CAT’s Cradle

Caterpillar Inc. (CAT) is one of the biggest heavy equipment manufacturers in the world, and almost everyone recognizes its iconic CAT logo. CAT is a multinational company with several subsidiaries around the globe. One such subsidiary, CSARL, the Swiss entity, caught lawmakers’ attention a while ago, leading to an investigation into CAT’s tax strategy called the “Global Value Enhancement or GloVE program.”

GloVE involved the sales of finished parts from the U.S. entity to the Swiss entity with the intent of shifting profits to Switzerland, where the corporate tax rate is lower than the U.S. A detailed report written by the U.S. Committee on Homeland Security and Governmental Affairs Permanent Subcommittee on Investigations in 2014 delved into how the company negotiated an effective corporate tax rate of 4 to 6 percent with Switzerland, shifting billions in profits out of the U.S., where the current corporate tax rate sits at 21 percent.

One aspect of this strategy that raised eyebrows was the disproportionate profit recognition by CSARL compared to its workforce. The report stated, “By 2008, approximately 45% of Caterpillar’s consolidated revenues and 43% of its profits had been shifted to CSARL, an entity with less than one-half of one percent of CAT’s 118,500 employees.” In simpler terms, nearly half of the revenues and profits were generated by 5,925 employees out of a total workforce of around 118,500. The report concluded that $8 billion in U.S. taxable income was offshored to Switzerland, resulting in a whopping $2.6 billion in deferred or avoided taxes.

If you are familiar with CAT’s international affairs, the IRS raided CAT facilities in 2017, seeking deferred or avoided taxes and levying a $2.3 billion penalty. After a five-year investigation, Caterpillar announced in a press release dated October 27, 2022, that a $740 million settlement was reached with the IRS regarding tax issues for fiscal years 2007 through 2016.

To shed light on the underlying motivation behind the IRS settlement, Senate Finance Committee Chair Ron Wyden (D-OR) and Senate Budget Committee Chair Sheldon Whitehouse (D-RI) expressed concern in a March 14 letter to Attorney General Merrick Garland over alleged interference by former AG Bill Barr to halt the DOJ’s probe into CAT’s use of CSARL, the Swiss-based subsidiary, to avoid U.S. taxes.

This inquiry by the Senate Finance Committee members revived some critical questions regarding CAT’s transfer pricing practices. Transfer pricing refers to the pricing of goods and services exchanged between related entities within a multinational corporation. Established regulations aim to ensure these prices are set at arm’s length, reflecting what unrelated parties would charge in a similar transaction. Critics allege that through the GloVE program, CAT might have manipulated transfer pricing by artificially inflating the cost of parts sold to CSARL, thereby shifting profits to the lower-taxed Swiss entity.

Since transfer pricing does not have a traditional formula, it can seem more like an art than a science. However, transfer pricing guidelines are provided by tax authorities globally, starting with the OECD (Organization for Economic Co-operation and Development) and the IRS.

While “aggressive” transfer pricing practices might sometimes be subjectively justified, it is vital to acknowledge the benefits of a conservative approach. This approach will likely provide a solid and defensible basis for intercompany transactions. While McGuire Sponsel’s experience suggests that many CPA firms primarily serve clients with less complex operational and tax structures than CAT, transfer pricing regulations and reporting remain applicable under U.S. tax law for all companies engaged in such transactions. Irrespective of the intricate nature of transactions, operational structures, tax frameworks, or corporate scale, the IRS and foreign tax authorities will apply an equally rigorous scrutiny to transfer pricing practices.

Contact our Global Business Services team for more information on transfer pricing or other international tax issues.