Fraud Accusations Could Mean More than Tax Trouble for Caterpillar

Government-commissioned report clearly accuses Caterpillar of tax fraud, and the very rare federal raid may be just the first extraordinary action taken on Cat’s offshoring of revenues

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The IRS has challenged six years of tax returns filed by Caterpillar, but financial-professional trainer Training The Street suggests tax troubles may be the least of the construction equipment giant’s problems after a surprise raid by federal enforcement authorities signaled the possibility of more serious financial crimes.

The March 2 raid at three Caterpillar Inc. offices in Peoria and Morton, Illinois, was carried out by officials from the criminal investigation unit of the Internal Revenue Service, the Federal Deposit Insurance Corp.’s Office of Inspector General, and the U.S. Department of Commerce‘s Office of Export Enforcement.

The raid shocked many in the business and legal community, and a lack of specific information has led to multiple theories about what exactly Caterpillar is being investigated for.

A Caterpillar statement links the raids to years of criticism Cat faced for its relationship with its Swiss affiliate Caterpillar SARL. A congressional committee excoriated the company in 2014 for shifting $8 billion in profits to the European unit to avoid $2.4 billion in U.S. taxes, a move the committee called morally questionable. In early 2015, Caterpillar told shareholders that its cash movements overseas were being probed by a grand jury. The government took no action against Caterpillar at the time.

But a new government-commissioned report by Leslie Robinson, an accounting professor at the Tuck School of Business at Dartmouth College, concludes that Caterpillar intentionally violated U.S. tax laws and financial reporting rules. The report, which suggests Caterpillar may have repatriated some offshore funds without paying U.S. taxes due on them, was the subject of a March 7 report in The New York Times, days before it was shared with Caterpillar at the company’s behest.

“Caterpillar did not comply with either U.S. tax law or U.S. financial reporting rules,” wrote Robinson, as reported at NYTimes.com (leaked to the Times, the report has not been made public). “I believe that the company’s noncompliance with these rules was deliberate and primarily with the intention of maintaining a higher share price. These actions were fraudulent rather than negligent.”

United States companies owe corporate income taxes at a rate of 35% on profits earned around the world. However, they are permitted to defer taxes owed on the profits generated offshore until they bring those earnings back to the States, a process known as repatriation. Once they bring cash back, they generally owe federal income taxes, with a credit for any income taxes they have already paid overseas, the New York Times explains.

Dr. Robinson’s report estimated that Caterpillar has brought back $7.9 billion into the States, structured as loans, over and beyond the income that had already been taxed overseas. She concluded that the company failed to report those loans for tax or accounting purposes, and she wrote that those profits should be subject to federal taxes.

Robinson’s report does not explain whether Caterpillar used the type of creative, and often legal, transactions that U.S. multinationals use to avoid tax on earnings brought home from offshore. For instance, they do not owe tax on short-term loans made by their offshore subsidiaries to their domestic parent company. In her report, Dr. Robinson does not mention this legal exception, and it is unclear if Caterpillar used such transactions.

Robinson confirmed to Trainingthe Street.com’s Law360 that her conclusions were accurately represented in the Times, and that her report was delivered to a Jason LeBeau at the FDIC’s OIG last month.

Since the raids, several legal firms have filed class action lawsuits on behalf of different groups of investors seeking damages from Caterpillar, according to Herald-Review.com. They name the company and top management like current CEO James Umpleby and former CEO Doug Oberhelman, as defendants.

The lawsuits claim that Caterpillar's high share price was artificially inflated by the company’s allegedly illegal tax practices that, once revealed, would immediately lessen its value and so cause losses for investors.

“At the time of the purchases and/or acquisitions by Plaintiff and the Class, the true value of Caterpillar securities was substantially lower than the prices paid by the Plaintiff and the other members of the Class,” one lawsuit says.

“The market price of Caterpillar securities declined sharply upon public disclosure of the facts alleged herein to the injury of the Plaintiff and Class members.”

Raids on large multinational corporations are said to be extremely rare because these companies tend to have sophisticated legal and accounting teams, both in-house and externally hired, that can advise on how to stay within the law.

Also, the IRS is usually “very collaborative in trying to reach an understanding in terms of facts and finding a resolution,” according to Robert Rostan, chief financial officer at Training The Street.

“A raid from the IRS is extremely unusual, but also, to see the IRS with other federal agencies involved is unusual as well. What they would be looking for is some sort of evidence contrary to their tax position,” Rostan said.

“This tax matter could be a lot of cash, but at the same time … it’s a little bit easier to overcome, and a black eye goes away more quickly,” Rostan said, adding that a federal investigation could bar Caterpillar from participating in federal contracts.

Other potential consequences for Caterpillar could include significant fines, back taxes, interest and maybe even jail time for executives, depending on what charges, if any, can be brought and proven, experts said.

Caterpillar spokeswoman Rachel Potts told Law360 that the IRS has challenged its taxes for the 2007 to 2012 years through an administrative process.

“We disagree with the IRS’ position, have cooperated for requests for information, and believe that we are compliant with tax laws and stand by our financial reporting,” Potts said.

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