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21st century Icarus: Alignment is critical to international tax planning

March 6, 2017 Blog 1 min read
Bill Henson
The raid on Caterpillar’s headquarters by federal agencies highlights the critical need for alignment between business operations and international tax strategy.

Caterpillar’s tax woes have culminated in a raid on their corporate offices by agents from the IRS and the Department of Justice, who are seeking information on the company’s international tax planning strategies. Caterpillar has a well-deserved reputation for manufacturing excellence and outstanding service on delivery of parts to its customers. The tax strategy that put the company in the cross-hairs of federal agencies revolves around the latter, the sale of parts to customers.

Caterpillar delivers parts necessary for equipment repairs to customers anywhere in the world within 24 hours. Many of these parts are made by Caterpillar suppliers. This service has been a key offering and differentiator for Caterpillar, and it generates substantial profits for the company. Prior to 1999, Caterpillar U.S. was the prime purchaser of these parts, and 85 percent of the related profits were recorded — and taxed — in the United States.

However, starting in 1999, Caterpillar’s tax advisers were paid $55 million to devise a strategy to shift most of those profits to a Swiss subsidiary that was subject to a negotiated tax rate that varied between four and six percent. The Senate Permanent Subcommittee on Investigations estimated that the strategy shifted $8 billion in profit from the United States to Switzerland — and saved $2.4 billion in taxes.

Caterpillar’s strategy attracted the Senate’s attention when a company employee involved in implementing the tax strategy filed a whistle-blower lawsuit. Internal Caterpillar documents collected by the Senate noted as late as 2012 that the Caterpillar parts business remained “US-centric.” The report issued by the Senate on Caterpillar’s tax planning in turn attracted the attention of the IRS. Shareholder lawsuits have been filed as well.

Caterpillar’s story highlights an important lesson: Tax planning that’s not aligned with the business can create significant exposure.

We recently held a webinar on Tax Planning with Intellectual Property, which discusses the current state of international tax planning and how to best take advantage of changes in business and tax law. If you have any questions, give us a call.

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