee 
has investigated on numerous cases? Could both of you give us a 
response? Either one first, I do not care.
    Mr. Avi-Yonah. If we cut the corporate tax rates to 20 to 
25 percent, we could apply it to all of the overseas profits of 
U.S. multinationals without putting them at a significant 
competitive disadvantage because that is the same rate that 
our----
    Senator McCain. And that would be sufficient incentive, you 
think, for them to bring that home, a 20-percent rate, roughly?
    Mr. Avi-Yonah. I think so, yes.
    Senator McCain. Thank you very much, Professor.
    Senator Levin. Thank you, Senator McCain.
    Mr. Wells. My main point is when we talk about 
repatriation, tax rates, and whatever, I think the public may 
have a different point of view, Senator McCain, whether or not 
the profits are really U.S. origin profits that have migrated 
away and are circling back, or if they really are profits that 
are functionally created and attributable to activities that 
occur outside the United States. I think that before you look 
at any reform, Section 482 needs to be absolutely clear that 
you cannot just designate an entrepreneur to just take the 
profits of an multinational corporation (MNC). We need to have 
rules that say that the profits are going to be scored in the 
right jurisdiction economically first. And then what we do with 
foreign income after that will be a next question.
    But I do not think that the public would be excited or 
happy about having profits end up as foreign income that are 
truly U.S. origin profits and get a different tax rate than 
what the general American has to pay for the taxes that they 
really are having to pay based on their wages earned in the 
United States. I think Section 482 is the first place that we 
need to make very sure is protected.
    Senator McCain. OK. Thank you.
    Thank you, Mr. Chairman.
    Senator Levin. Thank you, Senator McCain. Senator Johnson.
    Senator Johnson. Thank you, Mr. Chairman.
    Professor Wells, my information is that Caterpillar sells 
roughly 70 percent of its total sales overseas and claims 
roughly 70 percent of its profits overseas. Is that pretty 
accurate?
    Mr. Wells. That sounds pretty accurate.
    Senator Johnson. And, of course, transfer pricing 
allocation of profits is a pretty complex process, correct?
    Mr. Wells. Not when you get the facts in front of you. When 
you get the question of excessive profitability related to 
spare parts, you then have to go through a complicated question 
of factually determining, Senator Johnson----
    Senator Johnson. OK, and I got that from your testimony. So 
let me just ask a little bit--you have done an awful lot of 
practicing in tax law with large multinational corporations, I 
imagine. Talk to me a little bit about how the IRS works with a 
large multinational company like Caterpillar. What is that 
relationship like?
    Mr. Wells. That is likely to be a better question for your 
next panelists. I have no specific information on how the 
Caterpillar audit worked.
    Senator Johnson. My understanding is Caterpillar in this 
case probably has about 12 full-time IRS agents auditing them--
does that sound reasonable to you? Is that your understanding 
of it?
    Mr. Wells. It could be. That sounds reasonable and 
consistent with my experience.
    Senator Johnson. I would think if you have full-time IRS 
agents, that is my experience as well--looking at your tax 
returns, poring over it, talking to tax managers in that 
business about how they are working to comply with the laws, 
that is a pretty ongoing monitoring and ongoing thorough 
investigation of the tax situation.
    Mr. Wells. But, generally, the process at an audit level is 
through an information disclosure request (IDR), where a 
question is asked and answered. Subpoena power is very little 
used in an IRS and it--like the subpoena process used by this 
Subcommittee. So that when you ask for all documents, I want to 
know what are the relevant documents other than just the 
specific statement you want me to know, that is oftentimes not 
given over to the IRS.
    And so when cases go to trial or get docketed for trial, 
there may well be a complete set of documents handed over. But 
the IRS at the audit level typically will just be asking 
questions and will not be given all of the responsive documents 
or the emails or the internal documents or the internal----
    Senator Johnson. My experience with the IRS is they are 
pretty detailed, and they ask a lot of pretty good questions, 
and they require you to provide an awful lot of documentation 
on how you fill out your tax returns and how you reported 
income.
    Let us assume that Congress can address this situation and 
write a law to address what Caterpillar is doing here. With 70 
percent of Caterpillar's sales going overseas, what could 
Caterpillar do functionally to make sure that even if we change 
the law, the economically earned profits are actually earned 
overseas so they can take advantage of certainly lower tax 
jurisdictions than what we find here in the United States right 
now?
    Mr. Wells. Yes, that is an excellent question.
    Senator Johnson. They could move operations overseas, 
couldn't they? They could start manufacturing overseas.
    Mr. Wells. Yes.
    Senator Johnson. Which probably, if we do this, would be 
exactly what large corporations like Caterpillar would do. They 
would stop manufacturing in the United States, and they would 
start manufacturing overseas so that they are matching their 
economic activity with their actual sales overseas.
    Mr. Wells. Well, if what you are asking----
    Senator Johnson. How would that benefit the United States?
    Mr. Wells. If what you are asking is we want taxpayers to 
report their taxes consistent with the economic truth, then 
that is a worthy goal. If Congress wanted to promote in 
subsidies and some other way, then that is fine. But what we 
should not have, Senator Johnson, is have average Americans 
report on their tax returns taxes that they economically 
believe are due here. But sophisticated taxpayers are able to, 
through complex transactions ignore that truth.
    Senator Johnson. Through laws that Congress passes to 
incentivize manufacturers to stay here in the United States, 
provide jobs here, and yet export overseas. So then when you 
have a company like Caterpillar actually doing that, 
manufacturing here, exporting product overseas, now we are 
going to do a thorough investigation, as opposed to have this 
adjudicated in a tax court with tax law, we are going to hold a 
trial here against a company that is manufacturing and 
exporting, which is what everybody here, all these politicians 
here in Washington want us to do. I mean, does that sound just 
a little crazy to you?
    Mr. Wells. It does not sound crazy to me if your goal is to 
know what the current reality is so that your laws for the 
Nation actually describe the truth, and so----
    Senator Johnson. So we can change that law, we can change 
that reality, and then companies like Caterpillar will start 
manufacturing overseas. Does that make any sense to you at all?
    Mr. Wells. I believe that Caterpillar, if they are 
benefiting from the U.S. economy, should avoid paying their 
fair share of taxes related----
    Senator Johnson. They are paying 29 percent effective rate, 
are they not----
    Mr. Wells [continuing]. To their profits here, and 
allocating profits to a subsidiary that did not economically 
perform those functions or create the residual profits; that is 
not an appropriate answer.
    Senator Johnson. So it is true that Caterpillar pays an 
effective tax rate of 29 percent, correct?
    Mr. Wells. That is correct.
    Senator Johnson. In multinationals, that is a pretty high 
effective tax rate, correct?
    Mr. Wells. Depending on who your benchmarking against, 
but----
    Senator Johnson. I mean we----
    Mr. Wells. But if all of the functions that create the 
residual profits are in the United States, then I think it is 
not a high tax rate under current law. If what you are asking 
me, Senator Johnson, is should we reduce the corporate tax rate 
from 35 to 25, I think that is a fine suggestion. But whatever 
the tax rate is, we should not just say I can skim the rate 
down----
    Senator Johnson. Well, no. You talked about fair share, and 
I am just saying when you have a corporation, a multinational 
paying 29 percent effective rate, I think that is generally--
relative to other multinationals, that is a pretty high 
effective tax rate. I would be literally talking to my tax 
manager and going, ``What are you potentially doing wrong 
here?''
    Let me just quickly ask the differentiation between tax 
avoidance and tax evasion.
    Mr. Avi-Yonah. So tax evasion is illegal and tax avoidance 
is legal. Neither of us I think would say that what was done 
here was tax evasion. This was tax avoidance. The question is 
whether it complies with the law.
    Senator Johnson. But I think you both said that what 
Caterpillar was doing was probably illegal and that the IRS 
should challenge it.
    Mr. Avi-Yonah. Well, I think that the IRS should challenge 
it, and I think that a court would hold that it violated the 
economic substance doctrine, which would still make it tax 
avoidance and not tax evasion.
    Senator Johnson. So, again, that is my final point. If 
Caterpillar is doing something wrong, the proper venue would be 
a court of law, tax court, and have the IRS adjudicate this 
thing, not Congress. Thank you.
    Senator Levin. Thank you, Senator Johnson.
    Let us have a second round. Professor Wells, I think your 
main point here is that if Caterpillar has 57 or 54 
manufacturing facilities here and its economic functions are 
principally carried out here, that it should not pretend that 
it is in Switzerland. Is that basically right?
    Mr. Wells. That is exactly right, and that in order to have 
the confidence that our laws are working correctly, what we 
should say is that you cannot just nominate a Swiss tax 
entrepreneur. The residual profits, if it is billions of 
dollars, and there is only a couple of million dollars in SG&A 
costs in that entity, if it is far in excess of what function 
it is actually performing, that is problematic.
    Senator Levin. Now, you have made reference to what you 
called, I think, ``CACO.'' I think they describe ``C-ACO,'' so 
I am going to keep calling it ``C-ACO.'' Maybe the Caterpillar 
folks can give us the correct way to pronounce that acronym.
    But at any rate, in 1999, Caterpillar, as we indicated, 
hired Pricewaterhouse to review its business operations to 
reduce its taxes. And they, at that time, claimed that it 
identified that CSARL has certain marketing intangibles that 
were so valuable that they justified dramatically increasing 
the portion of non-U.S. profits sent to Switzerland, and you 
have discussed that is not the case in your judgment. And I 
have indicated that in my judgment, and I think our report 
makes it clear, that your judgment is indeed the correct one.
    But here is my question. In 2001, Caterpillar decided to 
transfer the same type of marketing intangibles from CACO to 
CSARL, and then Pricewaterhouse, found that those same 
marketing intangibles had little value. Here is what they said 
in 2001 relative to the same type of a transfer. They described 
the intangibles being transferred now to CSARL from CACO as 
existing contracts with dealers; training programs; order 
tracking software, which was originally developed by 
Caterpillar U.S.; written sets of procedures and manuals, which 
were originally developed by Caterpillar U.S.; marketing 
brochures and a Web site, both of which were originally 
developed by Caterpillar U.S.; any other marketing-related 
intangibles such as customer and dealer lists; goodwill and 
going-concern.
    They found that particular marketing company, which was 
doing the same kind of marketing as CSARL, dealing with 
customers, dealing with the dealers, they found that those 
CSARL-like marketing intangibles were routine. Have you seen 
that exhibit, by the way?
    Mr. Wells. Yes, I have seen the exhibit, and I have it in 
front of me.
    Senator Levin. All right. I think it is Exhibit 13.1A\1\ Is 
that correct?
---------------------------------------------------------------------------
    \1\ See Exhibit No. 13, which appears in the Appendix on page 374.
---------------------------------------------------------------------------
    Mr. Wells. Yes, it is Exhibit 13.
    Senator Levin. All right. Now, they also said that these 
intangibles are common to most distribution and marketing 
companies, they only had limited economic life, easily 
reproduced, had little or no value on a stand-alone basis.
    Now, are those positions reconcilable?
    Mr. Wells. No, they are not reconcilable. And PwC, I think, 
in a subsequent email on page 92 of your Report, they, after 
the fact, tell you that it is not reconcilable, where they say, 
caveat, that in 2001 we said in another transaction there is no 
significant marketing intangibles. So even after they were 
maintaining that marketing intangibles magically or newly 
discovered intangibles were found, they recognized that making 
that argument, it was inconsistent and continues to be 
inconsistent with the CACO transaction, Senator Levin.
    And what I want to make sure that you and Senator McCain 
understand, that as to the CACO transaction, Section 367(d) 
gives a continuing, ongoing obligation every year for the next 
20 years after that transaction to true it up.
    Senator Levin. Now, there is another issue which has been 
referred to briefly, but I want to go into it, and that has to 
do with what was done from 1992 to 1998, which was to assign a 
routine profit to the divisions that performed routine business 
services and to assign the larger residual profit, called the 
``entrepreneurial profit,'' to the divisions that contributed 
directly to the creation of those residual profits.
    According to Caterpillar's internal management books, 
Caterpillar treated CSARL's predecessor, COSA, as a routine 
parts distributor and gave it only a routine share of non-U.S. 
parts profits in the range of 15 percent. That is before this 
transaction. But now after the transaction, after the CSARL 
transaction, Caterpillar maintained the same practice. On their 
internal management books to determine bonuses, CSARL continued 
to receive credit only for the type of routine profits 
allocated to a parts distributor, about 15 percent.
    So when it comes to paying income tax, Caterpillar reports 
to Uncle Sam that CSARL received about 85 percent of the 
profits for the parts business, but when it comes to bonuses, 
internal financial practices, that was not the case.
    Now, let me ask you both, does the fact that the 
accountable profits for bonus purposes did not change affect--
it would affect, I guess, anybody--as to which Caterpillar 
business functions created value and profit in the non-U.S. 
parts business?
    Mr. Avi-Yonah. It seems to me that is the most important 
indicator because that is what shows internally what the 
company valued it at, and I think that the IRS should look at 
these kind of compensation-related factors as a very important 
way to measure what the true profit assignable to each of their 
related companies is.
    Senator Levin. Professor Wells.
    Mr. Wells. Yes, we are getting to the same question, 
Senator Levin, and a court will use a number of data points to 
determine what are the real functions and what will it take 
for--what contribution of those functions to the overall 
profits. And so that would be another important data point.
    Senator Levin. OK. My time is up.
    Senator McCain. [Sen. McCain nodded that he had no 
questions at this time.]
    Senator Levin. All right. One of the common reasons that is 
offered for shifting profits under a licensing agreement to an 
offshore subsidiary in a tax haven is a claim by the U.S. 
parent that it also shifted the business risks to its offshore 
affiliate. The U.S. parent asserts, could assert that because 
the risk has been transferred, the offshore affiliate is 
entitled to the lion's share of the business profits. But here, 
using that line of reasoning, Caterpillar has claimed that 
CSARL now has the risk for the parts business because it ``owns 
the inventory.'' But Caterpillar also issues a consolidated 
financial statement that includes all of CSARL's financial 
results, which seems to me to indicate that Caterpillar retains 
the risk for the business. If something happens to that 
inventory, Caterpillar bears the risk, not just CSARL.
    So let me ask you both for your analysis on this point. Was 
the business risk really transferred to CSARL? Professor Avi-
Yonah.
    Mr. Avi-Yonah. I do not think you can transfer this kind of 
business risk. I mean, the risk to the parts business is the 
risk to the overall Caterpillar business. They build machines 
that only take these parts. To the extent that there is a risk 
to the parts business, it is a risk to the machines business, 
which is still centered in Caterpillar U.S. So there is no 
specific risk here that can be transferred. It is not like a 
situation where you develop an intangible and the research may 
succeed or may not succeed and you are putting that risk 
offshore. In this case, there was no risk independent of the 
risk of the entire business, and that remains in the United 
States.
    Mr. Wells. Senator Levin, they shifted the risk until they 
did not. You remember the virtual inventory in your opening 
statement? I think it said it was, well, we want to claim that 
one company is the sole owner except when the part is needed 
somewhere else, and then it is assigned over back and forth. 
Over 10 percent of the parts shift seamlessly back and forth.
    So the course and conduct of the parties would be necessary 
to look to. So, I think I would answer you in two parts. One, 
when you say I have the risk of the parts, but the parts are 
managed and controlled by Caterpillar Inc., and whenever 
Caterpillar Inc. wants to use the part for any other purpose, 
they can, and it seamlessly shifts back and forth, I think it 
takes away that defined, immediate ownership. Point No. 1.
    The second point I would argue is that even if there is a 
routine profit for being an entrepreneur, the value here has 
nothing to do with that entrepreneur function. It has to do 
with the business system. It has to do with what the 
independent dealers created, the logistics capability, the 
manufacturing, and the spare parts that are specially designed 
to work in equipment and are being sold and can get to that 
customer at a moment when there is an urgent need by the 
customer to pay for those parts. It is that business system 
that was created by Caterpillar Inc. that explains the residual 
profits. That is the intangible that needs to be valued.
    So if CSARL deserves some entrepreneur profit for 
speculating in spare parts, strip out the proprietary aspect of 
the spare parts; strip out the logistics residual profits 
related to the sophisticated logistical exercise and the 
algorithms and all the rest; strip out those to the appropriate 
functions, and allocate the profits to the functions that 
create those aspects of the residual value. And when you do, 
you will find that there is very little left for CSARL other 
than what Pricewaterhouse said in their CACO report that there 
is nothing other than a routine function that CACO performs 
compared to everything else that is building this mousetrap.
    Senator Levin. If the value of the CACO transfer was 
treated the same as CSARL's intangibles were, as claimed by 
Pricewaterhouse, doesn't that create a huge tax liability? In 
other words, if they were treated the same way, the CACO 
transfer, in terms of intangibles, don't you have a situation 
then where you have an ongoing tax liability for CACO and that 
means for America?
    Mr. Wells. Yes, that is true. And the point that Congress 
dealt with when they enacted Section 367(d) is that if 
marketing intangibles do leave the U.S. taxpayer, the U.S. 
taxpayer needs to be paid a royalty commensurate with the 
income created from that marketing intangible. So as the 
company says that we have found this newly discovered value, 
then the royalty would have to be upticked by a commensurate 
amount.
    Senator Levin. And I guess I would restate the question a 
little bit more clearly, by the way. If their analysis of the 
value of those intangibles carried the day when they discovered 
those intangibles in CSARL, well, now when CACO transfers those 
same intangibles, and if the same valuation method is used, 
then that would be a major transfer, would it not?
    Mr. Wells. It would.
    Senator Levin. And then would that not have an on going tax 
impact to Caterpillar because CACO is in the United States?
    Mr. Wells. That is true. And what is also true, Senator 
Levin, is we would also have to ask the question, these newly 
discovered intangibles, did they come from a U.S. company in 
another transaction? Did they matriculate over to CSARL? And if 
so, then there needs to be a super royalty for those as well.
    Senator Levin. All right. Would you agree with that?
    Mr. Avi-Yonah. Yes.
    Senator Levin. OK. Just my last question, and this has to 
do with the question that PwC, as Caterpillar's tax consultant, 
proposed, designed, and implemented this tax strategy that led 
to the formation we have just described. Now, at the same time, 
Pricewaterhouse performs two functions; in other words, it is 
Caterpillar's independent auditor, but it is also its tax 
consultant, advising on Swiss tax strategy. So one of the 
auditors responsible for advising on tax issues, on the audit, 
at the same time spent about a third of his time working with 
his tax consultant colleagues on the Swiss tax strategy.
    So during this several-year period, Caterpillar paid PwC's 
tax consulting service over $80 million, including more than 
$55 million for the Caterpillar Swiss tax strategy, while 
paying PwC's auditing service more than $200 million.
    Now, when an independent auditor approves the tax strategy 
proposed by its own colleagues, it creates an appearance of a 
conflict of interest, and I want to be clear that Sarbanes-
Oxley permits an accounting firm to provide tax consulting 
service while acting as a company's auditor if the company's 
board of directors gives its approval. And I want to be clear 
that the Caterpillar Board of Directors provided that approval. 
So there is no suggestion here that there was any violation of 
Sarbanes-Oxley. That is not my question.
    The question is: Should that be allowed? Because I think 
that is something we can perhaps get some expert testimony from 
you on this. Should a board of directors approve this kind of 
arrangement? They did, and I am not suggesting a violation of 
Sarbanes-Oxley, because they did approve it. But I just want to 
spend 1 minute before we turn to our next panel on this 
subject, because this goes to whether or not we should change 
the law in this regard. Professor Avi-Yonah.
    Mr. Avi-Yonah. I think we should. I do not think this 
should be allowed. I think there is an inherent apparent 
conflict of interest when the independent auditor is also the 
person that is devising the tax strategy that the independent 
auditor is supposed to pass on. And under our new FIN 48 and 
its successor rules, there has to be an opinion that a tax 
strategy is more likely than not to succeed in order not to 
take a reserve on the financials, and when it is the same 
person doing both, then obviously you would reach that level 
more easily than when it is an independent person evaluating 
it. So I think we should change the law to make this kind of 
situation impossible.
    Senator Levin. Professor Wells.
    Mr. Wells. I do not disagree with that, but I do want to 
say that, again, under current law, I think that 
Pricewaterhouse and Caterpillar, from what I have seen, did 
everything they needed to do to appropriately inform their 
board to get the appropriate permission.
    Senator Levin. Right.
    Mr. Wells. So I want to make clear that----
    Senator Levin. I made it clear in my question.
    Mr. Wells. You did, and I just want to make it clear in my 
response that I do not think under current law there was any 
ethical or legal violation of Sarbanes-Oxley. I think that 
looking at having more silos between the person that is 
proposing tax strategies and the independent auditor is a fine 
thing to think through and perhaps needs to be recommended.
    Senator Levin. All right. And, again, I think it was clear 
that we were not suggesting otherwise.
    We had a picture up there of a mining truck where the parts 
profits go to Switzerland but that is about the only 
relationship that Switzerland had, the profits. There was no 
manufacturer of anything other than, United States, and it was 
sold in Canada, this mining equipment. So the question is 
whether or not you can assign income that way. Is there not a 
judicial doctrine that prohibits an inequitable distribution of 
profits that results from a taxpayer separating the fruit, or 
the income, as I think Professor Wells talked about, from the 
tree on which it grew? Can you explain how an assignment of 
income doctrine might apply to the facts in this case study?
    Mr. Avi-Yonah. So if you think of the sale of a part as 
something that is inextricably related to the sale of the 
machine that the parts fit into--and this is the way that both 
the company and PricewaterhouseCoopers described it, both in 
the board discussion where it discusses it as an annuity that 
flows out of the sale of the machine, in the seed-grow-harvest 
model that Professor Wells alluded to, in the PwC transfer 
price interpretation, the parts are always linked to the sale 
of the machines. If that is the case--and I think the IRS can 
make a good argument and a court may well accept an argument 
that the profit from the sale of the parts is inextricably 
linked to the profit from the sale of machines, and if that is 
the case, if the sale of the machines continues to be--the 
machines continue to be made in the United States and exported 
from the United States, the profit from the sale of the parts 
should go with the machine, including in the case of these 
mining trucks.
    Senator Levin. Professor Wells, do you have anything more 
to add on that?
    Mr. Wells. Other than I agree with the statement that 
Professor Avi-Yonah said.
    Senator Levin. Thank you. You are excused. We will move to 
our second panel.
    We will now call our second panel of witnesses for today's 
hearing: Thomas F. Quinn, a tax partner at 
PricewaterhouseCoopers in Chicago, Illinois; Steven Williams, a 
managing director at Price-waterhouseCoopers in McLean, 
Virginia; and James Bowers, a tax partner at 
PricewaterhouseCoopers in Dallas, Texas. We appreciate all of 
you being with us today. We look forward to your testimony, and 
I think as you have heard, pursuant to Rule 6, all witnesses 
who testify before the Subcommittee are required to be sworn. I 
would ask that you now just stand and raise your right hands.
    Do you swear that the testimony you are about to give 
before the Subcommittee will be the truth, the whole truth, and 
nothing but the truth, so help you, God?
    Mr. Quinn. I do.
    Mr. Bowers. I do.
    Mr. Williams. I do.
    Senator Levin. Thank you.
    We will be using the timing system today, which means that 
about a minute before the red lights comes on, you will see a 
light change from green to yellow. That will give you an 
opportunity to conclude your remarks. Your written testimony, 
of course, will be printed in the record in its entirety, and 
we would ask that your oral testimony be minutes less.
    And * understand, Mr. Quinn, that you are going to be 
presenting the PricewaterhouseCoopers statement, so please 
proceed, with our thanks for being here today.

      TESTIMONY OF THOMAS F. QUINN,\1\ TAX PARTNER, PRICE-
WATERHOUSECOOPERS LLP, CHICAGO, ILLINOIS; ACCOMPANIED BY JAMES 
  G. BOWERS, TAX PARTNER, PRICEWATERHOUSECOOPERS LLP, DALLAS, 
       TEXAS; AND STEVEN R. WILLIAMS, MANAGING DIRECTOR, 
         PRICEWATERHOUSECOOPERS, LLP, MCLEAN, VIRGINIA

    Mr. Quinn. Thank you. Good morning, Chairman Levin, Ranking 
Member McCain, and Members of the Subcommittee. I am going to 
make some brief oral remarks, but I will ask that my written 
statement be placed in the record.
---------------------------------------------------------------------------
    \1\ The prepared statement of Mr. Quinn appears in the Appendix on 
page 116.
---------------------------------------------------------------------------
    Senator Levin. And it will.
    Mr. Quinn. My name is Thomas Quinn. I am a Certified Public 
Accountant (CPA) and a partner at PricewaterhouseCoopers. I 
began my career with PwC in 1984 and have been advising 
companies with respect to their Federal income tax obligations 
for over 30 years. I am joined by James Bowers, who also is a 
CPA and a partner in PwC's tax practice. Having joined PwC in 
1976, Mr. Bowers has been advising clients with respect to 
their tax obligations for over 37 years. I am also joined by 
Steven Williams, a managing director with PwC. Mr. Williams is 
an economist and holds a master's degree with a concentration 
in international economics. He has been with PwC since 1982 and 
has specialized in transfer pricing for 28 years.
    I understand that today's hearing relates to the tax 
implications of a business reorganization that Caterpillar Inc. 
began almost 15 years ago. I was one of the PwC partners who 
provided tax advice to Caterpillar and its outside law firm, 
McDermott Will & Emery, in connection with that matter. Mr. 
Bowers is a tax partner who assisted PwC's audit team with its 
audit of the tax aspects of Caterpillar's financial statements. 
And Mr. Williams provided Caterpillar with assistance regarding 
transfer pricing rules.
    At the outset, let me say on behalf of PwC that we 
recognize both the longstanding interest of this Subcommittee 
in corporate tax issues and the importance of those issues. In 
that spirit, PwC has cooperated fully with the Subcommittee 
throughout this inquiry and has willingly accepted your 
invitation to testify here this morning.
    Before addressing our engagement with Caterpillar, allow me 
to provide an overview of PwC's tax practice. PwC is the 
leading provider of tax services worldwide in terms of both the 
size and scope of our tax practice and, we believe, in terms of 
our reputation. We strive to combine our specialized tax 
knowledge in national and local jurisdictions with a deep 
understanding of our clients' business and economic 
environments in order to assist them with their tax compliance 
obligations across the globe.
    In working with multinational businesses, we routinely 
evaluate issues of international taxation, which can be 
particularly complex.
    Caterpillar is one of the world's largest manufacturers of 
construction and mining equipment, diesel and natural gas 
engines, and industrial gas turbines. Caterpillar and its 
subsidiaries sell more than 300 different types of products to 
customers in 180 countries from facilities on six continents.
    Caterpillar and its subsidiaries sell both machines as well 
as replacement parts for those machines. Machine sales lead to 
parts sales, and parts sales support and encourage machine 
sales. There is no separate parts business. It is an integrated 
activity organized around Caterpillar's product groups, and it 
is designed to maximize both value to its customers and 
Caterpillar's profitability.
    Demand for replacement parts is derived from the 
independent dealer network and the field population of 
machines. That demand is then fulfilled through its logistics 
organization.
    Caterpillar's business has been expanding throughout the 
world to meet increasing global demand. In the late 1990s, 
sales outside the United States accounted for more than 50 
percent of consolidated sales. Today more than 65 percent of 
sales are outside of the United States. To meet that demand, 
Caterpillar has established subsidiaries outside the United 
States to market its products and provide product support 
abroad.
    Caterpillar also has expanded subsidiary manufacturing 
facilities worldwide to meet global demand for its products. 
Today the Caterpillar Group manufactures products in more than 
20 countries. In short, Caterpillar has transformed itself from 
a U.S.-based manufacturer of machines and parts for sale to 
U.S. dealers into a global manufacturer of products and parts 
for dealers around the world.
    In 1998, as the globalization of Caterpillar's business 
continued to evolve, Caterpillar engaged McDermott and PwC to 
advise the company with respect to its international tax 
position. To develop our advice, PwC tax professionals first 
engaged in an extensive study of Caterpillar's organization and 
its global operating footprint, spending considerable time at 
Caterpillar's operating facilities all over the world. We 
observed that this business organization as it existed in 1998 
failed to capture the evolution of the true economics of the 
business and subjected to current U.S. income taxation income 
earned from the sale of products to foreign customers largely 
as a result of the Subpart F rules.
    Working with Caterpillar's operations group, its tax 
department, and McDermott, we analyzed alternatives that would 
better align the true economics of the business with 
Caterpillar's operations and positively affect its global 
effective income tax rate.
    After reviewing the information provided by McDermott and 
PwC, and in light of the evolution of its global operating 
footprint, Caterpillar decided to undertake a significant 
reorganization of its foreign operations.
    Considering the growth of its foreign operations, 
Caterpillar determined that it made business sense to 
centralize within one company the manufacture and distribution 
of products outside of the United States. Through Caterpillar 
Overseas, Caterpillar already had a substantial business 
presence in Switzerland, with hundreds of personnel based in a 
multi-story facility in Geneva, including a number of key 
corporate executives.
    Beginning in 1999, Caterpillar Overseas transferred its 
assets and its operations to Caterpillar SARL, a company based 
in Switzerland. Over the next few years, Caterpillar SARL took 
over operations across the globe to handle sales of machines 
and parts outside of the United States. Caterpillar Inc. 
continued to handle sales of parts and machines in the United 
States.
    From its outset, Caterpillar SARL carried the business and 
market risks and received the profits or losses from being the 
owner and seller of the machines and purchased finished 
replacement parts (PFRPs), in the international markets. 
Caterpillar SARL purchased finished parts directly from third-
party suppliers and sold finished parts directly to third-party 
dealers. Because the sales no longer involved a related-party 
transaction between Caterpillar and its foreign affiliates, or 
between foreign affiliates themselves, they were subject to the 
fundamental U.S. tax rule that foreign business income is not 
taxed until the income is remitted to Caterpillar in the United 
States. The reorganization culminated in changes to roles and 
responsibilities, had significant operating, legal, and 
economic effects, and resulted in significant tax savings.
    After the global business reorganization, Caterpillar 
Inc.'s role included acting as a service provider for certain 
purchases made by Caterpillar SARL in exchange for a service 
fee. Caterpillar also licensed its rights to Caterpillar SARL 
to make machines, to purchase and distribute replacement parts, 
and to use Caterpillar technology and trademarks on those 
products for sale outside the United States in exchange for a 
license fee.
    Because Caterpillar and Caterpillar SARL were related 
companies, these payments were subject to IRS transfer pricing 
rules. PwC tested these prices annually, not only under the 
Best Method, as required by U.S. law, but also under each of 
the other relevant transfer pricing methods prescribed by the 
Treasury regulations. Each analysis supported the arm's-length 
nature of Caterpillar's related-party pricing.
    In addition to providing these tax services, PwC has also 
been auditing Caterpillar's financial statements for many 
years. We have been asked to address the applicable auditor 
independence rules.
    The delivery of tax consulting services to audit clients 
subject to applicable safeguards has long been permitted by the 
rules of the Securities and Exchange Commission (SEC), the 
Public Company Accounting Oversight Board (PCAOB), and the 
American Institute of Certfified Public Accountants (AICPA). 
PwC's tax and audit services to Caterpillar complied with these 
independence standards. PwC assessed its independence on a 
quarterly and yearly basis and disclosed to Caterpillar's Audit 
Committee any relationship that bore on our independence. PwC's 
provision of tax services to Caterpillar as our audit client 
was entirely appropriate.
    Chairman Levin and Members of the Subcommittee, thank you 
again for this opportunity to testify about PwC's tax services 
with respect to Caterpillar. We firmly believed then, and 
firmly believe today, that the tax services we provided and the 
positions that Caterpillar took in that regard complied with 
the law and were entirely appropriate. Likewise, we believe 
that our tax and audit engagements satisfied both the letter 
and the spirit of the independence rules that govern our 
practice.
    We would be happy to answer any questions you have.
    Senator Levin. Thank you very much, Mr. Quinn. We 
understand you are giving the statement for all three. Is that 
correct?
    Mr. Quinn. That is correct.
    Senator Levin. All right. Thank you so much, and thank you 
again for being here and your cooperation with our 
Subcommittee.
    Mr. Quinn, I gather you were the lead partner for PwC tax 
consulting. Did Mr. Williams report to you at that time?
    Mr. Quinn. That is correct.
    Senator Levin. And Mr. Bowers was in the auditing shop. Is 
that correct?
    Mr. Quinn. Mr. Bowers is a tax partner who assisted the 
audit practice with their audit of the financial statements of 
Caterpillar.
    Senator Levin. OK. And the key contacts in Caterpillar for 
you were the people in the company's Tax Department. Is that 
correct?
    Mr. Quinn. In part, Senator, that is true. We also had 
significant contact with individuals in the Operations 
Department of Caterpillar. The tax strategy that was developed 
was dependent very much on the understanding of the operations 
of the business, and contact with them was critical.
    Senator Levin. OK. Now, prior to the tax consulting 
engagement, Caterpillar had been reporting most of the income 
from the sale of its replacement parts outside of the United 
States on its U.S. tax return. Is that correct?
    Mr. Quinn. That is correct.
    Senator Levin. And that is when it sold parts to 
Caterpillar's non-U.S. dealers. Is that correct?
    Mr. Quinn. Yes.
    Senator Levin. And so 85 percent or more of its non-U.S. 
parts sales income was included on Caterpillar's U.S. tax 
return. Is that correct?
    Mr. Quinn. That is correct.
    Senator Levin. After Caterpillar executed the CSARL 
transaction, starting in 1999, is it correct that Caterpillar 
basically reversed those percentages and allocated 15 percent 
or less of the non-U.S. parts income to itself in the United 
States and 85 percent or more to CSARL in Switzerland, which 
had an effective tax rate of somewhere between 4 and 6 percent? 
Is that correct?
    Mr. Quinn. That is correct. In terms of the arrangement 
that Caterpillar had with respect to its relationship with 
Caterpillar SARL, it was, in fact, a business arrangement that 
included a license for more than just the parts activities 
themselves, but it included the entire business activities 
undertaken by Caterpillar SARL, which included their 
manufacturing machines in France and Belgium as well.
    Senator Levin. All right. But the basic, in terms of the 
profits on the parts themselves, there was a shift between 85/
15 to basically 15 and 85. Is that correct? Just looking at the 
parts.
    Mr. Quinn. Yes, that is correct.
    Senator Levin. OK. Now, if you would take a look at Exhibit 
7.\1\
---------------------------------------------------------------------------
    \1\ See Exhibit No. 7, which appears in the Appendix on page 343.
---------------------------------------------------------------------------
    [Pause.]
    Mr. Quinn. OK. Yes, I have that, Senator.
    Senator Levin. All right. Well, before we get to the fact 
that you were hired in 1998 by Caterpillar through its tax 
advisor, McDermott Will & Emery, to review Caterpillar's 
operations and to recommend ways to lower Caterpillar's overall 
tax payments--is that correct, by the way?
    Mr. Quinn. Yes, that is correct.
    Senator Levin. OK. Is it not true that PwC had an ongoing 
program called Global Tax Optimization Program (GTOP), to 
reduce corporate taxes? Is that true?
    Mr. Quinn. Yes, correct.
    Senator Levin. And PwC approached a number of U.S. 
corporations to talk to them about a GTOP program. Is that 
correct?
    Mr. Quinn. That is correct.
    Senator Levin. So that your tax strategy--the Caterpillar 
tax strategy was a result of a PwC GTOP effort. Is that 
correct?
    Mr. Quinn. If I could----
    Senator Levin. It followed that presentation.
    Mr. Quinn. It followed that presentation, yes.
    Senator Levin. All right. Now, the tax consultants, PwC, 
conducted a review of Caterpillar's operations and in 1998 gave 
Caterpillar a list of 49 possible ways to lower its taxes, one 
of which was the Swiss tax strategy that involved assigning 
non-U.S. parts profits to a Swiss affiliate, and that is 
Exhibit 7. Is that correct?
    Mr. Quinn. This Exhibit 7 is from that report and is part 
of that original investigation, yes.
    Senator Levin. OK. And was this the strategy that was 
adopted finally?
    Mr. Quinn. In very simplified form, yes.
    Senator Levin. All right. Now, if you will take a look at 
the top of that exhibit, this is labeled 4618 at the bottom--
the purpose was to get CAT Inc. out of chain. That is the top 
headline: ``Recharacterize Marketing Company Income to Achieve 
U.S. Tax Deferral.'' Do you read that line?
    Mr. Quinn. Yes.
    Senator Levin. That was its purpose. Right?
    Mr. Quinn. Yes, that is correct.
    Senator Levin. OK. And the description of the idea was to, 
``Remove Caterpillar Inc. from the chain of title passage for 
purchased finished parts (from U.S. or foreign sources) sold to 
foreign marketers. The foreign marketers would then buy from 
and sell to unrelated parties.''
    So this was the description of the idea, your own 
description.
    Mr. Quinn. Yes, correct. This is a PwC document.
    Senator Levin. That is correct, to ``Remove . . . from the 
chain of title . . . for purchased . . . parts.''
    The benefits: ``Eliminates subpart F character of foreign 
marketers profits on purchased finished parts sales.'' And, 
``Relatively simple re-invoicing requirements.'' Do you read 
those words there?
    Mr. Quinn. I do.
    Senator Levin. Did I read those correctly.
    Mr. Quinn. I would also reflect on those, Senator, that in 
light of--this was done at the beginning of the project in 
terms of providing ideas in response to Caterpillar's Tax 
Department with respect to our investigation.
    Senator Levin. Right.
    Mr. Quinn. I could tell you, reading these words, 
``Relatively simple re-invoicing requirements,'' that following 
the implementation of this, those relatively simple re-
invoicing requirements took probably 3 to 4 years of very 
difficult work by Caterpillar's systems team in order to 
implement.
    Senator Levin. All right. Well, we will also get to the 
implementation in a minute.
    From 1999 to 2004, PwC was paid about, what, $55 million to 
implement this tax strategy? Is that correct?
    Mr. Quinn. That is correct.
    Senator Levin. Now, is it fair to say that you and Mr. 
Williams helped design and implement this strategy from the 
very beginning in 1999 and that Mr. Bowers worked at the same 
time that he provided tax advice to the audit team, he was 
working with you? Is that correct?
    Mr. Bowers. That is correct, Senator.
    Senator Levin. And, Mr. Quinn, were you the lead partner 
for PwC tax consulting services on this matter?
    Mr. Quinn. Yes, I was.
    Senator Levin. And did Mr. Williams report to you?
    Mr. Quinn. Yes.
    Senator Levin. And you mentioned some of the key contacts 
at Caterpillar. Among them were Robin Beran--I am asking you, 
were they Robin Beran, the tax director; Rodney Perkins, senior 
international tax manager?
    Mr. Quinn. Yes, we had regular interaction.
    Senator Levin. All right. My first round time is over. 
Senator Johnson.
    Senator Johnson. Thank you, Mr. Chairman.
    Mr. Quinn, in the earlier panel I was asking the professors 
the basic relationship--how does the IRS interact with a large 
multinational corporation. I would like to expand that not to a 
large multinational corporation like Caterpillar but also to a 
large accounting firm like yourselves. Can you describe how the 
IRS interacts during the whole tax year?
    Mr. Quinn. So the IRS' interaction at Caterpillar in 
particular during the entire year is a continuous audit 
exercise, as you described earlier. They do maintain a 
continuous presence onsite. They actively engage with 
Caterpillar personnel directly. We do not have direct 
interaction with the IRS, only through Caterpillar, and when 
invited in by Caterpillar to assist them in those matters.
    Senator Johnson. Was there any consulting done, as you were 
working with Caterpillar, to obviously comply with the law but 
potentially lower their tax burden, was there any contact with 
the IRS by either yourself or Caterpillar during that point in 
time?
    Mr. Quinn. No, I had no contact with the IRS.
    Senator Johnson. Do you know whether Caterpillar did?
    Mr. Quinn. I do not know that.
    Senator Johnson. You are obviously familiar with Enron and 
a firm that used to be called Arthur Andersen?
    Mr. Quinn. I am.
    Senator Johnson. Would you say most CPAs or most accounting 
firms are pretty familiar with that situation?
    Mr. Quinn. Yes.
    Senator Johnson. Would you say what happened to Arthur 
Andersen, which no longer exists because of the Enron scandal, 
is that something that in general disciplines the accounting 
profession?
    Mr. Quinn. Absolutely. I think in reflection upon those 
events, it has been--in terms of my involvement in the 
profession, that was a considerable change following that 
activity.
    Senator Johnson. Can you talk a little bit about tax 
avoidance versus tax evasion?
    Mr. Quinn. Sure. I think the earlier panel described that 
accurately, correctly: that tax evasion is illegal, tax 
avoidance is appropriate in terms of managing your overall 
costs associated with your business, as long as it is done 
within the rules and regulations as provided by the tax 
authorities.
    Senator Johnson. So in light of obviously what happened to 
Arthur Andersen with the Enron scandal, you are preparing these 
types of documents, now they are being shown in a Senate 
hearing. Would these concern you if all of a sudden the IRS 
were to take a look at this and your interaction? Do you think 
this is basically what accountants do in working with their 
clients to comply with the tax code?
    Mr. Quinn. Yes, I do. Earlier, Senator, I think you had 
made a statement to the last panel about if you saw a tax rate 
of 29 percent, what would be your response to your manager of 
your Federal tax function? At the time that we started this 
project, Caterpillar's tax rate was 35, 36 percent, effective 
tax rate, and that is exactly what management was asking in the 
Caterpillar Tax Department and its service providers.
    Senator Johnson. That was actually the next question I was 
going to ask. How does that relate to other large multinational 
manufacturers? Well, first of all, 35, 36 percent, where is 
that in the range of effective tax rates for a multinational?
    Mr. Quinn. I would think that based upon my study in this 
area that 35, 36 would be not unusual for a manufacturing 
company which had its sales based all within the United States. 
When we take a look at those domestic companies that do not 
have extensive international operations, a tax rate between 35 
and 39 percent is very much the rule.
    Senator Johnson. Again, that is when all your operations 
and all your sales are in the United States.?
    Mr. Quinn. Yes, correct.
    Senator Johnson. And then what happens, of course, if you 
are a multinational and you have 65 to 70 percent of your sales 
going overseas?
    Mr. Quinn. That would depend on how you would organize 
those transactions and those affairs. As was addressed, again, 
in the earlier panel many times those operations are subject 
not only to tax in the foreign jurisdiction, but because of the 
way they have been organized, they may be subject to U.S. tax 
at the same time. This document that we just looked at, this 
exhibit, is a good example of that, where Caterpillar did, in 
fact, have an extensive amount of international operations, but 
the way that the business had been structured, the way that the 
Operations Department had put in place the relationships it had 
in moving product to the international markets created a cost 
which could be avoided.
    Senator Johnson. And there is nothing wrong with any 
taxpayer trying to comply with the tax code and trying to lower 
their tax burden, correct?
    Mr. Quinn. That is correct.
    Senator Johnson. Can you talk a little bit about the types 
of tax laws that have been enacted by Congress to incentivize 
manufacturers to export product overseas? Can you just name 
some of the tax treatments that this body has actually enacted 
to induce that exact type of behavior that Caterpillar was 
engaged in?
    Mr. Quinn. Yes, certainly. That history goes back many 
years. Back when I first started practicing in the 1980s, the 
Domestic International Sales Corporation was promoted as an 
export incentive. That was succeeded by the Foreign Sales 
Corporation, which was a tremendous benefit for U.S. exporters, 
U.S. manufacturers, including Caterpillar.
    Senator Johnson. Exactly what did that do?
    Mr. Quinn. It incentivized companies to do manufacturing in 
the United States. With respect to the income that was earned 
on those transactions, it reduced their effective tax rate as 
much as 5 percent. So rather than paying 35 percent on that 
income, it would be closer to 30 percent.
    Senator Johnson. I had an earlier discussion with the 
previous panel that if we tried to change the tax law to try 
and capture more of the income on foreign sales, what would a 
large multinational corporation at least consider doing?
    Mr. Quinn. I think exactly what you suggested: They would 
move operations offshore. They would move those functions and 
those jobs to foreign locations outside of the United States. 
The differential in tax rate is so great that you could not 
ignore that as a steward of the corporate assets.
    Senator Johnson. Are you aware of other businesses, maybe 
other of your clients, have done exactly that?
    Mr. Quinn. They have, in fact, yes.
    Senator Johnson. Do you care to name any examples? Or 
probably not the appropriate place to do it.
    Mr. Quinn. I would prefer not to.
    Senator Johnson. OK. Thank you very much, Mr. Quinn.
    Thank you, Mr. Chairman.
    Senator Levin. Thank you, Senator Johnson.
    Senator Paul.
    Senator Paul. Thank you. I would like to take my time to 
apologize to Caterpillar for this proceeding. I think rather 
than having an inquisition, we should probably bring 
Caterpillar here and give them an award. They have been in 
business for over 100 years. It is not easy to stay in 
business. It is not easy to start a business, but to keep a 
business employing 52,000 people for over 100 years is a 
remarkable achievement, and we should be complimenting 
Caterpillar and perhaps giving them an award.
    Caterpillar not only employs 52,000 people but pays $600 
million in taxes every year. So, really, we have the wrong 
people on trial here. The tax code needs to be on trial here. 
It would be malpractice for PricewaterhouseCoopers to give 
advice to Caterpillar saying, well, we are not going to tell 
you how to minimize your taxes, but here is how to maximize 
your taxes. They would actually--they probably could be sued 
for giving bad advice on how not to minimize tax costs.
    So I think we are making a great mistake here, and we have 
to understand that behavior, legal behavior, to minimize your 
taxes is really your responsibility if you have stockholders. 
You have to do that. It is a requirement that you try to 
minimize your costs. So rather than chastising Caterpillar, we 
should be complimenting them.
    It is a big error not to know where the problem is here. 
The problem is in the tax code. Money is said to go where it is 
welcome. Some money is going overseas. For decades we have been 
lamenting the loss of American jobs overseas. Why? Because it 
is the tax code. We have the highest corporate tax rate in the 
world. Canada is now down to 15 percent. So you can see how 
what we are doing is pushing people and pushing people and 
pushing people, and then we bring them forward for ridicule and 
to swear an oath and to pry into every nook and cranny of their 
legal tax behavior. It is insulting to American business, and 
it should not occur. We should be doing the opposite. We should 
be giving an award to an American business that creates 52,000 
jobs.
    There are some policy matters that we could address. Why 
don't we lower the corporate income tax? We are at 35, give or 
take, throw in the State, 39-percent rate. Why don't we lower 
the corporate income tax if we want businesses to stay here? If 
we want to encourage profit earned overseas to come home, why 
don't we have a low repatriation tax, 5-percent repatriation 
tax? When we did it in 2005, $20, $30 billion in revenue and 
hundreds of billions of dollars in income came back to the 
country to create jobs. Why don't we do that instead of 
vilifying people for legal behavior?
    I guess my question ultimately would be: Do you have a 
legal responsibility to offer to companies that ask you or 
advice, are you legally responsible for offering advice that 
would minimize their tax costs? If you were to not tell a 
company about a legal option to reduce their taxes, could a 
company potentially sue you for not giving you complete advice?
    Mr. Quinn. I think, Senator, that is our professional 
proposition to our clients and their expectation is that when 
they come to us, we have an expertise in understanding the tax 
law, the rules, the regulations, and we can help them 
understand that so that they can take a look at their bona fide 
business transactions and understand what the tax cost is that 
is associated with those.
    So, yes, that is a client's expectation of what we are 
bringing them, and even if it were not a legal issue, it would 
be from the standpoint of professionalism, I think, would be 
less than what was expected.
    Senator Paul. Thank you.
    Senator Levin. Are you done, Senator Paul?
    Senator Paul. Yes.
    Senator Levin. OK. Senator Portman.
    Senator Portman. Thank you, Mr. Chairman, and I appreciate 
you all being here. I know we have another panel coming up, and 
I would like to have the opportunity to talk with them as well. 
But to me, the problem here is not Caterpillar. It is a broken 
tax code. And I think this is not just an important matter; I 
think it is an urgent matter.
    In response to the question Mr. Johnson asked earlier, you 
indicated that some of your other clients are actually moving 
some of their operations overseas. It is happening as we sit 
here today. And it is a fiduciary responsibility if you are a 
publicly traded company, as was said earlier, to look where you 
can maximize your profits for the stakeholders. I am very 
concerned about it. In my own State of Ohio, we have companies 
that have left our State to be domiciled somewhere else because 
of the tax laws. One company merged with a company one-quarter 
its size in Ireland in order to take advantage of the lower 
rates in Ireland. Their headquarters is now not in Cleveland, 
Ohio; we lost one of our Fortune 500 companies to Ireland.
    I am a beer drinker. If you want to try an American beer, 
good luck. Luckily, I like Sam Adams and Yuengling. They are 
the biggest now. They have 1-percent market share each. Every 
other beer company is now foreign owned. And when I ask people 
why, including the folks who purchased these companies, they 
tell me it is the tax code. And this is a big deal. It is not 
just the loss of jobs, although that happens. It is also the 
loss of corporate headquarters, which has an intangible impact 
on all of our communities, including a lot of the good work 
that our companies do here for nonprofits and to help make a 
better way of life for everybody in those communities.
    So this is not just an important matter. It is an urgent 
matter. For that, I thank the Chairman for holding this hearing 
because I hope it will shine a light on the fact that we have a 
broken code, not just the highest rate among all the developed 
countries now, which is not a No. 1 you want to have. Now that 
Japan has lowered its rate, we are No. 1. The fact is that we 
have an international tax code system that is so non-
competitive and so complicated that it is driving jobs, 
investment, and capital overseas.
    Of our OECD partners, the other developed countries, almost 
all of them have gone, as you know, to territorial systems. If 
you could talk about that for a second, I would appreciate it. 
Mr. Quinn, you may be the right person, but you all decide. 
What impact is this having on your clients as they look at what 
their options are going forward? Because of the U.S. tax law 
being so antiquated, inefficient, and non-competitive, what 
impact does it have on them? And specifically if you could 
address not just the rate being so high but the fact that we 
have a worldwide tax system that makes it difficult for them to 
be able to do business overseas and easier for them to move 
their businesses overseas?
    Mr. Quinn. Yes, it is the issue that is at the forefront of 
many decisions and many conversations that are taking place 
within corporate tax departments throughout the population of 
U.S.-based multinational companies, that this debate around how 
the United States has decided to tax foreign earnings is one 
that is of critical importance. As U.S. companies continue to 
grow and expand offshore, that cost becomes an increasingly 
larger portion of their overall cost structure for their 
business and impacts their ability to compete with foreign 
companies.
    As you said, we are one of the few, if not the last 
remaining country which still taxes worldwide earnings, that 
does not employ a territorial system. And that is a 
considerable competitive disadvantage when companies are trying 
to compete against companies that do not have the same tax 
burden, even in the United States, that a U.S.-based MNC might 
have.
    Senator, a lot of the debate that I hear, the discussions 
that take place among my clients, a lot of it has to do with 
rate as well. It is not just the basis of taxation but the rate 
that applies. And I think there was some questioning earlier 
about, well, what is the right rate that would incent this type 
of activity or cause this activity to go away. I think if the 
U.S. corporations could be subject to a rate of tax of 20 
percent or less, there would probably be very little incentive 
to continue moving business activities outside of the United 
States.
    If you think about the opportunity now and express it in 
percentage terms, the opportunity to move from a 35-percent tax 
rate to a 10-percent tax rate is a 25-percentage-point 
improvement. That is material. When you start talking about a 
20-percent tax rate moving to a 10-percent tax rate, that is 
only 10 percentage points, and it becomes, when you look at the 
costs and the relative benefits, much more of a push. So I 
think that companies might be looking at both sides of that 
question, both the basis of taxation in terms of the need for a 
territorial system, as well as the tax rate that would apply. 
Their feeling is that you might actually, at a lower tax rate, 
bring more income into the U.S. tax net.
    Senator Portman. I think that is very likely. In fact, you 
would see a lot of repatriation, wouldn't you, of the nearly $2 
trillion that is now tied up overseas? People are not going to 
bring it back at the high rate. So the two are combined.
    Let me just make the obvious point, which is that we have 
done this before.
    Mr. Quinn. We have.
    Senator Portman. In the 1980s, we looked at our tax code 
and said let's end up with a rate that is below the average to 
be competitive. And this was in the 1986 Tax Reform Act, and we 
took the rate, as you recall, down to 34 percent, thinking that 
that was getting us below the average. To get to below the 
average now, we would have to be, when you include our States 
corporate rates, as you indicate, somewhere in the low 20s 
probably; 25 is the rate that some of us talk about. But you 
need to get at least to that, which is probably right in the 
middle.
    Since 1980s, isn't it true that every other one of our 
competitors around the world--all the other countries have 
reformed their codes. Every one of them has, except us. We are 
the ones left on the sidelines, and those reforms have 
included, as you indicate, going to a system of taxation that 
is more territorial, but also lowering the rates. And that 
combination of our competitives allowing companies to pay their 
income taxes where their earnings occur and a lower rate has 
made us non-competitive.
    So I think the United States, frankly, has waited way too 
long to make these reforms while every other country in the 
world that we compete with has moved ahead and gotten a more 
competitive tax system. And that is why it is urgent that we 
act now.
    By the way, on the international side, it has been since 
the 1960s. So since the 1960s, we have not changed; whereas, 
all of our own OECD countries, all our developed competitives 
have adjusted.
    I hope that you can be in a position in the next few years 
to be able to tell your clients, ``You know what? There is a 
new tax code that actually encourages you to stay in America 
and create your jobs here, and that is why we at PwC think you 
ought to stay here in America and take advantage of a better 
environment for success.''
    Thank you, Mr. Chairman.
    Senator Levin. Thank you very much, Senator Portman.
    First of all, without doubt we have to reform our tax code. 
It is long overdue. Congress has been dawdling on this subject 
for a long time. You can argue what the corporate tax rate is 
currently. A Government Accountability Office (GAO) study says 
the effective corporate tax rate in the United States is 13 
percent. But in any event, the use of all these tax loopholes, 
many of which give incentives to shift your profits to tax 
havens--not your operations, your profits to tax havens--is 
totally unacceptable. We ought to close those tax loopholes and 
not wait for a total reform of the tax code because that could 
be an endless wait. We cannot tolerate the loss of our taxable 
revenue the way it is currently lost to Uncle Sam, which is the 
use of these tax loopholes, which are unjustified and which are 
exploited and pushed over the limit at times. And we have had 
hearing after hearing which shows that. And I do not think we 
ought to accept it.
    Of course, this company is a terrific company. That is not 
the question. And, of course, it pays taxes. That is not the 
question. The question is whether or not it properly avoided 
paying $300 million a year in taxes, which is what its tax 
saving is now as a result of this strategy. That is the 
question. We are very happy it pays $600 million a year in 
taxes. Should it pay $900 million? That is the question. That 
is a heck of a lot of money. But that is the issue, and we are 
not going to be distracted by the fact that this is one 
terrific American company. That is not the issue. The issue is: 
Was there a tax strategy here which was put in place which is 
justified under the current tax code? Change the code, I am all 
for it. But the question--we are going to come back to it now 
and not be distracted by the argument about whether or not this 
is a great company--it is--or whether or not it pays a lot of 
taxes--it does--or whether or not the effective tax rate in 
this country is 13 percent as distinguished from the statutory 
tax rate of over 30 percent, or whether we ought to change the 
tax code.
    So now let me get back to the subject of the hearing. 
Obviously you can structure a business to minimize taxes, but 
would you agree with me, Mr. Quinn, that when you send profits 
to a related party in a tax haven, that transaction must meet 
an arm's-length standard? Do you agree with that?
    Mr. Quinn. Absolutely, Senator.
    Senator Levin. No matter how much you pay in taxes.
    Mr. Quinn. Yes. When you talk about the arm's-length 
standard, what that requires is a measurement and an 
understanding of what functions exist offshore, what risks have 
been accepted offshore, what property exists offshore.
    Senator Lev
    [Pause.]in. All right. But it must meet that standard.
    Mr. Quinn. And the exercise is then to align profit with 
those functions----
    Senator Levin. Exactly right. Regardless of how many taxes 
you currently pay or do not pay, that must be met. Is that 
correct?
    Mr. Quinn. Absolutely.
    Senator Levin. And must you meet a business purpose 
standard?
    Mr. Quinn. I think in order to support the transfer pricing 
result, you would want to make sure that when we take a look at 
the functions and the risks and the property that has been 
evaluated, that it does, in fact, make sense within the 
business and how it has been operated.
    Senator Levin. All right. Now, take a look at Exhibit 
33,\1\ if you would. We are trying to figure out what the 
annual parts benefits was from this structure, this strategy 
that was put in place. Do you have Exhibit 33?
---------------------------------------------------------------------------
    \1\ See Exhibit No. 33, which appears in the Appendix on page 490.
---------------------------------------------------------------------------
    Mr. Quinn. I do. That is a district court document.
    Senator Levin. No, it is a Caterpillar--sorry did I say 43?
    Mr. Quinn. Oh, sorry.
    [Pause.]
    Yes, a PwC document.
    Senator Levin. All right. And it is entitled, if you look 
at No. 3, it has a mark of 2449 at the bottom, January 2010, 
Slide 19. It is No. 3, ``WW [worldwide] Parts Management in 
Geneva.'' Do you see that?
    Mr. Quinn. Yes, I have it.
    Senator Levin. Take a look at the bottom line.
    Mr. Quinn. Sure.
    Senator Levin. ``The WW''--worldwide--``Parts Management 
Structure provides further substance to preserve annual parts 
benefit of $300m [$300 million.]'' Do you see that?
    Mr. Quinn. I do.
    Senator Levin. So that is the benefit, tax benefit, as a 
result of this tax strategy. Is that correct?
    Mr. Quinn. That is accurate.
    Senator Levin. OK. Now, take a look at Exhibit 6,\1\ if you 
would, Mr. Quinn.
---------------------------------------------------------------------------
    \1\ See Exhibit No. 6, which appears in the Appendix on page 337.
---------------------------------------------------------------------------
    Mr. Quinn. A PwC document, Global Tax Optimization Case for 
Action.
    Senator Levin. Right. And if you will take a look at the 
number of Caterpillar at the bottom, 4646, do you see that? 
This was the document that laid out 32 tax strategies for 
Caterpillar, PwC.
    Mr. Quinn. Yes.
    Senator Levin. Page 12, it says, ``Strategy for 
Caterpillar.'' Do you see that?
    Mr. Quinn. Yes.
    Senator Levin. ``We have developed a strategy that we 
believe will achieve tax optimization for Caterpillar. This 
strategy can be summarized as follows:''
    ``Migrate income from the U.S. to lower-tax 
jurisdictions.'' Do you see that?
    Mr. Quinn. Yes.
    Senator Levin. And do you see below that, ``Global Income 
Migration''?
    Mr. Quinn. Yes, I do.
    Senator Levin. All right. Now, on that strategy is there 
any reference there at all to hiring new people, moving people, 
or changing operations? Do you see that anywhere----
    Mr. Quinn. Oh, it can only be the consequence----
    Senator Levin. Oh, I am sure of that, but do you see it 
anywhere on this document what you now say are the 
consequences?
    Mr. Quinn. Right, It is not in this document, Senator.
    Senator Levin. Was it on any document at the time that they 
would have to move people?
    Mr. Quinn. Yes, it certainly would have been.
    Senator Levin. How many people would they have to have 
moved? If they had less than 100 people working in parts--
right?
    Mr. Quinn. If I can ask what particular part of the 
reorganization you might be referring to?
    Senator Levin. In Switzerland.
    Mr. Quinn. In Switzerland as it relates to the overall 
business?
    Senator Levin. No, the parts business.
    Mr. Quinn. The parts business.
    Senator Levin. Yes.
    Mr. Quinn. So our view----
    Senator Levin. Did they have less than 100 before? Did they 
have less than 100 after?
    Mr. Quinn. Our view then and our view now and our view at 
the time that we put this together is that the substance that 
exists with respect to the parts business is provided through 
the marketing organization, that those individuals, those 
thousands of individuals that are managed out of the 
organization based in Switzerland now that comprises the 
marketing company outside the United States for Caterpillar 
products and replacement parts associated with those are the 
substance which creates the demand for those products. They 
have nurtured the dealer relationships. They have created the 
field population upon which the demand is created for 
replacement parts activity as well as reflect the integrated 
nature that is taking place in the business, both selling parts 
as well as machines, going back to my opening statement, where 
this is, in fact, an integrated activity.
    Senator Levin. We understand. Did anybody have to move?
    Mr. Quinn. In order to support the parts planning?
    Senator Levin. No. As a result of this proposal that you 
were making here, which was adopted, did anybody have to move?
    Mr. Quinn. Yes, there were people that had to move as a 
result of it.
    Senator Levin. How many had to move?
    Mr. Quinn. A dozen.
    Senator Levin. Out of thousands?
    Mr. Quinn. Senator, that is because people were already----
    Senator Levin. Whatever the cause is, if you could answer 
the question, that would be a dozen out of thousands. Is that 
correct? You just talked about thousands. I am just asking you 
a direct question.
    Mr. Quinn. Yes, correct. In terms of people that had to 
move----
    Senator Levin. Is that a dozen out of thousands?
    Mr. Quinn [continuing]. To support the addition--the 
structure or the substance that was already in place, it was 
just the dozen.
    Senator Levin. So that structure, which was already in 
place----
    Mr. Quinn. That is correct.
    Senator Levin [continuing]. Which then led to the shift 
from 15 percent of the profits going to Switzerland to 85 
percent of the profits going to Switzerland, that----
    Mr. Quinn. No, Senator, that----
    Senator Levin. Oh, you want to use 70 percent instead of 85 
percent?
    Mr. Quinn. No----
    Senator Levin. OK.
    Mr. Quinn. I will not argue with the percentages.
    Senator Levin. OK.
    Mr. Quinn. I will argue with what creates the ``income 
shift,'' as you call it, and that can only result as a result 
of the measurement of what has been taking place with respect 
to the functions, where those exist, the risks where those have 
been accepted, and the property where it exists in the company. 
And our evaluation of that within the context of this planning 
was that when we looked at substance and when we looked at 
economic substance, that we used rules which have been provided 
to us in case law as well as in the Internal Revenue Code and 
its underlying regulations that say in order to evaluate that 
appropriateness of an income shift, first we have to look at 
what functions exist, what risks are in place, and what 
property exists. And then we align the income with that. We 
never shift income.
    Senator Levin. Well, I am talking about the allocation of 
profits was shifted. Is that correct? Following all that 
assessment.
    Mr. Quinn. The allocations of profits changed as a result 
of that.
    Senator Levin. Was changed, shifted, from approximately 15 
percent to Switzerland to 85 percent. Is that true? Based on 
your assessment----
    Mr. Quinn. Again, with respect to the parts business----
    Senator Levin. Yes.
    Mr. Quinn [continuing]. Because we did view----
    Senator Levin. Yes, with respect to the parts business. 
After your assessment, the allocation of profits shifted from 
15 percent to approximately 85 percent. Is that true?
    Mr. Quinn. That is correct.
    Senator Levin. OK.
    Mr. Quinn. But what is----
    Senator Levin. No people, but a few had to shift. It was 
just your assessment which looked at the whole operation, and 
in your judgment what had already existed justified the shift 
of profits from 15 percent to 85 percent to Switzerland.
    Mr. Quinn. It absolutely does.
    Senator Levin. OK. Thank you.
    Senator Johnson.
    Senator Johnson. Thank you, Mr. Chairman. I just want to 
make a quick point and ask one question.
    Mr. Chairman, you stipulated that, yes, Caterpillar is one 
terrific American company and that is not what this hearing is 
about. I think that is exactly what this hearing is about. As 
Senator Portman mentioned, our concern about our uncompetitive 
tax code is that we actually want to maintain Caterpillar as an 
American company, and far too many American businesses are 
choosing not to remain an American company and far too few 
global manufacturers are willing to relocate here in America to 
create those types of jobs.
    Let us face it. When you have Canada with a top marginal 
tax rate, corporate tax rate, of 15 percent and Detroit at 35 
percent, if you are a German manufacturer wanting to come here 
to take advantage of the world's largest market, take advantage 
of relatively reasonably priced energy prices, are you going to 
locate your manufacturing facility for North America in Toronto 
at 15 percent or Detroit at 35?
    So, no, this hearing is all about what do we need to do in 
America to make America an attractive place for global business 
investment, business expansion, and job creation? So I just 
disagree in terms of the purpose of this hearing. I think the 
purpose of this hearing is exactly that. Let us keep American 
companies American. Let us try and incentivize investment of 
global companies into America. And we are not doing a very good 
job that way.
    Mr. Quinn, I hear the term all the time, and it is like 
fingernails on a chalkboard, talking about tax loopholes. Is 
there such a term in the tax code as a tax loophole? It is a 
political term, correct?
    Mr. Quinn. That is correct.
    Senator Johnson. Can you define some tax loopholes for me? 
What are we talking about when politicians use the term ``tax 
loophole''?
    Mr. Quinn. Generally they are either incentives which were 
deliberately placed in the tax code or they are----
    Senator Johnson. I mean, just give us a couple pretty good 
examples of where it made some sense to create an incentive in 
the tax code to incentivize manufacturers or drilling or just 
give us a couple examples that might actually work.
    Mr. Quinn. Well, so we had talked about some earlier in the 
course of the hearing here. One was the old rules which existed 
around foreign sales corporations. I think that was 
characterized as well many times, inappropriately, as a 
loophole that was created for corporations that exported 
product.
    More recently, we talked about the Homeland Repatriation 
Act where companies had an opportunity to bring earnings back 
into the United States at a 5-percent effective tax rate. This 
was back in the early 2000s. And that as well was viewed as a 
loophole.
    Senator Johnson. Was it also safe to say that a lot of 
times people typified timing differences as a loophole? In 
other words, it is true that corporations account for things 
differently. There is book accounting, there is tax accounting. 
A lot of that has to do with timing differences, correct? For 
example, if you have a piece of machinery and you know it is 
going to wear out in 5 years, according to Generally Accepted 
Accounting Principles (GAAP) accounting, you depreciate it over 
that 5 years. But tax accounting made to incentivize 
investments in plant and equipment might grant you a 10-year 
depreciation schedule, correct?
    Mr. Quinn. Correct, yes.
    Senator Johnson. What about oil drilling, a pretty risky 
venture? I am hearing all these subsidies for big oil. Can you 
just kind of speak a little bit about what those subsidies 
really are? And are those loopholes or are those incentives 
written into the tax code to give people the incentive to risk 
their capital to drill oil?
    Mr. Quinn. I think as someone who reviews the tax code 
regularly and understands the legislative process around it, I 
know that those are incentives, and many of those are put in 
there very deliberately to incent activity.
    Senator Johnson. Specifically, can you talk to some of 
these timing issues specifically? How oil companies have to 
account for their risk capital when they are investing? I know 
it is a little off subject, but I think it is exactly on point, 
because what we are talking about is how do you comply with a 
tax code that has been written by Congress that is trying to 
incentivize behavior? And, by the way, I would like to scrap 
the current tax code. I would like to just raise the revenue we 
need and stop economic and social engineering through the tax 
code. But that is the system we have right now, and companies 
take advantage of and respond to those incentives, correct?
    Mr. Quinn. Yes, that is correct. And in terms of an example 
that you are looking for that would also apply not just to oil 
companies but to the particular facts at hand in this case 
study, the U.S. system with respect to foreign earnings works 
that way as well. When we think about the deferral opportunity 
that exists for foreign earnings, that is, in fact, a timing 
issue. And that timing issue can be affected either through 
paying a dividend back to the U.S. company, at which time that 
income then becomes immediately taxable; or it can happen as a 
result of the application of Subpart F, which takes a look at 
certain classes of income and says, despite the fact that you 
did not return that cash to the United States, the income is 
going to be immediately taxable. That is an example of a 
deferral strategy. It is also one where there are very 
deliberate actions that have been taken by Congress and by the 
Treasury Department in putting in place regulations in that 
area to respond to known business issues.
    Senator Johnson. When I took tax law in college, one of the 
tenets of tax law really was the ability to pay. I think most 
Americans assume that when a corporation or a business spends 
money, they get to deduct it. That is not the case, right?
    Mr. Quinn. That is correct. Absolutely.
    Senator Johnson. I mean, in so many cases businesses invest 
money. They pay out the cash. They may have to borrow it, but 
they are spending the money----
    Mr. Quinn. It becomes capitalized.
    Senator Johnson. They are forced to capitalize, and then 
they have to amortize or depreciate that over----
    Mr. Quinn. Sometimes it is not even amortizable.
    Senator Johnson [continuing]. A long period of time, 
correct.
    Mr. Quinn. Sometimes it is not even amortizable. Sometimes 
it is held up on the balance sheet, your tax balance sheet, 
forever.
    Senator Johnson. So let us say you have $100 and you decide 
to invest $100 in capital equipment--or let us say a million, 
you invest a million. If you make a profit that year, where is 
the money going to come from to pay the tax?
    Mr. Quinn. You will borrow it.
    Senator Johnson. You are going to have to borrow it, 
correct? So that is not real incentivizing from the 
standpoint----
    Mr. Quinn. No.
    Senator Johnson [continuing]. Having people risk their 
capital.
    So, again, I just think it is extremely important for 
people to understand really how our tax code operates, the 
incentives that Congress has written into the law, the 
disincenting nature of high tax rates, of forcing businesses to 
capitalize cash that is spent, not being able to recover that 
for years. That is not a loophole. That is actually 
economically very disincentivizing and it is very harmful in 
terms of job creation.
    OK. Thank you. Thank you, Mr. Chairman.
    Senator Levin. Thank you very much, Senator Johnson. 
Senator Portman.
    Senator Portman. Mr. Chairman, thanks very much, and I just 
had a couple questions to followup on how the international tax 
code works, specifically as it relates to Caterpillar.
    You talked earlier about the fact that U.S. companies are 
competing globally at a disadvantage given that we have a 
relatively high rate and because we are taxing on a worldwide 
basis rather than what they call a territorial basis, meaning 
if you have active income earned abroad, it is taxed at U.S. 
rates.
    What does that do to a company, Caterpillar is an example, 
but any U.S. company, that wants to take advantage of the 
international marketplace and that wants to be competitive in 
terms of acquisitions as they come up? Eighty percent of the 
purchasing power in this world is outside the United States; 95 
percent of the consumers are outside the United States. We want 
our companies to access those consumers, that purchasing power, 
in order to create more jobs here, right?
    Mr. Quinn. That is correct.
    Senator Portman. And with regard to Caterpillar in 
particular, do you have any idea how many of their 51,877 U.S.-
based employees are dependent to some extent on their 
international sales? I understand their revenue is about 67 
percent from overseas. So how many of the people who work here, 
over 50,000 people, have their jobs because Caterpillar does 
business overseas?
    Mr. Quinn. I do not know the exact number, Senator, but I 
would expect it is a large portion of those who support the 
export nature of the business.
    Senator Portman. You had some testimony that some of your 
colleagues gave that 14 years ago you estimated that exports 
supported 16,000 U.S. Caterpillar jobs here and another 30,000 
U.S. supplier jobs here.
    Mr. Quinn. I would not find that unreasonable.
    Senator Portman. So that number is going to be a lot bigger 
than that now, now that they have more employees and they do 
more internationally, correct?
    Mr. Quinn. Correct.
    Senator Portman. So we are talking about U.S. jobs here 
being supported by U.S. companies having access to foreign 
markets. That is something we want to encourage, not 
discourage, because it creates more jobs here in America.
    Again, if there is an acquisition that comes up, let's say 
there is a company that becomes available and the competitors, 
let's say, are a German company, a French company, a Brazilian 
company, a Chinese company, a Korean company, and Caterpillar 
is in the mix. What is the relative advantage or disadvantage 
based on the tax laws for those acquisitions?
    Mr. Quinn. What they will be looking at whenever an 
acquisition is made is what is the earnings opportunity in the 
future, and that earnings opportunity is going to be viewed on 
an after-tax basis. So they will take a look at the tax costs 
that will be associated with the earnings in that business as 
well. I am sure the example you gave earlier of the company 
within your State took a very similar approach to it. Just the 
hard economics of looking at what is that after-tax cost of 
operating as a U.S.-based MNC or a foreign-based multinational 
company.
    Senator Portman. What I am hearing from the companies in 
Ohio, and I am sure the same is true in Michigan and Wisconsin, 
is that they are not just at a competitive disadvantage 
globally, but in terms of these acquisitions, other companies 
can pay a premium because of those after-tax profits that they 
are looking at.
    Mr. Quinn. That is correct.
    Senator Portman. In other words, we are having to not just 
compete head to head, but we are shrinking as American 
companies, relative to the size we should be, because of our 
tax code, because other companies can come in who are domiciled 
somewhere else and say, ``Hey, I will pay you a premium.'' So 
we are not expanding as we should be and, therefore, not taking 
advantage of international opportunities that create jobs here 
in America.
    Who are CAT's biggest foreign competitors, do you know?
    Mr. Quinn. Certainly Komatsu, which is a Japanese-based 
company. Steve [Williams], would you have any others to add?
    Mr. Williams. Volvo, which is a Swedish company. Now some 
Chinese companies are competitors.
    Mr. Quinn. And from Korea as well.
    Mr. Williams. From Korea, Samsung, and others.
    Senator Portman. Volvo is their top competitor in Europe, I 
am told, by far; Komatsu probably in Asia, and the Chinese 
companies are growing their market share. Volvo is in Sweden 
where the top rate is 22 percent, so it is 17 points lower than 
the combined U.S. corporate rate of 39.1, which would be the 
combined State and Federal role. Based on the public financial 
statements for both companies, CAT's effective tax rate was 
28.5 percent last year. Do you know what Volvo's effective tax 
rate was last year?
    Mr. Williams. Certainly lower than that, I would think.
    Senator Portman. Do you have a guess?
    Mr. Williams. Low 20s.
    Senator Portman. Twenty percent. So 28.5 percent for CAT; 
Volvo, their biggest European competitor, 20 percent. So it 
sounds to me like Caterpillar spent lots of money coming up 
with a tax strategy last year that did not even allow it to 
come close to achieving tax parity with its primary rival in 
Europe. Is that accurate?
    Mr. Quinn. That is a characterization----
    Senator Portman. You should not feel guilty about it. I 
mean, that----
    Mr. Quinn. Yes, it is accurate, Senator.
    Senator Portman. That is the reality.
    I would also say that there is a big issue here as to the 
ability to deploy resources to their most efficient uses. So it 
is not just the fact that the Volvos of the world have a lower 
rate. It is the fact that because they work on a territorial 
basis rather than a global basis, they can move capital around 
to where they need it, which is a huge advantage. And Komatsu 
has the same advantage.
    Mr. Quinn. Yes.
    Senator Portman. So, the Japanese have a 95-percent 
exemption rate, as you know, meaning that they allow their 
companies to do business in the United States, but then bring 
those profits back home and to deploy them in Japan or 
elsewhere without any tax penalty.
    I know this is about Caterpillar today, and I know that the 
Chairman is raising some specific points about our current 
code. But this all just cries out for reform, and if we do not 
do that, we are going to continue to see an erosion of U.S. 
jobs, U.S. capital going overseas, a lack of investment here in 
this country, and an inability for U.S. companies to expand as 
they should be able for the reason we stated earlier, that they 
are not as competitive on these acquisitions.
    So I really appreciate you all being here today, and I hope 
that, again, in the next few years you will be in a position to 
tell your clients that the United States now has a competitive 
tax structure and you ought to stay right here and build your 
jobs and build your investments in the United States of 
America.
    Thank you, Mr. Chairman.
    Senator Levin. Thank you very much, Senator Portman.
    I have to agree with Senator Portman about the need for the 
tax code to be totally reformed, and now let us talk about the 
tax strategy which Caterpillar used to save $300 million a 
year. And that is ongoing.
    Would Caterpillar have offered this deal to anybody but a 
related company? Would they have offered this license to 
anybody but a related company?
    Mr. Quinn. That was not what we were asked to opine on or 
under the tax----
    Senator Levin. In your judgment. You do an awful lot of 
this for decades.
    Mr. Quinn. So there is some recent----
    Senator Levin. I am just asking you the very simple, 
straightforward question. Caterpillar has created this very 
strong company, 90 years to buildup. It turns over to its own--
to itself in a tax haven 85 percent of the future profits on 
parts. OK? It does not get any pay for it. It does not get any 
compensation for it, any consideration for it.
    Mr. Quinn. I----
    Senator Levin. Well, let me just finish.
    Mr. Quinn. I am sorry.
    Senator Levin. OK. And the deal is on future parts you over 
there, my wholly owned subsidiary, you are going to get 85 
percent of the profits on these parts; I am going to keep 15 
percent. I am asking you just a very simple question based on 
your experience. Is there any way in heaven that Caterpillar 
would transfer its rights to those profits to a company that 
was not related to itself? That is all I am asking. I am not 
asking you whether it has to. I am just asking you would in 
your experience----
    Mr. Quinn. What is----
    Senator Levin. No compensation, no consideration. It loses 
85 percent of the profits it had been receiving. It continues 
to operate the company. It has to continue under the agreement 
the same operations in Illinois. So it keeps doing the same 
thing it has always done, but it is turning over 85 percent of 
the parts profits worldwide and gets nothing, no consideration 
for it.
    Mr. Quinn. Well, it----
    Senator Levin. Yes or no.
    Mr. Quinn. As a hypothetical, what Caterpillar would look 
at is exactly what you are expressing. What is the return it 
would receive for that?
    Senator Levin. My question is: Would it offer that to a 
non-related company? That is my question.
    Mr. Quinn. I do not know.
    Senator Levin. Sure you know.
    Mr. Quinn. What I----
    Senator Levin. Sure you know. You have been in this 
business for a long time. I am asking you a straight question. 
Do you not think it is incredible to believe that Caterpillar 
would hand over 85 percent of its worldwide profits on parts, 
keep 15 percent, continue to operate in Illinois the way it 
always has and everywhere else around the world where it does, 
get no consideration for that transfer, do you think that in 
any way they would offer that----
    Mr. Quinn. They would never do it for no consideration----
    Senator Levin [continuing]. For a non-related company?
    Mr. Quinn [continuing]. The rules that we were required to 
use were ones which did, in fact, evaluate the compensation 
that Caterpillar received and determined that----
    Senator Levin. I am just asking you, is there any way in 
your experience that Caterpillar would make this deal with a 
non-related company? This was a deal it made with itself to 
shift profits to Europe. You say it was legitimate. I do not. 
But that is beside the point at the moment. That is not my 
question. My question is: Is there any way that they would make 
this deal with a non-related company? That is my question.
    Mr. Quinn. I am sorry. I cannot answer that. I do not----
    Senator Levin. You cannot or you will not? You have an 
opinion on that, don't you, after all your years of experience?
    Mr. Quinn. I see companies that dispose of business 
operations all the time. Caterpillar has done it as well. 
Caterpillar has done it within their logistics organization.
    Senator Levin. You know what the deal was here: 85 percent 
of the profits were shifted to a related company in 
Switzerland. The tax savings are $300 million a year as a 
result of that strategy. That is why it was done. You have 
conceded that. Everybody has conceded that. That is why it was 
done. That is why you sold it to them.
    Mr. Quinn. Senator, I am focused on the question of value 
that you are asking as well, that Caterpillar would do that----
    Senator Levin. I am focused on a simple question.
    Mr. Quinn [continuing]. If they understood the value was 
appropriate.
    Senator Levin. No. I am focused on a simple question, and I 
am asking you to give us an honest answer.
    Mr. Quinn. Were the economics of that deal appropriate? 
Yes, they would.
    Senator Levin. I am asking you a question----
    Mr. Quinn. I cannot----
    Senator Levin. Whether or not----
    Mr. Quinn. I cannot answer without that qualification. It 
would have to be based upon their believing that they were 
receiving a return in exchange for that----
    Senator Levin. It would have to believe--would any rational 
company believe they are getting a return, handing over 85----
    Mr. Quinn. Oh, if, in fact, they were being relieved of all 
the risk associated with that, if they were relieved of the 
capital----
    Senator Levin. They are operating the company. They 
continue to operate the company in Illinois. It is the same 
operations. No people are shifted. Five thousand people--a 
dozen people have to shift. Five thousand people work for 
Caterpillar. Less than 100 people work in parts in Switzerland. 
Nothing changes, maybe 12 people move. I am just----
    Mr. Quinn. But it is not all----
    Senator Levin. I am asking you for an honest answer. Is 
there any rational company that would give up 85 percent of 
ongoing profits in a business that has been highly profitable 
put together over 70 years, a highly profitable company, is 
there any way that this would be sold, given away, no 
consideration, 85 percent of the profits on the ongoing parts 
business, hand it over to----
    Mr. Quinn. Yes, the answer is yes, under the economic 
circumstances which Caterpillar accepted. We cannot----
    Senator Levin. I am just asking you would they accept that 
with a non-related company, an arm's-length transaction?
    Mr. Quinn. Yes, that is the standard that we have to apply.
    Senator Levin. Not the standard. I am asking you in the 
real world would a company do that. I am just asking you a 
simple, straightforward question.
    Mr. Quinn. It is--Senator, in the real world, that is a 
hypothetical that would also still be based upon an economic 
analysis.
    Senator Levin. OK. Take a look, if you would, Mr. Williams, 
at Exhibit 4a.\1\
---------------------------------------------------------------------------
    \1\ See Exhibit No. 4a, which appears in the Appendix on page 302.
---------------------------------------------------------------------------
    [Pause.]
    Mr. Williams. Yes, sir, I have that.
    Senator Levin. This is a document from 1994. 
Pricewaterhouse looked at the intangibles for all of 
Caterpillar, including its Swiss marketing company, COSA, which 
was CSARL's predecessor. Now, here is what PwC described as the 
relative roles of Caterpillar and its marketing companies in 
developing the dealer network. This includes COSA as a 
marketing company: ``Cat Inc. has the largest role with regard 
to market and dealer development.'' Do you see that word there?
    Mr. Williams. It is on page 8685.
    Senator Levin. Do you see that on page 8685?
    Mr. Williams. Yes, I do see it.
    Senator Levin. OK. ``Cat Inc. has the largest role with 
regard to market and dealer development, since 1) it has the 
largest single market, 2) it was the originator of the basic 
marketing systems and concepts, 3) it continues to be involved 
with the development and oversight of worldwide marketing 
programs and approaches.'' And then it says, ``The marketing 
companies''--that includes CSARL--``also have major 
responsibility for market development; in fact, this is their 
primary responsibility'' is to do that. OK?
    So CAT Inc. in the description of Pricewaterhouse has the 
largest role in 1994 with regard to market and dealer 
development. Was that true?
    Mr. Williams. What I said there was that the dealer network 
was developed first, the concept, in the United States, in the 
1920s, 1930s. It originated it. That is what it says there. And 
it continued to be involved with the oversight. However, COSA 
and other marketing companies employed those concepts, 
developed those concepts, expanded the dealer network, and had 
the daily interaction with dealers all over the rest of the 
world.
    Senator Levin. Where do you see that?
    Mr. Williams. It is implied in the last----
    Senator Levin. Not implied. Where do you see that?
    Mr. Williams. That is my knowledge of the company.
    Senator Levin. No, where do you see that? I am reading from 
a document.
    Mr. Williams. It does not say that on the page. I was 
explaining----
    Senator Levin. Thank you. Now let us go back to this 
document. ``Cat Inc. has the largest''--this is what you said 
in 1994. It has ``the largest role with regard to market and 
dealer development,'' OK, and then it gives the three reasons. 
The marketing companies also have a major responsibility, but 
the largest role, you said in 1994, was Caterpillar. Was that 
true?
    Mr. Williams. That was the way Caterpillar viewed it----
    Senator Levin. Was that the way you viewed it?
    Mr. Williams. That was my understanding at the time.
    Senator Levin. All right. So you believe it was true.
    Mr. Williams. That was what we wrote, and I believed that 
at the time.
    Senator Levin. OK. Now, then if you take a look at 1995 
transfer pricing documentation, Exhibit 4b,\1\ Bates page 8930, 
```Cat Inc. had the largest role with regard to market and 
dealer development,'' in 1995. Right? Was that true?
---------------------------------------------------------------------------
    \1\ See Exhibit No. 4b, which appears in the Appendix on page 312.
---------------------------------------------------------------------------
    Mr. Williams. That is what it says in this text, yes, sir.
    Senator Levin. Did you write that text?
    Mr. Williams. I was certainly involved in----
    Senator Levin. Was it true when you wrote it?
    Mr. Williams. I am sorry?
    Senator Levin. Was it true when you wrote it?
    Mr. Williams. That was how the company viewed it at the 
time.
    Senator Levin. Did you believe it was true when you wrote 
it?
    Mr. Williams. Yes, that was how the company viewed it, 
and----
    Senator Levin. Did you believe it was true when you wrote 
it?
    Mr. Williams. At the time Caterpillar, starting in 1994, 
changed----
    Senator Levin. I understand all that. I am just asking you 
whether that statement was true when you wrote it in 1995.
    Mr. Williams. That is my understanding, yes.
    Senator Levin. Now, was it true when you said the same 
thing in 1997?
    Mr. Williams. Senator, we used much of the same language in 
these reports as they were updated each year, so I had the 
same----
    Senator Levin. And did you believe it was true?
    Mr. Williams. I used that language in 1997.
    Senator Levin. It is a pretty straightforward question. Did 
you believe it was true when you wrote it?
    Mr. Williams. Based on the facts at the time, yes, I 
believed that.
    Senator Levin. Thank you. Senator McCain.
    Senator McCain. I thank the witnesses again.
    Mr. Quinn, your job is to advise companies and corporations 
how they can maximize their profits and keeping with the 
existing tax code as it is written. Is that true?
    Mr. Quinn. That is true, particularly with respect to their 
operations.
    Senator McCain. So this restructuring obviously resulted in 
increased profits for Caterpillar, right?
    Mr. Quinn. I believe the increased profits largely resulted 
from the expansion of their markets. This provided the 
opportunity for them to expand their markets using a different 
base.
    Senator McCain. To this day, do you believe that there is 
any violation of the tax code as it was written then--And I do 
not know how much it has changed since--that you were 
completely in compliance with existing law and regulations?
    Mr. Quinn. Yes, that is my belief. That is my firm's 
belief.
    Senator McCain. I thank you, Mr. Chairman.
    Senator Levin. Thank you, Senator McCain. Senator Johnson.
    Senator Johnson. No more.
    Senator Levin. Thank you.
    Mr. Williams, during the 1990s, Caterpillar assigned a 13 
percent profit to its marketing companies, so it indicated it 
viewed them as having some value, which I think everybody 
concedes, but not a lot of value. That was before the 1999 tax 
strategy was implemented. So now let us look at what 
Caterpillar did after the tax strategy was implemented. Let us 
look at 2001.
    Would you please look at Exhibit 13\1\?
---------------------------------------------------------------------------
    \1\ See Exhibit No. 13, which appears in the Appendix on page 374.
---------------------------------------------------------------------------
    [Pause.]
    Senator Levin. Do you have it?
    Mr. Williams. Yes, sir, I have it.
    Senator Levin. Thank you. This is a 2001 economic analysis 
prepared by PwC valuing the marketing intangibles of 
Caterpillar Americas. Do you pronounce it ``C-ACO''?
    Mr. Williams. Caterpillar always called it ``C-ACO.''
    Senator Levin. OK. And this is a Miami-based U.S. company 
that was transferring its assets to CSARL. Now, CACO had served 
as Caterpillar's marketing company for the dealer network in 
Latin America, the Caribbean, and Canada. Did you work on this 
analysis?
    Mr. Williams. Yes, I participated in this analysis.
    Senator Levin. OK. PwC describes CACO's responsibilities. 
They are virtually identical to the functions of CSARL. They 
include signing contracts with independent dealers in the 
region, purchasing products and parts from the U.S. parent, 
reselling them to the dealers, helping with logistics support, 
maintaining minor parts inventories, helping dealers identify 
performance issues, providing dealers with marketing 
information and sales training, helping them with financing, 
and conducting monitoring and oversight activities to ensure 
compliance by dealers with the terms of dealer sales and 
service agreements. That is all from this document.
    Now, on page 4, PwC lists the marketing intangibles at 
CACO. They consist of: CACO's relationship with Caterpillar's 
independent dealers, its training programs, its order tracking 
software, various procedures and manuals, market brochures, its 
Web site, its goodwill and its going-concern value, and any 
other marketing-related intangibles. Sounds familiar because 
these are the same as CSARL's.
    Then on page 6, Mr. Williams, take a look at the 
description of all these markets intangibles. Do you see at the 
bottom there, ``Functional Analysis Conclusions''?o 
you see that?
    Mr. Williams. Yes, I have that.
    Senator Levin. ``Based on our analysis of the Intangible 
Assets Transferred, we conclude that they are routine and 
common to most distribution and marketing companies. These 
assets have only limited economic life and could be effectively 
reproduced by a new startup company with sufficient investment 
and time resources.''
    ``Therefore, we conclude that the Intangible Assets 
Transferred have very limited economic value and this value is 
mostly related to its assembled workforce in place.''
    Was that true?
    Mr. Williams. That was the analysis we wrote, and I would 
like to explain----
    Senator Levin. Well, finish that sentence, if you would.
    Mr. Williams. I am sorry, sir?
    Senator Levin. Would you finish the sentence? ``This was 
the analysis that . . . ?''
    Mr. Williams. That we wrote, and I would like to expand on 
it.
    Senator Levin. All right. Was it true, is what I am asking 
you? I know you would like to expand on it now in front of this 
hearing. I understand that. I am just asking you: Was that true 
when you wrote it? That is all I am asking.
    Mr. Williams. That was an understanding we had at the time. 
I think it was--as you pointed out, it was partially 
inconsistent with some of the other language we said. The 
reason for that is these were different analyses under 
different times and actually looking at different assets and 
different values.
    Senator Levin. I see. These are not basically those same 
intangibles?
    Mr. Williams. These were looking at----
    Senator Levin. Were these basically the same intangibles of 
CSARL's?
    Mr. Williams. These were looking at the intangibles that 
were inside the United States.
    Senator Levin. I understand that.
    Mr. Williams. It did not include----
    Senator Levin. Were these basically----
    Mr. Williams [continuing]. The intangibles outside the 
United States.
    Senator Levin. But were these basically--when you described 
these intangibles, they are pretty much the same as CSARL's, 
were they not?
    Mr. Williams. CSARL created a lot of intangibles outside 
the United States, and many of CACO's field and service reps 
were also outside the United States, working with the dealers 
who were outside the United States.
    Senator Levin. I understand, but these were basically the 
same intangibles, were they not, that you had previously 
described as CSARL intangibles?
    Mr. Williams. I think they are----
    Senator Levin. Are they basically the same intangibles?
    Mr. Williams. No, they are not basically the same.
    Senator Levin. They are not? They are different 
intangibles?
    Mr. Williams. They are different----
    Senator Levin. The ones I just read are different from 
CSARL's?
    Mr. Williams. These are the intangibles without the 
activities of the individuals who deploy those intangibles.
    Senator Levin. And your judgment----
    Mr. Williams. The activities are offshore--the activities 
are performed by the non-U.S. employees.
    Senator Levin. And this was the marketing company for Latin 
America, Canada, and the Caribbean?
    Mr. Williams. That is correct.
    Senator Levin. And these were the intangibles that they 
had--is that correct? You identified these intangibles.
    Mr. Williams. These were the identified intangibles, yes.
    Senator Levin. OK. We can compare them one for one. I have 
already done that to the best--I think accurately, but 
nonetheless, my question is: When you said that those 
intangibles--and I will read it to you again. Those intangibles 
that I read have very limited economic value, and this value is 
mostly related to its assembled workforce in place, I am just 
asking you this question: Was that true?
    Mr. Williams. I think that is not totally complete. Tom, 
[Quinn] would----
    Senator Levin. No. Do not refer to somebody else. You wrote 
this thing. So what you are saying is it was true but 
incomplete?
    Mr. Williams. I said I would prefer to expand on it by 
talking about the assets that CSARL--I am sorry, CACO had 
offshore with its employees.
    Senator Levin. Yes, I am sure you would, but this is the 
assessment that you made at the time. Is that correct?
    Mr. Williams. That is the assessment I made at the time.
    Senator Levin. All right.
    Mr. Quinn. Senator, I think I could offer some further 
explanation that might be helpful for you to understand----
    Senator Levin. No, I think the explanation--someone else, 
if they want, can ask you for it, but I am asking what was said 
at the time about these intangibles. And in 1999, you 
attributed huge value to similar intangibles, OK, you can say 
they are not similar. We will let the record speak for itself. 
We have read them, and you can--we will have someone else 
determine, reading them side by side, whether those 
intangibles, which were given huge value relative to CSARL's 
value, but given no value when it came to transferring these 
intangibles from the American company. I am just going to----
    Mr. Quinn. This report reviews those intangibles absent of 
the services that support them. It is a completely different 
context, Senator.
    Senator Levin. All right. OK. We will let anyone reading 
those two documents decide. He said--Mr. Williams--it was 
incomplete. Was it incomplete? Mr. Quinn, was it incomplete?
    Mr. Quinn. He did not have the opportunity to----
    Senator Levin. No. Was this assessment incomplete?
    Mr. Quinn. Oh, this assessment is complete with respect to 
the asset it is evaluating.
    Senator Levin. OK.
    Mr. Quinn. It is not evaluating the same asset that you are 
referring to from the earlier report.
    Senator Levin. OK. In other words, this does not list all 
the intangibles that CSARL had.
    Mr. Quinn. It is two different bases. This is looking just 
at the intangible asset itself, and the way that the rules and 
regulations require that we value an asset is separate and 
apart from the services that might support those. When we take 
a look at the earlier report, it was clear that is trying to 
evaluate the income potential and the income being generated by 
Caterpillar SARL. In that case, it adds to the asset the 
service itself. So it is comparing apples and oranges.
    Senator Levin. Both were intangibles, right, in both cases? 
CSARL----
    Mr. Quinn. No. In one case, you had an intangible. In the 
second case, you had an intangible plus its enabling service.
    Senator Levin. But both were listed as intangibles. Is that 
correct? When the transfer was made, they were both 
intangibles. Is that correct?
    Mr. Quinn. No, that is not correct.
    Senator Levin. OK. Then we are going to let the record 
speak for itself.
    Now, if you would turn to Exhibit 12,\1\ Mr. Williams? This 
is now 2007.
---------------------------------------------------------------------------
    \1\ See Exhibit No. 12, which appears in the Appendix on page 372.
---------------------------------------------------------------------------
    [Pause.]
    Do you see that, Mr. Williams?
    Mr. Williams. Yes, I have that, sir.
    [Pause.]
    Senator Levin. Is that not an email from you to a Mr. 
Matthews?
    Mr. Williams. Yes, it is, sir.
    Senator Levin. OK. You were talking about CSARL, that they 
spent decades building up the dealer network around the world, 
which is what a marketing company does; building the brand name 
through advertising. And then you say this. You say that--it is 
about the second or third paragraph from the bottom.
    Mr. Williams. Yes, sir.
    Senator Levin. It says there is a caveat: ``. . . in 
2001''--this is what you said--``we said in another 
transaction''--that is CACO, right?
    Mr. Williams. I believe that refers to CACO, yes, sir.
    Senator Levin [continuing]. ``That there is no significant 
marketing intangibles other than the workforce in place.''
    Mr. Williams. No significant U.S. marketing intangibles 
because the----
    Mr. Williams. It does not say United States. It says ``no 
significant marketing intangibles.''
    Mr. Williams. It does not include the word ``United 
States,'' but the marketing intangibles were a part of CACO's 
efforts offshore already----
    Senator Levin. Well, then, what is the caveat?
    Mr. Williams. The caveat was that I was recognizing that--
--
    Senator Levin. There was an inconsistency here?
    Mr. Williams. I was recognizing that in two different 
transactions under different circumstances and different 
approaches, different assets being valued, that there was a 
different conclusion.
    Senator Levin. Is that what you said here? You do not say 
there is--what is the caveat? Why do you have to say a caveat? 
Is there not an apparent inconsistency that you are worried 
about?
    Mr. Williams. There is an apparent inconsistency because of 
the differences in the transactions, and that was what I was 
advising my staff, is that we needed to reconcile those 
different approaches.
    Senator Levin. So you yourself saw that there was an 
apparent inconsistency at that time?
    Mr. Williams. I would use the word ``apparent,'' yes, sir.
    Senator Levin. OK. Now, take a look--Mr. Quinn, you were 
responding to an email of Mr. Williams. Take a look at Exhibit 
46,\1\ please.
---------------------------------------------------------------------------
    \1\ See Exhibit No. 46, which appears in the Appendix on page 545.
---------------------------------------------------------------------------
    Mr. Quinn. It is an internal email. I have that.
    Senator Levin. I would like both you and Mr. Williams to 
look at this email exchange between the two of you regarding 
what you both seem to see as a problem regarding CSARL's 
ability to justify receiving the lion's share of the non-U.S. 
parts profits in Switzerland.
    In the first email, Mr. Williams, you wrote to Mr. Quinn, 
in the last sentences, ``. . . just curious--say they decide 
most PMs [product managers]''--``stay in the U.S. How do we 
retain CSARL parts profit if those `US entrepreneurs' claim 
both machine AND parts profit?''
    Mr. Williams. If I can, sir, the PM there refers to product 
managers.
    Senator Levin. Product. I am sorry. Did I say ``parts''? I 
mean product manager. Now, did you have a concern here, Mr. 
Williams, about whether the product managers located in the 
United States might claim the parts profits related to the 
parts that they designed?
    Mr. Williams. Sir, my point was related to----
    Senator Levin. Could I ask you this question just directly? 
Did you have a concern here about whether product managers 
located in the United States might claim the parts profits 
related to the parts that they designed, was that a concern of 
yours?
    Mr. Williams. The concern was relocating the product 
managers from Switzerland back to the United States. I was 
concerned that by taking those entrepreneurial functions out of 
Switzerland and relocating them back to the United States, that 
would give me a concern.
    Senator Levin. Is the answer then it was not--the answer 
is, ``No,'' to my question?
    Mr. Williams. There was a concern, yes, sir, about the 
relocation----
    Senator Levin. No. I am saying that they might claim the 
parts profits. That is what I am asking, whether product 
managers--I am going to ask you again. Was there a concern that 
product managers located in the United States might claim the 
parts profits related to the parts that they designed? Yes or 
no.
    Mr. Williams. No. I was concerned about the relocation of 
the individuals from Switzerland back to the United States.
    Senator Levin. All right. Now, Mr. Quinn, you responded to 
Mr. Williams in the next email: ``PMs [Product managers] in US 
will put some pressure on the parts profit model. These guys 
are really bought into the [idea that] PM is king concept. We 
are going to have to create a story that will put some distance 
between them and parts . . . to retain the benefit. Get ready 
to do some dancing.''
    Mr. Quinn. Is there a question there?
    Senator Levin. Yes. What did you mean you were going to 
have to tell ``a story'' and ``get ready to do some 
dancing''?ow, let me just ask you this question: Was it not the 
fact that product managers who designed parts here in the 
United States normally get the profits related to those parts 
but that you were going to have to justify sending most of the 
parts profits to Switzerland where they have few product 
managers? Is that not the case?
    Mr. Quinn. This was a----
    Senator Levin. Is the answer yes or no to that?
    Mr. Quinn. I am not sure could you repeat the question, 
please?
    Senator Levin. Yes. Was it the fact that product managers 
who designed parts here in the United States normally get the 
profits related to those profits, but that you were going to 
have to justify sending most of the parts profits to 
Switzerland where they have few product managers?
    Mr. Quinn. No, that is not the intention of this statement.
    Senator Levin. What did you mean by ``dancing'' then?
    Mr. Quinn. Senator, that was a very poor choice of words, 
but this was, in fact, the first time I had knowledge of a 
restructuring that Caterpillar was proposing in 2008, which 
would change some of the substance that was put in place back 
in the earlier reorganization that began in 1999. My concern 
here was that, in fact, that would change some of the 
circumstances that we rely upon in terms of our economic 
analysis, and that we needed to make sure that management 
understood the consequences, the tax consequences of their 
actions.
    Senator Levin. Mr. Williams, this says, ``. . . say they 
decide most PMs [product managers] stay in US.'' Now, that is 
consistent with what you just said, which was about product 
managers moving to the United States.
    Mr. Williams. There were product managers in Geneva who 
were supervising important products outside the United States. 
This reorganization announced at the end of 2008 to take effect 
in 2009 would have relocated those product managers to the 
United States and taking with them the significant 
entrepreneurial responsibilities. That was our concern.
    Senator Levin. But you said, ``. . . say they decide most 
PMs [part managers] stay in US [the United States],'' not 
``move to the United States,'' ``stay in US.'' Is that not your 
memo?
    Mr. Williams. The word says ``stay.'' Out of the----
    Senator Levin. Yes.
    Mr. Williams. Out of the 15 or 20 product managers, they 
were proposing that all of them be in the United States. That 
is the meaning of the word ``stay.''
    Senator Levin. But you are saying the concern was that they 
move to the United States. That is not what the concern was in 
this memo.
    Mr. Williams. We were----
    Senator Levin. Why did you use the word ``stay'' instead of 
``move''?
    Mr. Williams. Because we knew what the existing location of 
them was, and the recommendation was to have them all in the 
United States. So that is what we mean by ``stay.''
    Senator Levin. You were worried about ``move'' to the 
United States. Is that right?
    Mr. Williams. Move and staying in the United States. in the 
future, no longer having those positions in Switzerland, 
staying in the United States instead.
    Senator Levin. Didn't you just say that the concern was 
that they would move in the United States? Isn't that what you 
just testified?
    Mr. Williams. I said to you ``stay''--I said to you 
``move.''
    Senator Levin. To the United States?
    Mr. Williams. Yes.
    Senator Levin. The email says the concern was that they 
stay in the United States. I am just asking you. Do you see----
    Mr. Williams. At that time already there were several 
important product managers in Switzerland. The point here is 
stay in the United States in 2009 and future. So the 
reorganization would have put and stayed everyone in the United 
States, and we were concerned about that reorganization and its 
effect on the tax benefits. We were needed to assist Corporate 
Tax to explain to the Executive Office the tax effect of their 
proposed reorganization.
    Senator Levin. Mr. Williams, you responded, ``What the 
heck. We'll all be retired when this comes up on audit.''
    Mr. Williams. Yes, sir, that was also an inappropriate use 
of words in an attempt at humor. My point was it----
    Senator Levin. Is this humor: ``Ed Bodham and Chris Dunn 
will have to solve it''?
    Mr. Williams. No, that is not humor, sir.
    Senator Levin. Would that be humorous to them?
    Mr. Williams. No, that would not be humorous to them.
    Senator Levin. Mr. Bowers, you were on the audit team. Did 
you know that Mr. Quinn and Mr. Williams had to figure out a 
story, that they had these views, that they were going to do 
some dancing, that they had plans to be retired when the whole 
issue came to a head? Were you aware of that? You were on the 
audit team.
    Mr. Bowers. Mr. Chairman, I was not aware of these emails.
    Senator Levin. And, Mr. Bowers, did you know that PwC's tax 
consultants had taken inconsistent positions regarding the 
value of marketing intangibles at CSARL and CACO?
    Mr. Bowers. Mr. Chairman, I believe the----
    Senator Levin. Were you aware of that apparent----
    Mr. Bowers [continuing]. Intangibles----
    Senator Levin. But were you aware of that apparent 
inconsistency?
    Mr. Bowers. Well, I do not agree with that inconsistency.
    Senator Levin. So you do not believe there was an apparent 
inconsistency.
    Mr. Bowers. That is correct.
    Senator Levin. OK. Mr. Bowers, one of our experts today 
said he had never heard of a company keeping two sets of 
inventory books using a virtual inventory system separate and 
apart from the company's general inventory system--one to track 
the parts for the business enterprise, the other to keep track 
of inventory for tax purposes. Prior to Caterpillar's use of 
the inventory system, had you ever heard of a virtual inventory 
system?
    Mr. Bowers. Senator, different management books from--or 
legal books are very common.
    Senator Levin. I am not talking about that. I am asking 
about inventory systems. Had you ever heard of a virtual 
inventory system prior to Caterpillar's use of an inventory 
system? Had you ever heard of it?
    Mr. Bowers. That particular term I had not heard of.
    Senator Levin. No, put aside that, have you ever heard of a 
virtual inventory system?
    Mr. Bowers. An inventory system similar to what has been 
referred to as ``virtual'' I have seen before.
    Senator Levin. You have?
    Mr. Bowers. Mm-hmm.
    Senator Levin. You have seen it. But you just never heard 
it described as a virtual one?
    Mr. Bowers. Yes, it is difficult to understand an inventory 
bin is a very physical thing.
    Senator Levin. Is that what you told our staff, by the way? 
We asked you specifically if you had ever heard of a virtual 
inventory system or similar system. You said no, before you saw 
this system. Did you not tell our staff you had never heard of 
it?
    Mr. Bowers. It depends upon how the question gets asked, 
sir.
    Senator Levin. The way I just asked it.
    Mr. Bowers. A virtual inventory system I have not heard of, 
but when you think about what that sentence says, an inventory 
bin is a very real thing.
    Senator Levin. Therefore?
    Mr. Bowers. Therefore----
    Senator Levin. If it is all merged?
    Mr. Bowers. Very straightforward to have an inventory bin 
full of parts, some parts belong to one owner, other parts 
belong to another owner.
    Senator Levin. Are they usually identified some way?
    Mr. Bowers. Why would that be the case?
    Senator Levin. They do not need to identify them?
    Mr. Bowers. No.
    Senator Levin. OK. Did you have discussions with the PwC 
audit team or the consultant for Caterpillar about tax risks 
associated with this virtual inventory? Did you ever have 
discussions about tax risks in doing what they were doing?
    Mr. Bowers. I did have conversations about tax risks. That 
is my role to provide assistance and advice to the audit 
partner.
    Senator Levin. Did you have concerns?
    Mr. Bowers. Not with respect to this inventory system.
    Senator Levin. And so you never discussed any concerns 
about this inventory system with them?
    Mr. Bowers. I explained this inventory system to him, and--
--
    Senator Levin. I am just asking: Did you ever have concerns 
about it?
    Mr. Bowers. I did not have concerns about it.
    Senator Levin. OK. Thank you all very much. We appreciate 
your testimony and your cooperation with this Subcommittee.
    Let me now call our final panel of witnesses for today's 
hearing: Julie Lagacy, Vice President of the Finance Services 
Division of Caterpillar; Robin Beran, Chief Tax Officer at 
Caterpillar; and Rodney Perkins, a former Senior International 
Tax Manager at Caterpillar.
    Thank you all for being with us today. Thank you for your 
cooperation with this Subcommittee. And pursuant to Rule 6, all 
witnesses who testify before the Subcommittee must be sworn, so 
we would ask you to please raise your right hand as you stand. 
Do you solemnly swear that the testimony you are about to give 
to this Subcommittee will be the truth, the whole truth, and 
nothing but the truth, so help you, God?
    Ms. Lagacy. I do.
    Ms. Beran. I do.
    Mr. Perkins. I do.
    Senator Levin. Thank you. A minute before the red light 
comes on on the timer, you will see a light change from green 
to yellow, giving you an opportunity to conclude your remarks. 
Your written testimony will be printed in the record in its 
entirety, and please limit your oral testimony to 10 minutes. 
And I understand, Ms. Lagacy, that you are going to be 
presenting the statement for Caterpillar. Is that correct?
    Ms. Lagacy. Yes, I will.
    Senator Levin. Please proceed.

   TESTIMONY OF JULIE A. LAGACY,\1\ VICE PRESIDENT, FINANCE 
    SERVICES DIVISION, CATERPILLAR INC., PEORIA, ILLINOIS; 
ACCOMPANIED BY ROBIN D. BERAN, DIRECTOR, GLOBAL TAX AND TRADE, 
     AND RODNEY PERKINS, FORMER INTERNATIONAL TAX MANAGER, 
               CATERPILLAR INC., PEORIA, ILLINOIS

    Ms. Lagacy. Good afternoon, Chairman Levin and Senator 
McCain. Thank you for the opportunity to appear before the 
Subcommittee today. My name is Julie Lagacy, and I am the Vice 
President of the Finance Services Division at Caterpillar, 
which includes its tax and accounting functions.
---------------------------------------------------------------------------
    \1\ The prepared statement of Ms. Lagacy appears in the Appendix on 
page 129.
---------------------------------------------------------------------------
    On my left is Caterpillar's Director of Global Tax and 
Trade, Robin Beran, a 24-year Caterpillar employee, and on my 
right is Rod Perkins, who retired in 2009 as one of our 
international tax managers after 35 years of service. We are 
proud to represent Caterpillar before you today.
    Caterpillar is a great American company, and our reputation 
is one of our greatest assets. I want to emphasize, Caterpillar 
complies with the U.S. tax laws, and we pay everything we owe. 
We are proud of what we do. We are proud of the men and women 
who make it possible. And we are equally proud of our U.S. and 
worldwide heritage.
    Our average effective tax rate is 29 percent. That is one 
of the highest for a multinational manufacturing company, 3 
percentage points higher than the average effective rate for 
U.S. corporations. This is particularly high when you consider 
that more than 65 percent of our sales and revenues are abroad. 
Over the last 15 years, we have increased employment in the 
United States by 35 percent to nearly 52,000 jobs, and we have 
more than tripled our exports to $16 billion.
    Caterpillar enjoys a strong legacy, and, in fact, my family 
has a long history with this company. Both of my grandfathers 
worked at Caterpillar. During World War II, my grandmother 
stepped up to work in the factory to help build the machines 
our servicemen relied upon. My father, whose career spanned 38 
years, began as an apprentice and worked his way up to manage 
one of our factories in East Peoria. Along the way he met my 
mother, who worked a decade at Caterpillar. All told, three 
generations of my family have more than 140 years of service at 
Caterpillar, and I am a current steward of this tradition.
    At Caterpillar, stories like mine are not uncommon. For 
nearly 90 years, Caterpillar has helped build the world, 
including the backbone of modern America. What began with two 
American inventors now employs over 118,000 people worldwide, 
and nearly 52,000 of those people are right here in the United 
States. When you consider our independent dealer and supplier 
networks, the worldwide reach of our company is even greater. 
At our roots, we are an American company. Our equipment was 
there to build the Golden Gate Bridge and create the interstate 
highway system. Caterpillar products, dealers, and employees 
also show up after tragedy strikes. In Oklahoma City, at 
Hurricane Katrina, and Ground Zero, we joined the first 
responders in cleaning up, powering up, and paving the way for 
recovery.
    We are proud that many of our products are ``Made in 
America.'' Along the Illinois River in our East Peoria 
factories, we make the machine on which our company was 
founded: The track-type tractor, better known as the bulldozer. 
Just down the road in Decatur, Illinois, is the only place in 
the world where we make the world's largest mining truck, which 
stands 2\1/2\ stories tall and can carry 400 tons. Eight out of 
10 large mining trucks made in Decatur are shipped outside of 
the United States. There are other examples like this across 
the country--from engines rolling off the line in Texas, to the 
locomotives we are building in Indiana, or the excavators made 
in Georgia. Our customers depend on Caterpillar's unmatched 
products, services, solutions, and the reliability of our 
machines.
    We grow and build near our customers worldwide, not only 
because it is what they demand but because remaining globally 
competitive helps create jobs right here at home. Growing where 
our business is means growing where our customers are located, 
not just in the United States but throughout the world. Most 
importantly, while more than 65 percent of our sales and 
revenues come from outside the United States, Caterpillar 
remains committed to our manufacturing roots here in America. 
That is why we continue to invest here at home with 69 
manufacturing and logistic facilities and CAT dealers from 
coast to coast.
    Remaining globally competitive helps create jobs right here 
at home. In the past 15 years, we have increased our U.S. 
employment by more than 13,000. Many of these jobs came from 
our exports, which last year alone totaled $16 billion. As you 
may remember, our effort to grow U.S. manufacturing jobs was 
highlighted by President Obama in his 2013 State of the Union 
address.
    I want to emphasize again that Caterpillar has fully 
complied with U.S. tax law. For 2013, we estimate that 
Caterpillar incurred approximately $700 million in income, 
property, sales, and use taxes to U.S. Federal, State, and 
local governments. Additionally, our wages accounted for 
approximately $1.7 billion in U.S. Federal, State, and local 
employment taxes.
    Over the last 8 months, Caterpillar has responded to 
several Subcommittee questionnaires and other information 
requests, has produced thousands of pages of documents, has 
voluntarily permitted and facilitated 11 separate Subcommittee 
staff interviews of current and former personnel, and has 
cooperated in every way possible with the Subcommittee's 
inquiry. We understand the Chairman and his staff are 
interested in one aspect of our company's business: parts sales 
outside of the United States.
    Caterpillar's philosophy is that our business structure 
drives our tax structure. We do not invent artificial tax 
structures. When we identify options that align with our 
business structure, comply with the tax laws, and generate tax 
savings, we pursue those opportunities. The restructuring of 
Caterpillar SARL, or CSARL for short, was one of those 
opportunities.
    Decades ago, Caterpillar had the vision to see new 
opportunities worldwide that would drive our business growth in 
the United States and globally, so Caterpillar established a 
subsidiary in Geneva, Switzerland, that would be responsible 
for putting in place a robust network of employees, independent 
dealers, and suppliers. That subsidiary is now known as CSARL. 
By the 1990s, CSARL had thousands of people supporting the 
business and almost 500 employees in Geneva, Switzerland, 
alone.
    CSARL is a vital business subsidiary responsible for 
manufacturing, marketing, and selling machines, engines, and 
parts outside of the United States. The Geneva entity has held 
these responsibilities since 1960. The 1999 restructuring 
further refined this role. One result of this restructuring was 
that CSARL streamlined its process and began buying parts 
directly from U.S. suppliers.
    Prior to the restructuring, Caterpillar Inc. acted as an 
unnecessary middleman, buying these parts from independent 
suppliers and selling them to CSARL, which then sold them to 
dealers outside the United States. Prudent, lawful business 
planning required us to eliminate the unnecessary middleman 
from the transaction flow. We cannot remain competitive, we 
cannot create jobs, and we cannot increase exports by incurring 
unnecessary expenses. Americans pay the taxes they owe, but not 
more. And as an American company, we pay the taxes we owe, not 
more.
    In planning and implementing the restructuring, Caterpillar 
appropriately relied on the advice of two of the world's 
leading tax advisory firms: PricewaterhouseCoopers, a leading 
Big Four U.S. and international accounting firm; and the law 
firm McDermott Will & Emery, renowned for its international tax 
practice. Both firms provided the advice that the changes were 
appropriate under the tax laws, and both stand behind that 
advice. This advice was consistent with the experience and 
judgment of Caterpillar's Tax Department. Caterpillar's in-
house tax professionals and outside advisors manage tax risk 
every day, and we remain convinced that the restructuring and 
subsequent transactions comply with the tax law.
    CSARL's purchases and sales of parts have more than 
sufficient business substance to be respected for tax purposes. 
The 1999 restructuring of parts purchases and sales did not in 
any way violate generally applicable judicial doctrines in the 
tax area. An independent expert, Professor John Steines, of the 
New York University School of Law, confirms this conclusion. 
Professor Steines' report was provided to the Subcommittee 
staff on March 10, 2014.
    CSARL pays Caterpillar Inc. an arm's-length royalty for all 
intangible property, including intellectual property made 
available by Caterpillar Inc. to CSARL as well as arm's-length 
service fees for all activities performed by Caterpillar Inc. 
for CSARL. So even with respect to parts that are sold to 
dealers located outside the United States, a portion of the 
resulting income is subject to current basis U.S. tax.
    CSARL's direct purchase of its parts inventory reflects 
nothing more than the standard business operations and tax 
planning that any prudent business would employ in conducting 
its operations and complying with U.S. tax laws.
    In closing, I would like to emphasize again that 
Caterpillar is a great American company--an iconic company, you 
might say--publicly listed since 1929. We have steadily grown 
by working our business model day in and day out. Caterpillar 
does a significant amount of business around the world, creates 
jobs, invests in the communities where we do business, and 
bears one of the highest effective tax rates for a 
multinational manufacturing company. Caterpillar complies with 
its legal obligations with respect to payment of taxes.
    We are happy to answer your questions. Thank you.
    Senator Levin. Thank you, Ms. Lagacy.
    My first question is for you. Were you involved in the 
implementation of the CSARL transaction in 1999?
    Ms. Lagacy. No, I was not.
    Senator Levin. Mr. Perkins, at the time of the 1999 CSARL 
transaction, you were working for Caterpillar in Peoria. You 
were serving as its Tax Department's main point of contact with 
PwC. Is that correct?
    Mr. Perkins. Mr. Chairman, that is correct.
    Senator Levin. And, Mr. Beran, you or Mr. Perkins, I 
believe--what was your role in 1999?
    Mr. Beran. I was and am the head of the Tax Department.
    Senator Levin. OK. And you worked directly on the CSARL 
transaction?
    Mr. Beran. I was involved with its formulation, yes. The 
implementation, other people did much more work than I.
    Senator Levin. So you were involved in the formulation of 
it.
    Mr. Beran. Yes.
    Senator Levin. And would you look at Exhibit 7,\1\ please. 
This was the way in which PwC recommended that Caterpillar 
could reduce its taxes. It is one page from the document, and 
here is what it says. Purpose: Take ``CAT Inc. out of chain. 
Recharacterize Marketing Company Income to Achieve U.S. Tax 
Deferral.''
---------------------------------------------------------------------------
    \1\ See Exhibit No. 7, which appears in the Appendix on page 343.
---------------------------------------------------------------------------
    And then if you look further down, the description of--and 
the chart there shows how it was simply done. As you point out, 
Caterpillar was, as you said, Ms. Lagacy, taken out of the 
chain as an unnecessary middleman. We will get into that in a 
minute as to just how unnecessary Caterpillar may have been. 
But at any rate, the direct purchase, so-called, went to COSA 
in Geneva from these suppliers. Is that correct so far, Mr. 
Beran?
    Mr. Beran. Yes, sir.
    Senator Levin. All right. Mr. Perkins, is that correct?
    Mr. Perkins. Yes, it is.
    Senator Levin. All right. Now, was it the Caterpillar Tax 
Department that came up with the idea to remove Caterpillar 
Inc. from the title chain, or was that a PwC idea?
    Mr. Perkins. Mr. Chairman, I can respond to that. The 
original idea or the genesis of that was within the Caterpillar 
Tax Department.
    Senator Levin. All right.
    Mr. Perkins. Predated the PwC proposed changes by at least 
a half a dozen years.
    Senator Levin. OK. Now, take a look at Exhibit 32,\1\ if 
you would. By the way, before we leave Exhibit 7, I will repeat 
it again. One of the benefits and costs was this change in the 
title, ``relatively simple re-invoicing requirements''; in 
other words, the parts never went to Switzerland. Is that 
correct, Mr. Beran?
---------------------------------------------------------------------------
    \1\ See Exhibit No. 32, which appears in the Appendix on page 487.
---------------------------------------------------------------------------
    Mr. Beran. The parts would be distributed all over the 
world.
    Senator Levin. But they did not go to Switzerland.
    Mr. Beran. Many of them went to one of the--well, they went 
to warehouses that----
    Senator Levin. Switzerland itself.
    Mr. Beran. They went to the warehouses that CSARL oversees.
    Senator Levin. And how many warehouses are there in 
Switzerland?
    Mr. Beran. None in Switzerland.
    Senator Levin. How many warehouses in the United States, do 
you know?
    Mr. Beran. I do not know the exact number. It varies.
    Senator Levin. Ten, does that sound about right?
    Mr. Beran. In the range.
    Senator Levin. In the range, OK. Now let us get to Exhibit 
32. This is February 2011. It is a deposition of Sally Stiles 
under oath. Do any of you know who Sally Stiles is? Let me ask 
you, is she the Caterpillar director of global tax, do you 
know, Mr. Beran?
    Mr. Beran. She is the director of global tax operations 
now.
    Senator Levin. OK. So she is now the director of global 
tax. Here is what she said in her deposition:
    ``Question:''--this is Exhibit 32. ``Is it fair to say that 
the driving force behind . . . CSARL was the tax department and 
not any business unit''?nd her answer is: ``Yes.'' Was 
that correct?
    Mr. Beran. Senator, the context is that the Tax Department 
has to continually adapt to the way the business is run.
    Senator Levin. I understand.
    Mr. Beran. And that is what we were doing.
    Senator Levin. I understand. Was her statement correct, 
that the Tax Department was the driving force?
    Mr. Beran. At the point in time we were aligning our tax 
reporting with the way the business was run, yes, we have to 
propose that, business----
    Senator Levin. I am not arguing with you. I am just asking 
you whether or not the Tax Department was the driving force 
behind the CSARL transaction. That is all I am asking.
    Mr. Beran. Yes.
    Senator Levin. OK. Now, according to information which PwC 
has provided us, from 1999 to 2003 Caterpillar paid PwC $55 
million to design, develop, and implement the Swiss tax 
strategy involving CSARL, which Caterpillar called the Global 
Value Enhancement (GloVE), program. Does that match what you 
know, Mr. Beran?
    Mr. Beran. I believe that is in the range.
    Senator Levin. All right. Mr. Perkins, does that match your 
understanding, too?
    Mr. Perkins. Yes, it does.
    Senator Levin. All right. So from the beginning, the 
decision to use CSARL and direct Caterpillar's non-U.S. profits 
to Switzerland was to shift profits to a low-tax jurisdiction. 
Is that correct?
    Mr. Beran. Senator, as I said, it was to align the profit 
recognition where the business was being run and managed.
    Senator Levin. But wasn't the purpose to shift profits for 
tax purposes to a low-tax jurisdiction. Is that correct?
    Mr. Beran. We had to get the profits where they were 
earned.
    Senator Levin. Well, I am asking you----
    Mr. Beran. So it was not a shift. It was to get them to 
where they were earned. I mean, it changed the location, but 
the point was to get them to where they were earned.
    Senator Levin. Take a look at page 4619 in Exhibit 7.\1\ Do 
you have that page. It says at the head of the page, ``Increase 
Profit Associated with Marketing, U.S. Tax Deferral.'' Do you 
see that?
---------------------------------------------------------------------------
    \1\ See Exhibit No, 7, which appears in the Appendix on page 343.
---------------------------------------------------------------------------
    Mr. Beran. Yes.
    Senator Levin. OK. And then look at ``Benefits/Costs,'' 
where it says, ``Migrates profits from CAT Inc. to low-tax 
marketing companies.'' Do you see that?
    Mr. Beran. Yes.
    Senator Levin. OK. Was that accurate? Was that a benefit?
    Mr. Beran. Yes, it is a benefit to earn income in low-tax 
jurisdictions.
    Senator Levin. All right.
    Ms. Lagacy. Senator, could I add that----
    Senator Levin. Well, let me just finish. To migrate the 
profits from CAT Inc. to a low-cost marketing company. Is that 
what it says?
    Mr. Beran. Yes.
    Senator Levin. And this was the plan that you put in place. 
Is that correct?
    Mr. Beran. That is PwC's choice of terms, I guess.
    Senator Levin. Whose?
    Mr. Beran. PricewaterhouseCoopers' choice of wording.
    Senator Levin. That is their choice of wording.
    Mr. Beran. Yes.
    Senator Levin. Fair enough. And that is what your company 
bought?
    Ms. Lagacy. And, Senator, could I add, please?
    Senator Levin. Well, I just want first Mr. Beran; then you 
will have a chance.
    Mr. Beran. We paid them for their services, yes.
    Senator Levin. So you bought their plan, their strategy.
    Do you want to add something there, Ms. Lagacy?
    Ms. Lagacy. Yes, just that, again, keep in mind that CSARL 
and its predecessor company, COSA, were in business since 1960. 
At the time of this realignment, we had approximately 500 
employees in our Geneva office, but perhaps more importantly, 
thousands of employees outside the United States doing the work 
to help sell parts on machines.
    Senator Levin. Oh, sure. Those employees were all 
Caterpillar's employees, were they not?
    Ms. Lagacy. No. There are Caterpillar employees and also 
CSARL employees.
    Senator Levin. How many employees did Caterpillar have?
    Ms. Lagacy. In 1999?
    Senator Levin. No, at the time--the moment you just 
talked--you just said----
    Ms. Lagacy. I do not know the exact number of total 
Caterpillar employees.
    Senator Levin. How many employees did CSARL have?
    Ms. Lagacy. CSARL had thousands of employees. We had 500 
employees at that time in Geneva, Switzerland.
    Senator Levin. Right.
    Ms. Lagacy. But many other employees around the world. 
CSARL is not just in Geneva, Switzerland. It is the effort that 
markets--does also manufacturing and sells machines, engines, 
and parts outside of the United States.
    Senator Levin. And you had another 400 or so in Singapore, 
but all of the employees around the world, other than that, are 
working for Caterpillar or Caterpillar-owned companies. Is that 
not correct?
    Ms. Lagacy. CSARL----
    Senator Levin. Take a look at your own numbers of 
employees, total number of Caterpillar employees around the 
world are in the----
    Ms. Lagacy. We have over 118,000 employees around the world 
today; 52,000 of those employees are in the United States. So 
more than half of our employment is outside of the United 
States.
    Senator Levin. Of course, but that is Caterpillar's 
offshore employees.
    Ms. Lagacy. But I----
    Senator Levin. Is that not true?
    Ms. Lagacy. No.
    Senator Levin. OK. Let me give you the numbers, and then if 
you can tell me where we are wrong----
    Ms. Lagacy. OK.
    Senator Levin. These numbers came in a letter to the 
Subcommittee. Total Caterpillar employees globally, 118,000. 
Caterpillar U.S. employees, 52,000. Caterpillar offshore 
employees, including CSARL, 66,000.
    Now let us get down to CSARL. CSARL employees global, 682. 
CSARL employees Switzerland, 400.
    Is that wrong? That is a letter that came into the 
Subcommittee from you?
    Ms. Lagacy. There are also employees that I believe you 
have not included there from Singapore and some other areas.
    Senator Levin. We give you the total Caterpillar employees, 
so how many of the 118,000 employees then would you attribute 
to Singapore?
    Ms. Lagacy. I do not have those exact numbers, but, again, 
if I could get that document, I can research that and check 
that, please.
    Senator Levin. OK. We will get you this document that you 
sent to us. OK?
    Ms. Lagacy. OK. Thank you. And, again, those non-U.S. 
employees we talked about, they are working for entities that 
report up to CSARL.
    Senator Levin. They are--you say ``report to CSARL.'' But 
they are Caterpillar employees, are they not?
    Ms. Lagacy. I do not understand the distinction you are 
making there exactly, but again----
    Senator Levin. Do they get a check from CSARL?
    Ms. Lagacy. There are definitely employees of CSARL, many 
employees outside the United States supporting the work of 
CSARL.
    Senator Levin. Well, we are going to look at your chart.\1\ 
We are going to give you your chart.
---------------------------------------------------------------------------
    \1\ See Exhibit No. 50b, which appears in the Appendix on page 563.
---------------------------------------------------------------------------
    Ms. Lagacy. OK.
    Senator Levin. According to what we take off your document, 
CSARL employees globally are 682. Is that wrong?
    Ms. Lagacy. I do not recognize that number, so I would like 
to review the chart, if I could.
    Senator Levin. Do you know how many employees of CSARL in 
Switzerland?
    Ms. Lagacy. I know that in 1999 there were about 500.
    Senator Levin. All right. So at least in Switzerland there 
are 500 CSARL employees. We think there are 400 now, but we 
will not argue over 100. OK?
    Ms. Lagacy. I think that is probably right.
    Senator Levin. All right. And the total number of 
Caterpillar U.S. employees are 52,000. Is that correct?
    Ms. Lagacy. Yes.
    Senator Levin. And the total number of parts employees 
globally, according to your letter, 8,300. Does that sound 
right?
    Ms. Lagacy. Again, it depends on how you define parts, 
because we do not have a parts business----
    Senator Levin. OK.
    Ms. Lagacy [continuing]. And we do not identify that 
separately. I do not agree that those are all the employees 
working on parts now.
    Senator Levin. Will you take a look at Exhibit 50b?
    I will stop here because I have gone over my time. But just 
take a look at Exhibit 50b, answer number 10. This is the 
question: ``With regard to replacement parts business, for each 
year from 1999 through 2012, please provide the following 
information: The percentage of your company's worldwide 
headcount and payroll assigned to the PFRP [purchased finished 
replacement parts] business and located in the U.S. The 
percentage . . . assigned to [that] business and located in 
Switzerland.''
    Your answer is that you do ``not have employees assigned to 
a replacement parts business, however there are organizations 
throughout the enterprise that support purchase, storage, 
movement, and sales of replacement parts. In the chart below, 
we have identified divisions participating in these activities 
and provided U.S. based and non-U.S. based headcount statistics 
for the years 2006 through 2012.''
    And here is what you say: parts distribution, parts 
pricing, parts marketing. So on that chart you identify a 
certain number of employees related to parts distribution, and 
you show US Headcount, Total US Headcount, 3,619; Non-US 
Headcount Hourly, Non-US Headcount Management; and then your 
Total non-US Headcount, 2,027. And then you identify Geneva 
four or five lines down, Parts Pricing. You have--it is all 
parts, parts, parts, parts, parts. You got four in Geneva, you 
got six more in Geneva. Then you got Parts Marketing Support. 
And then you show these non-US Headcounts and so forth. So 
these are your numbers. So the chart that I read you is your 
numbers, but that means there are 4,900 parts-related employees 
in the United States, 66 in Geneva. Those are the totals from 
this chart.
    Ms. Lagacy. Senator, could I comment on that?
    Senator Levin. Of course.
    Ms. Lagacy. Just referencing our earlier questions, there 
is a line here for total non-U.S. headcount of 2,027, and then 
within purchasing another total non-U.S. headcount of 1,080. 
And, of course, as you referenced, there are some in Geneva. So 
it does appear to be thousands of employees outside of the 
United States.
    Senator Levin. Of course. That is what we said, and we 
believe those are all not CSARL employees but Caterpillar 
employees, and treat themselves as Caterpillar employees. 
Senator McCain.
    Senator McCain. Thank you, Mr. Chairman.
    The U.S. corporate tax rate is 35 percent, but I understand 
that the effective tax rate that Caterpillar paid was 29 
percent, which is 3 percent higher than the average effective 
tax rate for U.S. corporations. How does that happen? And does 
that include the overseas subsidiary income?
    Ms. Lagacy. Yes, Senator McCain, that does include--it is a 
rate that is an average rate on our global business, and so our 
overall average effective tax rate is 29 percent. That does 
include our global business.
    Senator McCain. So even though there are significant 
profits made by your overseas operation, you still pay an 
overall effective tax rate of 29 percent?
    Ms. Lagacy. Yes, that is correct.
    Senator McCain. How do you account for that?
    Ms. Lagacy. We do publish in our financial statements and 
our 10-K, if we look at the most recently completed year, we 
start with the U.S. statutory tax rate of 35 percent. About 5 
points or so comes off of that due to all of our business 
outside the United States, not just CSARL, of course, but all 
business outside the United States.
    There are then some provisions like the R&D credit and the 
production deduction that are part of U.S. tax law. You would 
then add some back in for State and local taxes. At the end you 
come up to 29 percent.
    Senator McCain. Again, I just am curious why it is that you 
would pay--even with the overseas profits, that you would still 
pay a higher effective tax rate than most other corporations.
    Ms. Lagacy. And we do think that that is significant, 
especially considering 65 percent of our business is outside of 
the United States.
    Senator McCain. Mr. Beran, when and how often since 1999 
has the IRS audited Caterpillar?
    Mr. Beran. Senator, we are under continuous examination. 
The IRS literally sits right outside my office. In that 
timeframe, we have closed 1999, 2000, 2001, 2002, 2003, 2004, 
2005, 2006----
    Senator McCain. What haven't you closed? What year?
    Mr. Beran. Two-thousand seven and later years are still 
under exam.
    Senator McCain. They are still under examination. So you 
are under constant auditing from the IRS?
    Mr. Beran. Yes, we are.
    Senator McCain. And they have not claimed you are in 
violation of IRS regulations?
    Mr. Beran. Each year's return provides substantial 
information, including transfer pricing information related to 
our international businesses. They have proposed no 
adjustments.\1\
---------------------------------------------------------------------------
    \1\ See Exhibit No. 56c, Memorandum to File from the Permanent 
Subcommittee on Investigations' Majority Staff regarding False 
Testimony Related to IRS' Position on Caterpillar's Tax Liability, 
which appears in the Appendix on page 633.
---------------------------------------------------------------------------
    Senator McCain. You heard that the first panel of witnesses 
said that the IRS was not doing their job. Would you agree with 
that?
    Mr. Beran. Well, they ask extensive questions about our 
business. We provided a lot of information to them, answered a 
lot of questions, reviewed our transfer pricing processes with 
them. I think they have been pretty diligent.
    Senator McCain. Maybe you could submit for the record the 
number of audits and the specific reasons for investigations by 
the IRS that they gave when they audited you. Could you do 
that?
    Mr. Beran. Certainly, Senator.
    Senator McCain. Caterpillar obviously can deliver a 
replacement part anywhere in the world in 24 hours or less. 
What role does the Swiss subsidiary and its dealer network play 
in making the 24-hour replacement parts delivery possible?
    Ms. Lagacy. CSARL plays a significant role in that, so at 
CSARL, who is administering dealers outside the United States, 
they first helped develop that dealer network; now they 
administer those dealers. So they are working regularly with 
dealers on how best to serve our customers around the world, 
which includes forecasting the needs of the customers, 
developing merchandising and marketing programs, etc.
    Senator McCain. The parts come from the United States, or 
where?
    Ms. Lagacy. Parts come from all over the world. 
Specifically CSARL does purchase about 70 percent of their 
purchased finished parts from the United States. They do get 
parts from other parts of the world, also.
    Senator McCain. Well, I thank you. I thank the witnesses.
    Thank you, Mr. Chairman.
    Senator Levin. Thank you very much, Senator McCain. Senator 
Johnson.
    Senator Johnson. Thank you, Mr. Chairman.
    Just getting back to your relationship with the IRS, Mr. 
Beran you said that they are sitting right outside your office. 
How many are sitting right outside your office, on average?
    Mr. Beran. On average, two or three work outside my office 
but several others, three or four work offsite. They have a 
number of members assigned, but they are in and out.
    Senator Johnson. Full-time. So you closed out through 2006, 
2007?
    Mr. Beran. Two-thousand six.
    Senator Johnson. Are they all just looking at 2007 now, or 
are they looking at all those years in kind of compilation?
    Mr. Beran. They typically do 2- or 3-year audit cycles. If 
they get behind, they extend.
    Senator Johnson. In the closed-out audits, you said they 
looked to transfer pricing. I mean, that encompasses this 
entire relationship with CSARL and, again, because they have 
proposed no adjustments, they have basically given their 
blessing to what you have done here from the standpoint of 
compliance with tax law, correct?
    Mr. Beran. That is the way I have taken it. There is 
extensive documentation that is provided every year, and we 
know they ask questions about it.\1\
---------------------------------------------------------------------------
    \1\ See Exhibit No. 56c, Memorandum to File from the Permanent 
Subcommittee on Investigations' Majority Staff regarding False 
Testimony Related to IRS' Position on Caterpillar's Tax Liability, 
which appears in the Appendix on page 633.
---------------------------------------------------------------------------
    Senator Johnson. Ms. Lagacy, in the scheme of things, in 
terms of the expenses of Caterpillar, what is your largest 
expense? Labor? Material?
    Ms. Lagacy. Yes, it would be the cost to build and make our 
products, yes.
    Senator Johnson. OK. In that hierarchy of costs, where does 
the tax expense fall?
    Ms. Lagacy. It is not the primary driver of our costs.
    Senator Johnson. But it is a large----
    Ms. Lagacy. Yes.
    Senator Johnson. It is a large cost center, correct?
    Ms. Lagacy. Yes.
    Senator Johnson. Certainly something that any responsible 
management team would take a look at managing, just like you 
manage labor, just like you manage material purchases, that 
type of thing.
    Ms. Lagacy. Correct.
    Senator Johnson. There is nothing nefarious in trying to 
minimize that tax burden?
    Ms. Lagacy. No, absolutely not.
    Senator Johnson. You had a whistleblower say that you did 
not report $2 billion worth of income tax to the United States. 
Let us say legally, properly or improperly, let us just 
stipulate that you saved yourself $2 billion in tax expense to 
the U.S. Government by complying with the U.S. tax code. What 
did Caterpillar do with that $2 billion or any tax savings that 
you may have enjoyed because of your compliance with the tax 
code?
    Ms. Lagacy. Well, I would like to say that we did have a 
former employee--he did file an employment lawsuit. That was 
resolved, and all of his concerns were taken seriously, and all 
of the experts, both internally and externally, 
PricewaterhouseCoopers and McDermott Will & Emery, found there 
to be no merit in his concerns.
    But to answer your question regarding what we do with that, 
we have continued to invest that in our business, and that is 
why we have seen the growth that we have seen. So in 1999, we 
were a $20 billion company. Last year our sales were $56 
billion. Our exports and our U.S. business grew over that time 
period.
    Senator Johnson. So you did not stuff any kind of tax 
savings in a mattress or a pillow case. I mean, you actually 
put that to use----
    Ms. Lagacy. Correct.
    Senator Johnson [continuing]. Growing your business, 
creating jobs.
    Ms. Lagacy. Correct.
    Senator Johnson. Both domestically as well as overseas.
    Ms. Lagacy. Yes, exactly.
    Senator Johnson. So those tax savings--I mean, we can 
quibble over who should have claimed those dollars. I mean, 
certainly had we taken them here in the Federal Government, we 
would have spent it somewhere. But you actually spent it 
putting people to work.
    Ms. Lagacy. We put it into our business, to grow our 
business, yes.
    Senator Johnson. Let us say we were able to pass a law here 
and capture a bigger share of Caterpillar's income. What 
options would Caterpillar have under that scenario if the tax 
burden just became too competitive and you could not compete 
with your global competitors?
    Ms. Lagacy. I think that is really the key, Senator. It is 
really important that we have a tax code that allows us to 
compete fairly in the global marketplace. We are not looking 
for a free lunch, but we are looking for the ability to compete 
fairly with companies inside and outside of the United States.
    Senator Johnson. Can you just speak to the relative 
competitiveness of what you are paying tax-wise to your 
competitors, the ones that were mentioned earlier in the 
hearing? And maybe just name the competitors that are your 
primary----
    Ms. Lagacy. Yes. Again, we talked about Volvo earlier in 
the hearing, who had a much lower effective tax rate; Komatsu 
is another one of our primary competitors outside the United--
--
    Senator Johnson. Do you know their exact tax rate? Can you 
give us the relative difference there?
    Ms. Lagacy. I do not have their exact tax rates.
    Senator Johnson. Mr. Beran.
    Mr. Beran. It varies year by year, depending upon 
profitability and their mix of income, just as it does with us. 
But they now have a lower Japanese statutory rate. But on top 
of that, they now have a territorial system that allows them to 
earn money in lower-tax environments and can move it wherever 
they can best employ it in their business.
    Senator Johnson. Do you feel that Caterpillar is at a 
competitive disadvantage because of the U.S. tax system? And 
can you be specific in terms of exactly what is the worst part 
of it?
    Mr. Beran. One of the worst parts is the international 
regime, which taxes much more foreign activity income than any 
of our competitor nations. So a business like CSARL would not 
tax that business at all back in their home country. You just 
pay the Swiss tax. And then the complexity of the U.S. rules 
that cause us to have to do much greater effort to be able to 
move money across our foreign subsidiaries, particularly back 
to the United States.
    Senator Johnson. Are you specifically aware of any maybe 
large contracts you have lost and potentially believe that it 
was because of our uncompetitive tax system?
    Mr. Beran. I could not say that we have lost contracts that 
way. It would probably come up more if we were looking to buy a 
company and a foreign competitor could bid more for that 
company.
    Senator Johnson. OK. So it puts you at a disadvantage in 
terms of M&A activity.
    What total percentage of your sales is parts?
    Mr. Beran. I do not know.
    Senator Johnson. Anybody on the panel know?
    Ms. Lagacy. Yes, we actually, Senator, do not separate our 
parts business, so we do not have a separate parts business. It 
is very integral to our products and our machine products. So 
it is our business model.
    Senator Johnson. OK. I was just trying to get a little bit 
better feel for the headcount issue that Senator Levin was 
talking about. I kind of view--and this is just my assumption, 
that CSARL in Geneva is kind of a headquarters, with a limited 
headcount, but you have people with other divisions 
internationally, either with direct reporting responsibility 
that may not be called CSARL but they are basically either 
directly reporting into CSARL or there is a dotted line of 
reporting.
    Ms. Lagacy. Correct.
    Senator Johnson. Can you describe that a little bit? Is 
that a correct assumption?
    Ms. Lagacy. Yes, exactly. That is a very correct 
assumption. We have a lot of key decisionmakers and a number of 
employees outside the United States who do as you just 
suggested. They understand our customers, they understand the 
needs of our customers. They work with our dealers on 
everything from financing to inventory management to 
understanding what the needs are to best serve the customers in 
that territory.
    Senator Johnson. So, again, I was trying to interpret the 
schedule that Senator Levin was talking about in terms of 
headcount, but I guess--maybe it is not direct. Maybe it was 
not answered because you were being very specific in terms of 
CSARL. But there are thousands of employees that really in some 
way, shape, or form are reporting or certainly contributing 
to----
    Ms. Lagacy. Yes.
    Senator Johnson [continuing]. The activities of CSARL. Is 
that an accurate statement?
    Ms. Lagacy. Yes. That is true.
    Senator Johnson. OK. Well, thank you for your testimony. 
Thank you, Mr. Chairman.
    Senator Levin. Are you saying that CSARL has thousands of 
employees?
    Ms. Lagacy. Again, there are----
    Senator Levin. I know there are a lot of people who 
communicate with CSARL. I am just asking you, are you saying 
CSARL has thousands of employees?
    Ms. Lagacy. Again, if you are asking very specifically on 
the legal entity structure of CSARL and it has a number of 
subsidiaries, I know that there are thousands of employees 
doing the work of administering the dealers, manufacturing, 
selling machines, etc., that are part of CSARL.
    Senator Levin. I do not know--``part of?-'' You are saying 
a lot of people communicate with CSARL. Are you actually saying 
CSARL has--we know how many employees Caterpillar has, right?
    Ms. Lagacy. Yes.
    Senator Levin. We have the number. How many employees does 
CSARL have?
    Ms. Lagacy. I do not have the exact number----
    Senator Levin. Do you have an approximate----
    Ms. Lagacy [continuing]. Of CSARL employees.
    Senator Levin. Do you have an approximate number?
    Ms. Lagacy. Again----
    Senator Levin. Just do you have an approximate number?
    Ms. Lagacy. No.
    Senator Levin. Now, let me ask you about what Caterpillar 
does. Take a look, if you would, at Exhibit 52.\1\ This is the 
servicing agreement between Caterpillar and CSARL, because 
Caterpillar just kept doing what it was always doing, a parent 
corporation, most of the employees by far, CSARL with very few 
employees, relatively, and here is what----
---------------------------------------------------------------------------
    \1\ See Exhibit No. 52, which appears in the Appendix on page 589.
---------------------------------------------------------------------------
    Mr. Ryan. Mr. Chairman, could we just get to the exhibit?
    Senator Levin. Sure.
    Mr. Ryan. We are not on the exhibit yet.
    Senator Levin. OK. And who is that just spoke?
    Mr. Ryan. I apologize, Your Honor. Stephen Ryan. I am 
counsel to the company. The witnesses were looking.
    Senator Levin. Thank you. I was just wondering, since you 
spoke, for our reporter to know who it was.
    Mr. Ryan. Thank you, sir.
    Senator Levin. So at the back of this Exhibit 52 is 
Schedule 1 that has a number 661 on it, ``Schedule of Services 
to be Provided by Caterpillar.'' This is the list of what they 
do. Have we got it?
    Ms. Lagacy. I am looking for Schedule 1.
    Senator Levin. OK.
    Ms. Lagacy. Yes, I have it.
    Senator Levin. It includes the following: creating and 
translating services manuals and materials for replacement 
parts; provides inventory availability management; provides 
parts custom service to dealers; processes dealer parts 
returns; maintains information systems; provides marketing 
consulting services to dealers; provides strategic planning and 
accounting services.
    Now, for the U.S. warehouses, Caterpillar--and, again, 
CSARL has no warehouses. Caterpillar agrees to manage and 
monitor inventory levels worldwide and perform expediting 
services, arrange for transportation of CSARL parts, perform 
general warehousing services and provide warehousing 
facilities, perform inventory management services. And for all 
those services, on the last page, Caterpillar gets reimbursed 
its costs plus 5 percent of those costs.
    So basically Caterpillar agreed to keep running the program 
for CSARL. CSARL has 65 employees handling parts, according to 
your charts, no warehouses, no parts suppliers, no parts 
inventories, no forecasting or other software being 
administered from CSARL.
    My question: Would Caterpillar perform all of these same 
services for a third party at cost plus a small service fee 
while giving up 85 percent of its profits? Ms. Lagacy, would 
you do that?
    Ms. Lagacy. Yes, and I would like to----
    Senator Levin. You would?
    Ms. Lagacy. Your question----
    Senator Levin. You are offering to a third party----
    Ms. Lagacy. No, I thought you asked me if I would answer 
the question.
    Senator Levin. No, I was asking you whether you would offer 
this--I thought you were making an offer right now to a third 
party to buy all that.
    Ms. Lagacy. No. I was attempting to answer your question. 
So, first, you said CSARL kept doing what it was doing, and, 
again, CSARL and its predecessor company were in business since 
1960 doing this work of supporting our dealers and selling 
parts, marketing parts, machines and engines in the territory--
--
    Senator Levin. You have gone into what CSARL has done, and 
I am----
    Ms. Lagacy. So I think that is significant.
    Senator Levin [continuing]. Just now telling you what your 
documents say Caterpillar is doing. That is all. Did I read it 
correctly?
    Ms. Lagacy. Yes, you read the document correctly.
    Senator Levin. OK. Now, take a look at Exhibit 18,\1\ 
Caterpillar Board of Directors Minutes. If you look at the 
first line in the second paragraph--do you have it? Exhibit 18, 
did you get it?
---------------------------------------------------------------------------
    \1\ See Exhibit No. 18, which appears in the Appendix on page 411.
---------------------------------------------------------------------------
    Ms. Lagacy. I am on Exhibit 18.
    Senator Levin. OK. Second paragraph----
    Ms. Lagacy. Which page?
    Senator Levin. It says, ``Mr. Larson.'' Who is that?
    Ms. Lagacy. I do not see that in the document.
    Senator Levin. OK. Is this a Board of Directors meeting you 
have, the minutes?
    Ms. Lagacy. Caterpillar Board of Directors Minutes 
Excerpts.
    Senator Levin. Yes.
    Ms. Lagacy. It starts with page 5?
    Senator Levin. Well, look at 1857 at the bottom, page 8.
    Ms. Lagacy. OK.
    Senator Levin. ``Larson,'' do you see that there?
    Ms. Lagacy. Yes.
    Senator Levin. ``Larson next described the efforts underway 
to transform the parts distribution business from a United 
States centric model''--this is 2012, there are ``efforts 
underway to transform the parts distribution business from a 
United States centric model.'' So in February 2012, about a 
year ago, your parts distribution business is called ``United 
States centric.'' That is what was told to the Board of 
Directors. Are you aware of that?
    Ms. Lagacy. No, I am reading those words on this page. I 
was not involved in this meeting, so I do not know the context 
under which this discussion occurred. But, again, I can tell 
you that we have employees and parts being handled all around 
the world by a number of people today and have for many years.
    Senator Levin. I am sure of that. That is not the question. 
The question is whether 85/15 is an appropriate split of 
profits on your parts, international parts deal, business.
    Ms. Lagacy. I would like to respond to that, if I could, 
Mr. Chairman.
    Senator Levin. Well, let me keep to these questions. ``Mr. 
Larson next described the efforts underway to transform the 
parts distribution business from a United States centric 
model''--this is a year ago, and you are not aware of that 
description to the Board of Directors. Is that correct, you are 
not aware of that by Mr. Larson?
    Ms. Lagacy. No. I mean, I was not a part of this.
    Senator Levin. This is the first you have seen that?
    Ms. Lagacy. If I have seen it at all, it has been simply 
for preparation for this hearing.
    Senator Levin. All right. Now, there was a discussion here 
at the board meeting, according to the title there, on ``Parts 
Growth and Distribution Facility Footprint Expansion.'' That 
was at the board meeting. Did you know that the board was going 
to be discussing that in February 2012?
    Ms. Lagacy. I did not.
    Senator Levin. OK. Now, let me ask you, Mr. Beran, 
information which has been provided to the Subcommittee by 
Caterpillar shows that 70 percent of all purchased finished 
replacement parts sold offshore were manufactured in the United 
States. That is a chart we are going to put up. That is Exhibit 
1f,\1\ which is the same thing as the chart. And I think, Ms. 
Lagacy, you used the same figure a moment ago. Is that correct?
---------------------------------------------------------------------------
    \1\ See Exhibit No. 1f, which appears in the Appendix on page 281.
---------------------------------------------------------------------------
    Ms. Lagacy. Yes, approximately 70 percent----
    Senator Levin. Of all purchased finished replacement parts 
sold offshore manufactured in the United States, correct?
    Ms. Lagacy. Yes.
    Senator Levin. OK. Mr. Beran, would you----
    Ms. Lagacy. Purchased finished, replacement parts again, by 
suppliers, yes.
    Senator Levin. Right. Do you agree with that, Mr. Beran?
    Mr. Beran. Yes.
    Senator Levin. And how many purchased finished replacement 
parts are manufactured in Switzerland, Mr. Beran?
    Mr. Beran. Narrowing things down to Switzerland does not 
describe----
    Senator Levin. I am just asking you a question. You would 
ask yourself a different question. How many parts are 
manufactured in Switzerland?
    Mr. Beran. CSARL manages----
    Senator Levin. Could you answer my question, please, and I 
am not asking you what you think they manage. We have gone 
through that. I am asking you a simple, direct question.
    Mr. Beran. They do not have any manufacturing in 
Switzerland.
    Senator Levin. Thank you. Now, what percentage of how many 
warehouses are there in Switzerland, Caterpillar warehouses or 
CSARL warehouses? Do you know?
    Mr. Beran. None, to my knowledge.
    Senator Levin. Do you know how many warehouses there are in 
the United States, Caterpillar warehouses?
    Mr. Beran. I think we discussed earlier there are around 
10, but I do not know the exact number.
    Senator Levin. Is it true, Mr. Beran, that Caterpillar has 
its largest parts warehouse and manages its global parts 
inventory in Morton, Illinois? The largest parts warehouse of 
Caterpillar in Morton, Illinois. That is my question.
    Mr. Beran. Morton has a very sizable facility. I think it 
is the largest.
    Senator Levin. Thank you.
    Mr. Beran. But we have large ones in Belgium, in Singapore, 
in----
    Senator Levin. None in Switzerland.
    Mr. Beran. None in Switzerland. All of them are owned by 
CSARL or one of its subsidiaries.
    Senator Levin. I understand. You say ``owned''? CSARL owns 
those?
    Mr. Beran. Owns----
    Senator Levin. Who owns CSARL?
    Mr. Beran. CSARL owns all of the--excuse me?
    Senator Levin. Who owns CSARL?
    Mr. Beran. Ultimately it is owned by Caterpillar Inc., but 
every government in the world expects us to report by legal 
entity.
    Senator Levin. Right. So CSARL is owned by Caterpillar.
    Mr. Beran. That is correct.
    Senator Levin. You say CSARL owns those warehouses?
    Mr. Beran. CSARL either owns the warehouses or owns the 
entity that owns them.
    Senator Levin. Right, and who owns the entity that owns 
CSARL?
    Mr. Beran. Ultimately Caterpillar Inc.
    Senator Levin. Fine. Are the names Stuart Levenick, Stephen 
Gosselin, Stephen Larson, and Barbara Hodel--are those names 
familiar to you?
    Mr. Beran. I recognize those names, yes.
    Senator Levin. Do you know those names, Ms. Lagacy?
    Ms. Lagacy. Yes, I do.
    Senator Levin. Do they work in the United States? Do you 
know?
    Ms. Lagacy. Could you read the list again? I am sorry. Stu 
Levenick----
    Senator Levin. Stuart Levenick?
    Ms. Lagacy. Yes.
    Senator Levin. Stephen Gosselin, Stephen Larson, and 
Barbara Hodel.
    Ms. Lagacy. Yes, all of them work in the United States.
    Senator Levin. Are they key leaders of Caterpillar's parts 
business?
    Ms. Lagacy. They are key leaders, but, again, keep in mind 
we do not have a parts business.
    Senator Levin. I am sure, but are they key leaders in the 
parts part of your business?
    Ms. Lagacy. They are key leaders of Caterpillar.
    Senator Levin. And do they work heavily in the parts part 
of Caterpillar, even though it is not signified as parts 
separately?
    Ms. Lagacy. They have, again, especially Stu Levenick would 
have multiple responsibilities that would go well beyond parts, 
but he does have some responsibilities there also.
    Senator Levin. And how about Stephen Gosselin? Does he have 
significant----
    Ms. Lagacy. He has significant overall product support 
responsibilities, but, again, not all of those----
    Senator Levin. Does that include parts?
    Ms. Lagacy. Yes.
    Senator Levin. Stephen Larson.
    Ms. Lagacy. Stephen Larson has retired.
    Senator Levin. OK. Barbara Hodel?
    Ms. Lagacy. Barb Hodel works in our parts distribution 
area, logistics.
    Senator Levin. Does she work in the United States?
    Ms. Lagacy. Yes, she does.
    Senator Levin. OK. Do you know how many parts approximately 
are warehoused in the United States?
    Ms. Lagacy. I do not.
    Senator Levin. Do you know, Mr. Beran?
    Mr. Beran. The number of parts----
    Senator Levin. Approximately, within a hundred million or 
so, warehoused in the United States. Would you know, Mr. 
Perkins?
    Mr. Perkins. No, I do not.
    Senator Levin. How about within half a billion?
    Ms. Lagacy. I would say in total I believe we have just 
under a million serviceable replacement parts. I do not know 
how many of those are stocked in the United States.
    Senator Levin. Would it surprise you to know that there is 
about a billion and a half parts, not types of parts but parts, 
that are warehoused in the United States?
    Ms. Lagacy. I do not know that number.
    Senator Levin. OK. It would not surprise you?
    Ms. Lagacy. Individual, so not part numbers but just 
individual numbers of parts, I frankly have no idea how many 
there might be housed in the United States.
    Senator Levin. OK. Would you take a look, please, at 
Exhibit 53?\1\
---------------------------------------------------------------------------
    \1\ See Exhibit No. 53, which appears in the Appendix on page 600.
---------------------------------------------------------------------------
    Ms. Lagacy. I do not have an Exhibit 53 in my book.
    Senator Levin. OK.
    Ms. Lagacy. Thank you.
    Senator Levin. Do you have it now?
    Ms. Lagacy. Yes.
    Senator Levin. OK. I want to talk to you about the value of 
what was transferred to CSARL as part of the license: ``What 
intangible property will be transferred from CAT Inc. to COSARL 
under the replacement parts license?'' ``Under the replacement 
parts license,'' that is what we are talking about, replacement 
parts, not machines, replacement parts license.
    So, first, please note that the document talks about parts, 
not machines, and ``COSARL'' refers to what we have been 
calling ``CSARL.''
    So here is what was planned to be transferred: patents and 
designs; parts, including patented elements; trademarks; parts 
sold under CAT trademark; contracts; buying from suppliers 
Caterpillar already has screened, qualified, negotiated prices 
with; systems and procedures; CAT proprietary LogNet 
information; know-how, methods, forecasts, estimates.
    Now, if you take a look at Exhibit 51,\1\ if you would, 
page 2 under ``Intellectual Property.'' This was transferred. 
Intellectual property includes, but is not limited to, know-
how, processes, designs, specifications, engineering standards, 
trade secrets, inventions, patent applications, patents, 
copyrights, trademarks, Caterpillar production system, customer 
lists, supplier lists, systems and more.
---------------------------------------------------------------------------
    \1\ See Exhibit No. 51, which appears in the Appendix on page 576.
---------------------------------------------------------------------------
    So the economic rights to use that were transferred to your 
subsidiary in a tax haven. Would you have transferred all that 
to anyone but a related party? Now you have a chance to answer 
that question. Ms. Lagacy.
    Ms. Lagacy. Keep in mind that again I do not agree with 
your characterization of a tax haven, but----
    Senator Levin. You do not think Switzerland is a tax haven?
    Ms. Lagacy. I do not really know the definition of a ``tax 
haven.''
    Senator Levin. Oh, OK. But you said you disagreed with my 
definition.
    Ms. Lagacy. Right, so I would not----
    Senator Levin. Obviously you do not know what a definition 
is.
    Ms. Lagacy. It is where we have done business and where we 
had headquarters since 1960.
    Senator Levin. All right. But it is a low-tax jurisdiction 
under your own documents, and that was one of the purposes of 
these transfers. Under your own documents, to a low-tax 
jurisdiction. That is what it says: ``Migrate profits to a low-
tax jurisdiction.''
    Ms. Lagacy. We, again, have had a headquarters in Geneva 
since 1960 and found it to be a good base from which to grow 
our business outside the United States, and we have been fairly 
effective----
    Senator Levin. Well, I am sure you said that, but take a 
look again at Exhibit 7:\2\ ``Benefits: Migrates profits from 
CAT Inc. to low-tax marketing company.'' It is not irrelevant, 
is it, that it was a low-tax marketing company? Or is it 
irrelevant? That is your own document. I have read it to you 
three times.
---------------------------------------------------------------------------
    \2\ See Exhibit No. 7, which appears in the Appendix on page 343.
---------------------------------------------------------------------------
    Ms. Lagacy. Right. This is----
    Senator Levin. Exhibit 7, page 3 at the end: Before: 
``Migrate profits from CAT Inc. to low-tax marketing 
companies.''
    Ms. Lagacy. Yes, and this is a PwC document, I believe. But 
I certainly would agree that the tax rate in Switzerland is 
much lower than the tax rate in the United States.
    Senator Levin. OK. So you use words, too, ``low-tax 
[marketing] countries''? Don't you ever use those words? 
Doesn't Caterpillar use those same words? Yes or No.
    Ms. Lagacy. We do not use the word ``tax haven,'' but there 
are certainly----
    Senator Levin. How about ``low tax'' and ``high tax''?
    Ms. Lagacy [continuing]. Countries that are lower tax than 
others.
    Senator Levin. How about ``low tax''? Do you ever use those 
words? Take a look at Exhibit 17.\1\ The number at the bottom 
is 5979. It has a CAT number at the bottom. Do you see it, 
page--I think it may be page 6 on your--do you see that?
---------------------------------------------------------------------------
    \1\ See Exhibit No. 17, which appears in the Appendix on page 403.
---------------------------------------------------------------------------
    Ms. Lagacy. Starting--the title----
    Senator Levin. Effective tax drivers.
    Ms. Lagacy [continuing]. Is ``2009 Effective Tax Rate--
Drivers.''
    Senator Levin. Yes, do you see that in that oval at the 
right, ``Losses in high tax rate countries, profits in low''? 
Do you see that?
    Ms. Lagacy. I do see that.
    Senator Levin. OK. My question is: Would you have 
transferred all that, all of that that was in the licensing 
agreement to anybody but a related party?
    Ms. Lagacy. Again, to answer that question, keep in mind 
that everything that we have done has been at an arm's-length 
standard, so all of that----
    Senator Levin. Well, that is my question. Would you sell 
that to an unrelated party? Would you give a license to an 
unrelated party? That is my question.
    Ms. Lagacy. That would require a business decision based on 
the economics of that situation. I cannot simply answer that 
yes or no.
    Senator Levin. You cannot answer that no?
    Ms. Lagacy. No, I cannot.
    Senator Levin. OK. I think it is you would not answer that 
no. But you can answer it no because nobody in their right mind 
would sell to an unrelated party what Caterpillar transferred 
in that license agreement for nothing.
    Ms. Lagacy. I think it would be----
    Senator Levin. No company will do that.
    Ms. Lagacy. And, again, it was not for nothing, of course. 
There is a royalty----
    Senator Levin. Well, not for nothing. They kept 15 percent 
of the profits and transferred 85 percent of the profits in the 
future, but there was no consideration for the transfer.
    Ms. Lagacy. And, again, if you look at the 15-percent 
number, if you consider CSARL's full--I do not think it gives a 
total picture because if you consider CSARL's total licensed 
business, that number is slightly above 30. And if you then add 
on to that the service fees and the Subpart F income, it is 
actually more than half of the income from CSARL that incurs 
U.S. tax rates.
    Senator Levin. My question to you is: Do you think any 
company would transfer with no consideration what was in that 
license? Are you not able to answer that? I think every 
corporate executive in the world would answer that, but you in 
front of this Subcommittee. There is no way you would transfer 
that to an unrelated company. Is that not true?
    Ms. Lagacy. Keep in mind----
    Senator Levin. OK. You cannot answer that. Is that right? 
You cannot give a yes or no answer to that?
    Ms. Lagacy. I am trying to answer your question.
    Senator Levin. Are you able to give a yes or no answer to 
that question?
    Ms. Lagacy. I cannot give a yes or no answer to that 
question without understanding the full situation and the 
economics of what you are talking about. I think it would be 
irresponsible----
    Senator Levin. I am talking about the license that was 
given to CSARL. That is what I have been talking about.
    Ms. Lagacy. Right. There was a license granted to CSARL, 
and CSARL was the organization that had developed the dealer 
network and continued to work with the dealer network to----
    Senator Levin. Had developed the dealer network? You mean 
Caterpillar never developed the dealer network?
    Ms. Lagacy. COSA, CSARL's predecessor company, COSA, was in 
business since 19----
    Senator Levin. Of course. I am not saying they did not help 
develop a dealer network, but according to your own transfer 
documents, the major developer was Caterpillar. I am not saying 
CSARL did not help develop a network.
    Ms. Lagacy. Right.
    Senator Levin. Of course they did.
    Ms. Lagacy. COSA, the predecessor company to CSARL, COSA, 
developed that dealer network outside of the United States.
    Senator Levin. They helped develop, but Caterpillar was the 
major developer of markets everywhere, according to your 
transfer agreement, your transfer documents, which I have read 
before.
    Ms. Lagacy. Again, I do not agree with the statement.
    Senator Levin. OK. All right. Are patents, trademarks, 
know-how, are they not crown jewels of a company?
    Ms. Lagacy. Those are very important, yes.
    Senator Levin. They were transferred to CSARL, the economic 
rights to those? Is that not true?
    Ms. Lagacy. So, again, there was a license agreement----
    Senator Levin. I am just asking you if it is true.
    Ms. Lagacy. There was a royalty paid.
    Senator Levin. I am just asking you if it is true.
    Ms. Lagacy. My colleague Mr. Beran may be able to talk more 
precisely about specifically what was included in the CSARL 
license.
    Senator Levin. Well, I read it to him once before. I read 
the patents, trademarks--OK? I read that to all of you. Are 
those not crown jewels of a company?
    Mr. Beran. What was transferred was the right to use them.
    Senator Levin. Of course.
    Mr. Beran. Caterpillar did not give them up. Caterpillar 
Inc. continued to receive compensation----
    Senator Levin. How much?
    Mr. Beran [continuing]. For the utilization of those.
    Senator Levin. You are just talking about the parts profits 
that they retained.
    Mr. Beran. No, the patents were related not just to the 
parts activities but----
    Senator Levin. I understand. I am talking about patent 
parts----
    Mr. Beran [continuing]. To the overall----
    Senator Levin. Come on, Mr. Beran. We are talking about 
patents relating to parts.
    Mr. Beran. The patents were related to all Caterpillar IP 
related to product design and parts.
    Senator Levin. And parts. That is what we are talking 
about. That is what the strategy related to, was parts.
    Mr. Beran. It is an overall license for the entirety of the 
business.
    Senator Levin. Including the parts.
    Mr. Beran. Parts are an integral element of our overall----
    Senator Levin. That is why I say ``including the parts.''
    Mr. Beran [continuing]. Product strategy.
    Senator Levin. That is why I said ``including the parts.''
    Mr. Beran. Yes, it includes the parts.
    Senator Levin. OK. The tax strategy, related to parts, did 
it not?
    Mr. Beran. It related to the overall business. We were 
aligning with how the product managers and the other managers 
of the company ran the business.
    Senator Levin. No, I understand what you are repeating 
here, but I am just reading document, after document, after 
document, after document, parts, parts, parts, parts. That tax 
strategy related to parts, did it not? That is my question.
    Mr. Beran. If you talk----
    Senator Levin. Did the tax strategy relate to parts? That 
is my question.
    Mr. Beran. It included parts.
    Senator Levin. All right. It did not relate to parts. It 
included parts. Did you see anything other than parts? Did you 
ever see anything other than parts related on the documents 
that I have read?
    Mr. Beran. Well, Senator, if you select documents prepared 
by people from our logistics business, they will primarily talk 
about parts.
    Senator Levin. And do you have documents with you that say 
that what was transferred was something other than parts?
    Ms. Lagacy. Well, again, CSARL is an integrated 
entrepreneur----
    Senator Levin. I know. I am just asking you----
    Ms. Lagacy. That does include----
    Senator Levin. You are talking about the documents which we 
got. I am just asking you, do you have other documents?
    Mr. Beran. I did not bring any documents.
    Senator Levin. Take a look at Exhibit 7.\1\ I am going to 
just go back to this one more time. This was the proposal that 
you accepted and implemented for this tax strategy in 
Switzerland: ``Recharacterize marketing company income''--
recharacterize it, mind you--``to achieve U.S. tax deferral.'' 
And look what is said down here. What is left out? ``Out of 
chain.''
---------------------------------------------------------------------------
    \1\ See Exhibit No. 7, which appears in the Appendix on page 343.
---------------------------------------------------------------------------
    Ms. Lagacy. I am still----
    Senator Levin. Are you having trouble finding it?
    Ms. Lagacy. Could you help me see--I am at the bottom it is 
4619. Is that the----
    Senator Levin. No.
    Ms. Lagacy. OK.
    Senator Levin. 4618.
    Ms. Lagacy. OK.
    Senator Levin. Do you see where it says, ``Remove 
Caterpillar Inc. from the chain of title for purchased finished 
parts . . .''? Do you see that?
    Ms. Lagacy. Yes.
    Senator Levin. That is the strategy. I am going to read it 
to you for the last time, because this is the strategy, is to 
``Remove Caterpillar Inc. from the chain of title passage for 
purchased finished parts . . .'' OK? I do not know----
    Ms. Lagacy. But I believe----
    Senator Levin. I know. I understand there was more than 
that, but I am just talking about----
    Ms. Lagacy. Right, it was more than that.
    Senator Levin. I am talking about the tax strategy.
    Ms. Lagacy. Well, again, the tax strategy was established 
to follow the business strategy. CSARL was set up as an 
integrated entrepreneur, and it did include more than parts. It 
did also include manufacturing facilities and other things.
    Senator Levin. All right. Mr. Perkins, if you take a look 
at Exhibit 34,\2\ this is a deposition that you provided under 
oath in 2010 about the Swiss tax strategy designed by 
Pricewaterhouse for Caterpillar involving CSARL and the non-
U.S. parts profits. When you were asked in that deposition, 
``Was there any business advantage to Caterpillar Inc. to have 
this arrangement''--meaning the CSARL transaction--``put in 
place other than the avoidance or deferral of income taxation 
at higher rates?'' you responded under oath, ``No, there was 
not.'' Was that truthful?
---------------------------------------------------------------------------
    \2\ See Exhibit No. 34, which appears in the Appendix on page 493.
---------------------------------------------------------------------------
    Mr. Perkins. Mr. Chairman, at the time that I gave that 
deposition in the employment lawsuit, it was a couple years 
after I had retired. In terms of the response to that specific 
question, that is a true statement. But I would like to have 
the opportunity to clarify what I did not say at that time. The 
activities associated with the removal of CAT Inc. from the 
supply chain did, in fact, have significant business activities 
accompanying them. When I responded to this question, I 
responded negatively, but the point is I----
    Senator Levin. I know what the point is now. I am asking 
you was it true that, when you said to the question, was there 
any business advantage to Caterpillar to have this arrangement 
put in place other than the avoidance or deferral of income 
taxation at higher rates, your answer: ``No, there was not.'' 
And my simple question to you--and I know what you would like 
to say now. My simple question to you is: Was that true when 
you said it?
    Mr. Perkins. When I responded, I am responding from a tax 
viewpoint, and I look at things from a financial impact, first 
upon legal entity, then upon the business unit, certainly from 
a legal entity standpoint there was a financial advantage, that 
legal entity changes are transparent to our business units. And 
so any after-tax benefit that was generated creating a 
financial advantage to the enterprise, that was not reflected 
on the business unit's performance.
    Senator Levin. ``Question: What was the benefit to 
Caterpillar Inc. to have CSARL purchase finished replacement 
parts instead of having Caterpillar Inc., buy them and sell 
them to CSARL?''
    Your answer: ``It would alter the character of the income 
from CSARL from includable deemed distribution income to the 
U.S. [United States].''
    Was that true?
    Mr. Perkins. Again, from----
    Senator Levin. I am just asking, was your answer true?
    Mr. Perkins. Yes, it was.
    Senator Levin. ``Question:''--same deposition under oath--
``So the advantage to Caterpillar Inc. would be that it would 
pay less Federal income tax?''
    ``Answer: Yes.''
    Was that true when you said it?
    Mr. Perkins. Yes.
    Senator Levin. Mr. Beran, are CSARL's financial results 
included within Caterpillar's U.S. consolidated financial 
statement?
    Mr. Beran. Yes, they are.
    Senator Levin. Are any CSARL losses that might come to pass 
ultimately then be reflected in that financial statement?
    Mr. Beran. They would be in the financial statements; they 
would not necessarily be reflected in the U.S. tax returns.
    Senator Levin. Of course. But in that financial statement, 
they would be included?
    Mr. Beran. In our----
    Senator Levin. Consolidated financial----
    Mr. Beran [continuing]. Consolidated financial statements, 
yes, they would.
    Senator Levin. Any of CSARL's losses are in that 
consolidated Caterpillar, as the parent, financial statement. 
Please take a look, if you would, at Exhibit 17.\1\
---------------------------------------------------------------------------
    \1\ See Exhibit No. 17, which appears in the Appendix on page 403.
---------------------------------------------------------------------------
    [Pause.]
    On page 5984, it says ``Cash Management, `Crossover' cash 
buildup in Geneva.'' Do you see that page?
    Ms. Lagacy. Yes.
    Senator Levin. OK. ``Caterpillar Definition: Crossover 
occurs when offshore cash no longer can be accessed in the 
United States without incremental U.S. tax cost.'' In other 
words, if you tried to bring that offshore cash back to the 
United States, you would have to pay taxes on it. And even with 
a credit for taxes paid in Geneva, it indicates you would have 
to pay 25 percent on that cash.
    At the bottom it says you are working to ``develop tax 
efficient repatriation strategies.'' And then on page 12, it 
lists some of those strategies, with a goal of repatriating $3 
billion. It talks about loans, tax-efficient dividends, 
prepaying royalties, and goods prepayment.
    Did you work on those strategies, do you know, Ms. Lagacy?
    Ms. Lagacy. I was not there at that time, but I think I can 
shed some light on this general topic. We are, again, about a 
$56 billion company----
    Senator Levin. Well, I am not talking about at that time. I 
am saying have you continued to work--let me put it in the 
present--on those tax strategies?
    Ms. Lagacy. We have approximately $3.5 billion offshore at 
this point outside of the United States, and that is available 
for general corporate use and can be repatriated without 
significant additional U.S. tax. Most of that money is outside 
the United States because it is needed to run our businesses 
outside the United States. Again, 65 percent of our $56 billion 
in sales and revenues comes from outside of the United States.
    Senator Levin. And how much, if you repatriated, would be 
subject to tax here?
    Ms. Lagacy. Again, because of previously taxed income, 
transactions that have already been taxed at the U.S. rate, a 
substantial sum can be returned, significant amounts can be 
returned, nearly all of that, without any substantial income 
tax in the United States.
    Senator Levin. All right. Is there any part of that which 
you would have to pay a tax on, U.S. tax?
    Ms. Lagacy. There might be some very minor, but it would be 
very insignificant. It is available for general corporate use 
and could be brought back to the United States without any 
additional significant tax burden in the United States.
    Senator Levin. What does this mean, ``tax-efficient 
repatriation strategies,'' and why can't you just--it says $3 
billion. Why can't you just bring it back to the United States?
    Ms. Lagacy. Again, I believe this is a 2010 document, and I 
am not exactly sure of the situation back in 2010 with cash. 
But, again, I am telling you that today I know you have 
situations of companies that you have talked to that have 
significant amounts of cash outside the United States that 
cannot be repatriated, but we are not one of those companies.
    Senator Levin. All right. So, in other words, you said $17 
billion? How much did you have in cash?
    Ms. Lagacy. No. We have $3.5 billion in cash as of the end 
of 2013.
    Senator Levin. And you could repatriate all of that without 
paying any U.S. tax on it?
    Ms. Lagacy. What I said was it is available for general 
corporate use, and that cash could come back without 
significant additional U.S. tax. There may be some small 
amounts there.
    Senator Levin. No. You answered the question.
    Ms. Lagacy. OK.
    [Pause.]
    Senator Levin. I had made a reference before to documents 
that were written in the 1970s which said that CAT Inc. had the 
largest role with regard to market and dealer development. Do 
you agree with that? These are Caterpillar documents. I have 
read them before, today, and you were here, I believe. Exhibit 
4a,\1\ if you want to look at it again.
---------------------------------------------------------------------------
    \1\ See Exhibit No. 4a, which appears in the Appendix on page 302.
---------------------------------------------------------------------------
    Ms. Lagacy. Yes, Exhibit 4a. Oh, this is a Pricewaterhouse 
document?
    Senator Levin. Yes. The same thing was said in 1996, 1995, 
1994, and 1997.
    Ms. Lagacy. Right. That was stated by Pricewaterhouse.
    Senator Levin. Right. I am just asking you, it says here, 
``Cat Inc. has the largest role with regard to market and 
dealer development,'' gives the reasons, it acknowledges or 
says that the marketing companies also have major 
responsibility for market development. In fact, this is their 
primary responsibility. That is what they do. But it says that 
the largest role with regard to market and dealer development 
is CAT Inc. Do you agree with that statement? That is what I am 
asking.
    Mr. Beran. Senator, at that time the U.S. market was over 
half the world, so by definition it would have the largest 
responsibility related to that.
    Ms. Lagacy. But, again, as we have said, COSA had the 
primary responsibility, the predecessor company to CSARL, to 
developing that network outside of the United States.
    Senator Levin. All right. By the way, it says it has the 
largest role with regard to that for three reasons. The third 
is, ``it continues to be involved with the development and 
oversight of worldwide marketing programs and approaches.'' Did 
you agree with that statement?
    Ms. Lagacy. Could you point me to the page that you are on 
now.
    Senator Levin. The same page.
    Ms. Lagacy. OK. Thank you.
    Senator Levin. No. 3, ``it continues to be involved with 
the development and oversight of worldwide marketing programs 
and approaches.'' Do you agree with that?
    Ms. Lagacy. I would say that most of the specific marketing 
programs and discounting and merchandising programs and such 
that happen outside of the United States are driven by CSARL 
today.
    Senator Levin. OK. My understanding, Ms. Lagacy, is that a 
dealer cannot be added or dropped from the Caterpillar network 
or significantly change its territory without permission from 
Caterpillar executives in the United States. Is that correct?
    Ms. Lagacy. We have 178 dealers around the world, and I do 
not know that for a fact. That seems reasonable to me, but I do 
not know that for a fact. Or we have very little attrition----
    Senator Levin. Do either of these other two witnesses know 
whether that is true?
    Mr. Beran. I do not.
    Senator Levin. OK.
    Mr. Perkins. Neither do I.
    Senator Levin. OK.
    Ms. Lagacy. We have very little attrition in our dealer 
network around the world, so that would not happen frequently.
    Senator Levin. Well, that I know, but I am just saying it 
is my understanding that a dealer cannot be added or dropped 
from the Caterpillar network or significantly change its 
territory without permission from Caterpillar executives in the 
United States, and you have no reason not to believe that. Is 
that----
    Ms. Lagacy. I have no reason not to believe that. I do not 
know it for----
    Senator Levin. But that is what was told to us by 
Caterpillar.
    Ms. Lagacy. OK.
    Senator Levin. Now, in February, Caterpillar launched a 
major effort to toughen oversight of its dealers around the 
world. Are you familiar with that, Ms. Lagacy?
    Ms. Lagacy. Yes. I believe you are referring to our across-
the-table initiative.
    Senator Levin. Well, I am not sure of the name of it, but 
let us keep going.
    Ms. Lagacy. OK.
    Senator Levin. It required ``underperforming dealers'' to 
submit by the end of 2014 a plan for improving their sales. Is 
that the same initiative?
    Ms. Lagacy. You said it was launched in February of this 
year? Yes.
    Senator Levin. Does that sound like what you just----
    Ms. Lagacy. Yes, it does sound like that.
    Senator Levin. OK.
    Ms. Lagacy. Yes.
    Senator Levin. Now, the plan has to be submitted to and 
approved by Caterpillar in the United States. Is that correct?
    Ms. Lagacy. I do not know----
    Senator Levin. You do not know for sure?
    Ms. Lagacy. I actually do not know that.
    Senator Levin. Well, then let me tell you that it does, and 
if it is not true, you can correct for the record what I am 
saying. OK?
    Ms. Lagacy. OK.
    Senator Levin. It has to be approved by Stuart Levenick. 
Who is he?
    Ms. Lagacy. He is one of our group presidents.
    Senator Levin. Is he the group president of Caterpillar's 
customer and dealer support?
    Ms. Lagacy. Yes.
    Senator Levin. He works out of Illinois?
    Ms. Lagacy. He does.
    Senator Levin. So dealers whose plans are approved then 
have 3 years to meet their sales targets, or they may be 
dropped from the network. Is that correct?
    Ms. Lagacy. I do not know all the specifics of the program. 
The intention of the program is benchmarking amongst our 
dealers and looking at the dealers that are the highest 
performing around the world in a number of different elements 
and helping to improve the performance of all of our dealers 
around the network.
    Senator Levin. Right. And those dealers then have to get 
their plan approved or they have to meet the sales, as I 
understand it, targets or they may be dropped. Is that true or 
not?
    Ms. Lagacy. I do not know. Stu Levenick's organization does 
include the distribution groups that are headquartered--one 
vice president in Geneva, one vice president in Singapore, and 
one vice president in the United States. And they have the 
distribution services responsibilities which will be 
coordinating the work with each of the dealers. I do not have 
all the details on that program.
    Senator Levin. But he is head of the whole thing, right?
    Ms. Lagacy. They report to Stu Levenick, those three 
distribution----
    Senator Levin. Right, and he is in Illinois, right?
    Ms. Lagacy. Yes, he is.
    Senator Levin. OK. So it is being run out of the United 
States. That is the top of it, that is the responsibility for 
it. It is not run by CSARL, is it?
    Ms. Lagacy. Well, but keep in mind----
    Senator Levin. I know CSARL is part of it. You just told 
us. I am just simply----
    Ms. Lagacy. Yes, but the----
    Senator Levin. I know CSARL is part of it and so are the 
other distribution companies--I am just asking you, the head of 
this effort, the driver of this effort, the one who is going to 
decide whether or not a dealer stays in or is not going to be 
allowed to stay in is Mr. Levenick in Illinois. Is that 
correct?
    Ms. Lagacy. Mr. Levenick will hold his vice presidents 
accountable----
    Senator Levin. I am sure he will.
    Ms. Lagacy [continuing]. To work with the dealers in their 
region, so those vice presidents have that accountability and 
responsibility, and, yes, they do work for Stu Levenick.
    Senator Levin. OK. They do not work for CSARL. The head of 
CSARL is not the guy who makes the decision, right? It is Mr. 
Levenick?
    Ms. Lagacy. Again, working----
    Senator Levin. OK. That is OK?
    Ms. Lagacy. OK.
    Senator Levin. Are the Caterpillar dealers independent 
outfits?
    Ms. Lagacy. Caterpillar dealers are--they are an 
independent dealer network, yes.
    Senator Levin. All right. And who is in charge of the 
oversight efforts?
    Ms. Lagacy. In terms of overall dealer administration, that 
reports into our distribution groups, of which we have three--
one in Geneva, one in Singapore, and one in the United States--
and their employees.
    Senator Levin. All right. Prior to the 1999 transaction, 
Caterpillar U.S. had been buying purchased finished replacement 
parts, mostly from manufacturers here in the United States, 
transferring them to its Swiss affiliate, which then 
transferred them primarily to Caterpillar's non-U.S. dealers. 
Is that right? Prior to 1999.
    Ms. Lagacy. Correct.
    Senator Levin. Caterpillar reported most of the sales 
income on its U.S. tax return, international parts sales income 
on its tax return. Is that correct?
    Ms. Lagacy. Mr. Beran.
    Senator Levin. Is that right?
    Mr. Beran. Until?
    Senator Levin. Until 1999.
    Mr. Beran. Caterpillar Inc. would have reported most of it, 
though a significant portion was paid out to the, what we call 
``commercial entities'' that were responsible for 
manufacturing. Not all of those were in CAT Inc. or in the 
United States.
    Senator Levin. Right, but most of that income would have 
been shown on the U.S. tax return.
    Mr. Beran. I believe most of it was, yes.
    Senator Levin. Is it true that until 1999, 85 percent or 
more of its international replacement parts sales income was 
included on Caterpillar's U.S. tax return and about 15 percent 
of the income was reported as Swiss income? Is that correct? In 
Switzerland. In other words, would not have been reported in 
the United States. Is that correct?
    Mr. Beran. I do not remember the exact ratio.
    Senator Levin. OK. Well, let us assume for the purpose of 
this discussion it was about that. Is that fair enough?
    Mr. Beran. OK.
    Senator Levin. OK. So Caterpillar had a method of keeping 
track of profits for business purposes, something known as 
``accountable profits.'' Is that correct?
    Ms. Lagacy. Yes.
    Senator Levin. And the accountable profits which 
Caterpillar tracked on its internal management systems 
allocated income to each of the business groups throughout 
Caterpillar, and incentive pay was based on each group's 
accountable profits results.
    So far are you with me? Is that true?
    Ms. Lagacy. Yes.
    Senator Levin. OK. Prior to the 1999 transaction, the 
accountable profits on parts sales matched the results for tax 
purposes. About 85 percent of the accountable profits stayed 
with the business groups in the United States which had 
designed and built and tracked and shipped the parts, while 15 
percent, approximately, of the accountable profits were 
allocated to Switzerland in exchange for their marketing 
efforts. Is that correct, Mr. Beran? Roughly, in other words, 
the accountable profits matched the legal entity's tax 
reporting. Is that correct?
    Mr. Beran. I am not really familiar with the accountable 
profit numbers.
    Senator Levin. Is anybody here?
    Ms. Lagacy. The accountable profit system is not intended 
to be the same as what we report legal entity. It is an 
internal organizational method of helping to drive behavior. So 
I do not believe that we are understanding the relationship you 
are making.
    Senator Levin. Well, is it not true that 85 percent 
approximately of the accountable profits stayed with business 
groups in the United States before 1999? Is that true?
    Ms. Lagacy. I do not know that.
    Senator Levin. All right. Now, the 1999 transaction 
significantly changed how profits were allocated for tax 
purposes. Would you agree with that?
    Ms. Lagacy. I would say that it did not change how profits 
were allocated; rather, it correctly identified in 1999 where 
the profits were earned.
    Senator Levin. And was that a major change from the way it 
was previously identified?
    Ms. Lagacy. The major change was removing the unnecessary 
middleman in the transaction----
    Senator Levin. I understand.
    Ms. Lagacy [continuing]. Because that work had always been 
done by CSARL.
    Senator Levin. Right.
    Ms. Lagacy. So in setting up the----
    Senator Levin. I understand the theory of it, and the 
``unnecessary middleman'' is absurd--to call Caterpillar Inc. 
an ``unnecessary middleman is utterly absurd. You have heard 
that from me, and I have heard from you your explanation. But 
in any event, was there a major change after 1999? You just 
described a major change.
    Ms. Lagacy. Again, so if I could be clear, the work being 
done in CSARL prior to 1999 and after 1999 was not a major 
change. The change----
    Senator Levin. All right. I am not saying the work was----
    Ms. Lagacy [continuing]. That came about----
    Senator Levin. Listen to my question, please. I am not 
saying that the work was changed after 1999. It obviously was 
not. What I am asking you is: Did that have an impact on the 
allocation of--did that have an impact on the tax return?
    Ms. Lagacy. Yes, in 1999, with the establishment of the 
license agreement, the royalty, and the service fees, and 
taking CAT Inc. out of the chain, there was an impact on taxes.
    Senator Levin. OK.
    Ms. Lagacy. Yes.
    Senator Levin. OK. Now, was it understood at the time that 
that transaction was not going to have a negative impact on the 
U.S. division's accountable profits? Was that understood, Mr. 
Perkins? Let me ask you.
    Mr. Perkins. Mr. Chairman, there are significant 
differences between legal entities and business units and 
accountable profits. I cannot answer that question.
    Senator Levin. You are saying that you do not know whether 
or not at that time there was an understanding that that 
transaction was not going to have a negative impact on the U.S. 
division's accountable profits?
    Mr. Perkins. Mr. Chairman----
    Senator Levin. You do not know?
    Mr. Perkins. I do not know. I was a tax person. I was 
involved----
    Senator Levin. You do not know whether there was any such 
understanding?
    Mr. Perkins. I do not know.
    Senator Levin. Do you know, Mr. Beran?
    Mr. Beran. I do not really recall.
    Senator Levin. Well, then let me tell you--do you know, Ms. 
Lagacy?
    Ms. Lagacy. I am not aware----
    Senator Levin. Was there an understanding?
    Ms. Lagacy. I am not aware--I mean, generally what I can 
tell you is that the accountable profit system that we use 
internally to drive behavior is a before-tax system, so it 
typically is not including after-tax measurements.
    Senator Levin. OK. But it is a way, is it not, of rewarding 
divisions for their work?
    Ms. Lagacy. It is a way----
    Senator Levin. It affects people's bonuses, does it not?
    Ms. Lagacy. It is a way of establishing goals and driving 
business behavior, which ultimately can impact the incentive 
pay.
    Senator Levin. And rewards. ``Incentive pay,'' that is good 
enough.
    Ms. Lagacy. Yes, it is an accountable system to drive the 
organization.
    Senator Levin. OK. And is it not true that the U.S. 
business divisions kept about the same proportion of that 
accountable parts profits after the CSARL transaction?
    Ms. Lagacy. I do not know that.
    Senator Levin. Do you know, Mr. Perkins?
    Mr. Perkins. As I said earlier, as a tax person, I focused 
on----
    Senator Levin. No, I am just saying, do you know?
    Mr. Perkins. I do not know.
    Senator Levin. Do you know?
    Mr. Beran. No. The accountable system was really 
independent of the legal entities reporting.
    Senator Levin. I am just asking you the question whether or 
not you are aware of the fact that the U.S. business divisions 
kept the same percentage of accountable parts profits after the 
transaction as they had before the transaction. They got about 
the same amount. Are you not aware of that? Did you not tell 
our staff that?
    Ms. Lagacy. I think that, again, part of the confusion----
    Senator Levin. No, no, no. Mr. Beran. Excuse me. Mr. Beran, 
did you not tell our staff that?
    Mr. Beran. We were not directly impacting the accountable 
system, so I do not know exactly what----
    Senator Levin. That is a pretty good answer, that this, 
whatever we want to call it, but that transaction, that CSARL 
transaction and license, did not affect the accountable profits 
issue. Is that----
    Mr. Beran. The accountable system was not aligned with 
international tax law. It was----
    Senator Levin. I understand.
    Mr. Beran [continuing]. To drive behavior. So----
    Senator Levin. Of course it was. I am just asking you a 
question. It was not impacted by that major change in how the 
taxes were going to be paid. Is that correct?
    Mr. Beran. Not to my knowledge.
    Senator Levin. OK. Mr. Perkins, while you were working on 
the CSARL structure in 1999, was it your understanding that it 
was not supposed to change the operational functioning of the 
parts business in any significant way, just the invoicing 
system? Was that your understanding?
    Mr. Perkins. The invoicing system with respect to unrelated 
suppliers to CSARL did----
    Senator Levin. Except for the invoicing system, my question 
to you is: While you were working on the CSARL structure, was 
it your understanding that it was not supposed to change the 
operational functioning of the parts business in any 
significant way? With that exception of invoicing, was that 
your understanding?
    Mr. Perkins. No. There were significant changes, both 
legal, accounting, as well as tax. Legal externally in terms of 
the contractual relationships----
    Senator Levin. I am not saying legal. I am talking about 
operational functioning. My question to you has to do with the 
operational functioning. Was it your understanding that there 
was not going to be any significant change in the operational 
functioning of the parts business? That is my question.
    Mr. Perkins. Physical goods moved the same way after the 
restructuring as it did prior to the restructuring.
    Senator Levin. Thank you.
    [Pause.]
    Well, there has been plenty of talk here today of 
suggesting that by enforcing the current tax laws, that somehow 
or other we are going to endanger American manufacturing. Well, 
I am as enthusiastic a supporter of American manufacturing as 
there is. At least there is no one who is more enthusiastic. 
But if Caterpillar has ideas for how our tax code can better 
support manufacturers, I am all ears. So is everybody else. It 
is pretty obvious that everyone on this Subcommittee would be 
very welcoming of such suggestions.
    I am a strong supporter of R&D tax credits. I am a strong 
supporter of advanced manufacturing tax credits. I am a strong 
supporter of accelerated depreciation and energy efficiency tax 
credits and other tax policies that help American 
manufacturing. So I support tax policies that help Caterpillar 
and other manufacturers compete around the world.
    What I do not support is making this a competition to see 
who has the most creative tax lawyers. I do not support tax 
loopholes that other manufacturers either are not positioned to 
exploit or refuse to exploit. We need more policies to support 
manufacturing, but that is not what we have here at this 
investigation.
    Caterpillar's Swiss strategy is not the result of conscious 
policymaking to support American manufacturing. It is just 
simply a tax loophole, actual or perceived. And allowing it to 
continue is unfair to other companies, to American families who 
do not have an army of lawyers and accountants at their 
disposal.
    So I cannot support what is going on here. I know 
Caterpillar is an American success story, and they have every 
right to be proud of that success. It is an American company. 
Its headquarters are here. Most of its executives are here. 
Most of its parts are made here. Most of its parts are stored 
here. Most of its parts are shipped from here. Most of its 
parts, forecasting, inventory management, and logistics are 
handled here.
    But since 1999, most of its international parts profits go 
to Switzerland. And the contrast between Caterpillar U.S. and 
Swiss parts operations is dramatic. Switzerland does not 
manufacture any Caterpillar parts. The United States 
manufactures 70 percent of the parts sold abroad. Switzerland 
does not have a single parts warehouse. The U.S. stores one and 
a half billion parts. Only 65 Swiss employees handle parts 
versus 5,000 in the United States. Caterpillar's Swiss 
operation does not have the personnel, does not have the 
infrastructure or expertise to run a global parts business.
    They have a role, obviously, in promoting parts and in 
working with dealers, but they do not have the personnel, the 
infrastructure, or the expertise to run a global parts 
business.
    Now, everyone knows what happened here. The documents could 
not be clearer. It is a tax deal. Caterpillar used to pay taxes 
on almost all of its parts profits. That was before 1999. In 
1999, Caterpillar transferred a license to its wholly owned 
subsidiary CSARL, which allowed it to sell Caterpillar parts, 
more Caterpillar parts overseas in more places. It got back a 
royalty equal to 15 percent of the parts profits, which meant 
the other 85 percent stayed in Switzerland, where, by the way, 
Caterpillar had negotiated a special low tax rate of 4 to 6 
percent. The usual Swiss tax rate is 8.5 percent. Caterpillar 
used the licensing agreement to shift profits of $8 billion to 
Switzerland while avoiding U.S. taxes of $2.4 billion and 
counting. That is an ongoing number. It is about $300 million a 
year now in tax avoidance that is going to Switzerland instead 
of here.
    Caterpillar was not compensated for turning over its parts 
business to CSARL--no compensation. Even though it had spent 75 
years developing the business and allowed CSARL to use its 
patented parts, supplier base, state-of-the-art parts tracking, 
forecasting, ordering and management systems it got paid less 
than nothing, by the way, since it traded $1 of profits to 
CSARL for 15 cents in return. And at the same time, Caterpillar 
kept doing all of the work--that is what it was doing, that was 
the deal--and it continued to bear economic risk, all of the 
economic risk. As the parent corporation, it is a consolidated 
return.
    No reasonable business would have transferred its crown 
jewels to an unrelated party for less than nothing, keep doing 
all the work and continuing to bear the economic risk. It is 
clear that the Caterpillar licensing transaction fails the 
arm's-length standard. It also fails the economic substance 
test because it had no business purpose other than tax 
avoidance. It started as a tax strategy, and Caterpillar paid 
over $55 million to Pricewaterhouse to design and to implement 
it.
    Yet Caterpillar asserts it acted in compliance with U.S. 
tax laws, and that issue is up to someone else to decide. But 
if Caterpillar is right, our laws need even more strengthening 
than I think they do. The IRS has to step up its enforcement to 
stop the multinational offshore profit shifting and needs to 
start requiring transfer pricing agreements that disclose and 
justify the profit splits between U.S. parents and their tax 
haven subsidiaries. It needs to clarify that the economic 
substance law applies to transfer pricing agreements, and 
Congress needs to pass the Stop Tax Haven Abuse Act, which I 
and others have introduced, to shut down the existing offshore 
tax loopholes.
    Thanks to all of our panelists, and again our thanks to 
Caterpillar and to Pricewaterhouse for their cooperation with 
the Subcommittee. We stand adjourned.
    [Whereupon, at 2:31 p.m., the Subcommittee was adjourned.]



                            A P P E N D I X

                              ----------                              

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]

                                 
