Caterpillar had 3 of its building in Illinois raided by three federal agencies on March 2, 2017. The departments conducting the raid were the Internal Revenue Service, the Federal Deposit Insurance Corp. and the US Department of Commerce.

The reason for the raid was Caterpillar’s offshore tax practices. PwC was Caterpillar’s tax advisor for these offshore practices. This caps what was already one of the worst weeks in PwC’s history.


In this article we will discuss:

  1.  What Caterpillar had to say about the government raids
  2. Some facts about Caterpillar’s current tax position
  3. Why we think the raids took place now
  4. Whether we think the raid of Caterpillar is justified
  5. What is PwC’s involvement

Caterpillar’s Statement About the Raids

This is Caterpillar’s statement on their website

PEORIA, Ill. – On March 2, 2017, law enforcement authorities entered three Peoria-area Caterpillar Inc. (NYSE: CAT) facilities, including the corporate headquarters, to execute a search and seizure warrant. The warrant is focused on the collection of documents and electronic information. Caterpillar is cooperating with law enforcement.

While the warrant is broadly drafted, we believe the execution of this search warrant is regarding, among other things, export filings that relate to the CSARL matter first disclosed in Caterpillar’s Form 10-K filed on February 17, 2015, and updated in Caterpillar’s most recent Form 10-K filed with the SEC on February 15, 2017.

Here is the disclosure from that 10-k

On January 30, 2015, we received a Revenue Agent’s Report (RAR) from the Internal Revenue Service (IRS) indicating the end of the field examination of our U.S. tax returns for 2007 to 2009 including the impact of a loss carryback to 2005. The RAR proposed tax increases and penalties for these years of approximately $1 billion primarily related to two significant areas that we intend to vigorously contest through the IRS Appeals process. In the first area, the IRS has proposed to tax in the United States profits earned from certain parts transactions by one of our non-U.S. subsidiaries, Caterpillar SARL (CSARL), based on the IRS examination team’s application of the “substance-over-form” or “assignment-of-income” judicial doctrines. We believe that the relevant transactions complied with applicable tax laws and did not violate judicial doctrines. We have filed U.S. tax returns on this same basis for years after 2009. In the second area, the IRS disallowed approximately $125 million of foreign tax credits that arose as a result of certain financings unrelated to CSARL. Based on the information currently available, we do not anticipate a significant increase or decrease to our recognized tax benefits for these matters within the next 12 months. We currently believe the ultimate disposition of these matters will not have a material adverse effect on our consolidated financial position, liquidity or results of operations. We expect the IRS field examination of our U.S. tax returns for 2010 to 2012 to begin in 2015. In our major non-U.S. jurisdictions, tax years are typically subject to examination for three to eight years.

Caterpillar’s Past Investigations

Caterpillar was investigated in 2014 by Congress for their use of Switzerland as a tax haven. The main reason that investigation was initiated because of an executive whistleblower. His whistleblowing attempts did not work, so he sued the company. The company settled with the executive for an undisclosed amount.

Caterpillar Tax Rates

It’s seems that the company is no longer employing the same tax strategy, or it only gave them benefit for a certain number of years. Even though management was aggressive in the past, it doesn’t seem that they are aggressive anymore.

One of the reasons I’m questioning why this news is coming out now is what happens when you look at CAT’s etr

  • 2016 – 137.8%
  • 2015 – 26.7 %
  • 2014 – 22 %

Those are pretty high tax rates relative to other large multinationals. Let’s look at Facebook for comparison sakes.

Facebook has recently seen their ETR (effective tax rate) move down to 18.4% because of their “foreign oprations”. 

Let’s also take a look at Google’s ETR for the past 3 years:

2016 – 21.1%

2015 – 16.8%

2014 – 19.3%.

Caterpillar historically used tax havens that all the largest companies in the world are now using, but it doesn’t seem like they are doing it anymore. Caterpillar now has a higher tax rate than many of those companies, so why the investigation now?

Caterpillar Income Taxes Paid

The amount of taxes paid that Caterpillar has paid for 2014 to 2016 are as follows

2016 – $623,000,000 (estimated)

2015 – $1,223,000,000

2014 – $1,646,000,000

As you can see Caterpillar is paying billions in taxes, so not sure why the IRS is pressing the issue now. It seems like these agencies were released on Caterpillar back when Congress was conducting their 2014 investigation, and now these watchdogs are being told to issue all-encompassing warrants as soon as possible to make the president looks bad and take advantage of PwC’s Oscar weakness.

Shareholder Lawsuit

PwC and Caterpillar are both being sued by a CAT shareholder for knowingly causing Caterpillar to engage in improper, illegal and possibly criminal course of conduct spanning more than a dozen years.

PwC’s involvement

PwC is Caterpillar’s independent auditor, but they were also Caterpillar’s tax advisor for the transaction in question for this investigation. PwC was reportedly paid over $50 million for the planning and consulting around the tax advice for this tax haven idea. Those fees have come way down over the years, and Caterpillar no longer pays large tax advice fees. If you look in past 10-k’s, you can see the huge tax planning fees. This was common in the pre Sarbanes-Oxley era. That is probably one of the reasons why the fees for tax advice are no longer significant.

This has huge implications for PwC. If they are found guilty of setting up unsupportable tax transactions, Pricewaterhousecoopers could face some harsh punishment and limitations on their tax practice similar to what happened to KPMG.

Conclusion

I don’t really see why Caterpillar is being investigated now. The use of tax havens is a common practice of many large corporations. As a tax director of a large public corporation, you can’t just say,”I want to pay the full 35% US corporate tax rate, and I am not even going to look at deductions or any tax planning strategies at all.”

Well, you could say that, but the problem would be that you would be out of your job the very next day.

This must have to do with Caterpillar making a political mistake. For example, they might have promised a congressman a certain amount of jobs in their district, and then it didn’t pan out. It could also be because President Trump recently showed support for Caterpillar and now democrats are using fed agencies to embarrass the president.

Trump also said that he’d like to use Caterpillar to help build his border wall.

It’s not Caterpillar getting away with the most tax savings in this type of offshore arrangement. Trust me. The tax planning that financial institutions utilize is much more egregious than what Caterpillar is doing.  I think Caterpillar is an easy target because they are manufacturing company. People understand manufacturing because there are actual physical widgets so that make them easy targets in these tax raids.

If I were Trump, the lawyers for PwC,  or the lawyers for Caterpillar, I’d investigate the motives behind this investigation happening right now because it doesn’t make any sense. I think they are utilizing PwC’s weakness with the Oscars and Trump’s weakness with the Russian investigation. If you investigate this investigation, I’m sure you’d find an email trail or communications trail from some democratic politician.