[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
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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\
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\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.
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\1\ The prepared statement of Mr. Avi-Yonah appears in the Appendix
on page 106.
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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?
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\1\ See Exhibit No. 13, which appears in the Appendix on page 374.
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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\
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\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?
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\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.
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\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\
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\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.
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\1\ See Exhibit No. 12, which appears in the Appendix on page 372.
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[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.
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\1\ See Exhibit No. 46, which appears in the Appendix on page 545.
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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.
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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.''
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\1\ See Exhibit No. 7, which appears in the Appendix on page 343.
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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?
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\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----
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\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\
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\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.''
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\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\
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\1\ See Exhibit No. 17, which appears in the Appendix on page 403.
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[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.
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\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
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