. Journal Star: “Caterpillar Raid Resurrects U.S. Sanctions Questions”
(Source: Journal Star
A federal raid of Caterpillar Inc. offices last month
drew instant connections between the global headquarters in Downtown Peoria and the company’s Swiss subsidiary in Geneva – the entity at the center of the company’s controversial strategy to avoid paying U.S. taxes.
But recent comments by a Caterpillar official and the mission of one of the federal agencies investigating the company also lend new significance to years-old questions about Caterpillar’s business dealings in countries deemed state sponsors of terrorism by the U.S. State Department.
Since 2010, Caterpillar has faced pointed inquiries from investors, activists and the Securities and Exchange Commission (SEC) into its business interests in three sanctioned countries: Sudan, Syria and Iran.
And the company’s dealings in those countries have a direct connection to its embattled tax strategy. The linchpin of the plan that a congressional investigation found helped Caterpillar avoid $2.4 billion in U.S. taxes is the company’s Swiss subsidiary, Caterpillar SARL – the same entity that records all Caterpillar sales in Europe, Africa and the Middle East.
The complex corporate bureaucracy Caterpillar established to execute the tax strategy represents the type of internal structures that can put multinational corporations in danger of violating U.S. foreign policy, said Ryan Fayhee, the former national export control coordinator in the National Security Division of the Department of Justice who is now a partner with Baker & McKenzie LLP in Washington, D.C.
“U.S. persons can’t engage in financial support of any countries subject to sanctions. … Transactions involving Iran, for example, are kryptonite to U.S. persons,” Fayhee said. “There are innocent mistakes made, because people sometimes don’t appreciate the complex internal systems by which companies are run, and they don’t understand the technical processes by which the system interacts with export rules.”
Ever since Caterpillar’s former global tax strategy manager, Daniel Schlicksup, filed an employment lawsuit seeking whistleblower protections in 2009, the company’s complex offshore structures created to reduce its U.S. income tax liability have been extensively scrutinized by federal investigators.
The company is still fighting a proposed $2 billion fine for back taxes and penalties that resulted, so the presence of Internal Revenue Service agents during the execution of search warrants on March 2 at the headquarters and two other nearby facilities probably wasn’t as shocking as the raid itself.
The participation of investigators from a different federal law enforcement agency in the raid, one with far less name recognition, may have been more unexpected.
Window placards in unmarked vehicles lining Northeast Jefferson Avenue outside Caterpillar’s headquarters identified the other agents as members of the U.S. Department of Commerce Bureau of Industry and Security Office of Export Enforcement.
Government documents usually refer to the agency as BIS or OEE – not exactly household acronyms. The scope of the agency’s duties, when viewed in the context of the scant public information available on the Caterpillar investigation in the leaked March 2 search warrants, presents different implications than a tax inquiry alone.
Amy Campbell, Caterpillar’s director of investor relations, acknowledged as much in comments at a March 22 industrials conference
“The search warrant was broader than just the matters related around the IRS issue, so it included export filings among other things,” Campbell said. “We’re still trying to gain an understanding of the complete picture of why the authorities came in the way they did.”
Caterpillar Inc. declined to comment for this article.
The most recent agency guidelines in the Federal Register characterize the mission of the OEE
as: “to enforce the provisions of the Export Administration Regulations (EAR), secure America’s trade, and preserve America’s technological advantage by detecting, investigating, preventing, and deterring the unauthorized export and reexport of U.S.-origin items to parties involved with: (1) Weapons of mass destruction programs; (2) threats to national security or regional stability; (3) terrorism; or (4) human rights abuses.”
Since 2010, the OEE has successfully prosecuted more than 340 export violation cases
either through administrative adjudications or criminal proceedings undertaken with the Department of Justice.
Less than a week after the March 2 Caterpillar raid, newly confirmed Secretary of Commerce Wilbur Ross announced the largest ever export-related settlement
– $1.19 billion in combined criminal fines and administrative penalties for ZTE Corp., a Chinese telecommunications giant with U.S. operations that pleaded guilty to violating U.S. economic sanctions against North Korea and Iran.
“We are putting the world on notice: the games are over,” Ross said. “Those who flout our economic sanctions and export control laws will not go unpunished – they will suffer the harshest of consequences. Under President Trump’s leadership, we will be aggressively enforcing strong trade policies with the dual purpose of protecting American national security and protecting American workers.” …
In 1999, Caterpillar began working with its external auditor, PricewaterhouseCoopers (PwC), and a Chicago-based law firm that specializes in tax issues, McDermott, Will & Emery, to develop an offshore subsidiary to reduce its U.S. tax liability.
Geneva-based Caterpillar SARL was the result.
The Swiss company negotiated a tax rate far lower than in the United States, and the parent company shifted some non-U.S. sales to that subsidiary’s books to keep more profit.
The strategy focused on replacement part sales, though Caterpillar SARL also was responsible for all sales of Caterpillar-branded and related products in Europe, Africa and the Middle East.
The Swiss subsidiary became the company’s “global parts purchaser” and the entity that recorded all parts sales in the world outside of the United States – about 85 percent of Caterpillar’s total parts sales. According to Schlicksup’s lawsuit, which was dismissed in 2012 after a series of depositions laid out the company’s tax strategy in public for the first time, parts sales generated $5.6 billion in profit over several years.
Prior to the initiation of the tax strategy in 1999, Caterpillar owned all of the replacement parts in the United States before selling them to its marketing companies, according to a report by the U.S. Senate Permanent Subcommittee on Investigations that reviewed the matter in 2014.
The subcommittee found not much changed after 1999, except the country where Caterpillar’s parts sales and profit were reported.
An essential element of the strategy was the Inventory Tax Accounting System (ITAS) created by Caterpillar and its consultants, according to the Senate report. The system established “virtual parts bins” where parts stored in the United States could be assigned ownership to the Swiss subsidiary when they were sold and shipped.
Establishing Caterpillar SARL ownership at some point in the supply chain was critical to claiming a tax exemption for non-U.S.-subsidiary-owned parts stored in U.S. warehouses.
“At the same time, Caterpillar did not want to incur the expense and inconvenience of formally segregating the CSARL parts from the other parts owned by Caterpillar Inc.,” the Senate report found.
The report continued: “The end result was that instead of segregating the Caterpillar versus CSARL parts, Caterpillar warehouse personnel stored all of the replacement parts together, pulled parts to fill orders the same way they always had, without regard to CSARL’s ownership, and then shipped the parts to the dealers or customers who had ordered them.”
Parts delivered all over the world with Caterpillar SARL invoices largely originated in the United States, with significant volumes from Caterpillar Logistics Services in Morton – one of the other company facilities raided March 2. The Senate report noted that the Morton warehouse is Caterpillar’s central hub for stocking replacement parts and is twice the size of the company’s next largest warehouse.
Dealers, distributors and customers from around the world look for hard-to-get parts in the Morton warehouse, which also stores about 40 percent by value of Caterpillar SARL-owned parts destined for sale abroad, according to the report.
“Caterpillar’s parts business has been and continues to be led and managed primarily from the United States. Nearly all the senior leadership of the parts business has been and remains in Illinois,” the report concluded.
“Caterpillar’s U.S. warehouses continue to operate in the same way as in the past. Caterpillar continues to manage the parts inventory and parts forecasting on a worldwide basis and manage the supplier base in the United States, just as it did before the transaction. CSARL continues to pay Caterpillar to keep doing the same work, which CSARL continues to be unequipped to perform.”
Three years before the Senate report published, however, Caterpillar attempted to legitimize sales in countries subject to U.S. sanctions by claiming to the SEC that the sales – including replacement parts – had been made by Caterpillar SARL and other non-U.S. subsidiaries “as permitted under U.S. economic sanctions and export controls.”
SYRIA, SUDAN, AND IRAN
In 2011, U.S. financial watchdogs began a campaign to lift the curtain on well-known companies’ business dealings in Iran, Sudan and Syria, all then considered state sponsors of terrorism and subject to economic sanctions.
Among the companies faced with demands from the SEC were Sony, Xerox, AIG, Siemens – and Caterpillar. Many of the U.S. companies provided correspondence indicating they believed they were within the letter of the law while still conducting business in those countries through a sanctions loophole that granted certain allowances for non-U.S. subsidiaries.
In a response to the SEC dated May 10, 2011, Caterpillar’s then-Chief Financial Officer Ed Rapp phrased it this way: “Several of Caterpillar’s non-U.S. subsidiaries have sold and continue to sell products to Syria and Sudan as permitted under U.S. economic sanctions and export controls. These sales were made principally to independently-owned and -operated dealers or distributors, who in turn sell or lease products to their own customers.”
By then, Caterpillar and its non-U.S. subsidiaries had ceased nearly all business in Iran, the comments continued.
The company had been pressured to undertake those actions in 2010 by an activist group United Against Nuclear Iran (UANI). The group publicly shamed Caterpillar with a billboard outside its Peoria headquarters for working in a hostile state with nuclear ambitions. UANI complimented Caterpillar for the decision to terminate sales arrangements that provided equipment to end users in Iran.
“We applaud Caterpillar’s decision to prohibit its non-U.S. subsidiaries from doing business in Iran,” said Mark Wallace, UANI president and former American diplomat to the United Nations. “All responsible companies that transact business in Iran through the veil of a foreign subsidiary should take this as a wake-up call.”
Caterpillar’s business interests in Sudan and Syria, however, continued through non-U.S. subsidiaries and decades-old relationships with exclusive dealer networks.
According to Rapp’s response to the SEC, Caterpillar SARL still had a dealership agreement with Jallad Group for Syria in 2011, though the company claimed no sales had been executed through that agreement since before 2008. The relationship between those entities and their predecessors dates back to 1929, and Jallad remains the exclusive dealer for Lebanon, Jordan and the Palestinian territories.
Different Caterpillar non-U.S. subsidiaries also conducted business with dealers and distributors in Syria before and after 2008 – the U.K. subsidiaries Perkins Engines Co. Ltd. and F.G. Wilson Engineering Ltd.
The letter explained a more complex situation in Sudan, where a network of distributors such as Earthmoving Services Ltd., Sudanese Tractor Co. Ltd. (Sutrac) and Ezentus FZE all sold Caterpillar equipment. But all of those distributors were owned by DAL Group, the largest holding company in Sudan.
In addition to the embargo on trade with Sudan, the U.S. Treasury’s OFAC also singled out one of DAL Group’s other companies for targeted sanctions in May 2007. Al Sunut Development Co. had entered into a joint venture with the Sudanese government to construct a $4 billion development intended to rival the skyscrapers of Dubai. The real estate project subsequently stopped.
DAL Group was founded in the 1960s after it won a contract to distribute Caterpillar tractors, according to a 2014 Financial Times interview with group’s current chief, Osama Daoud Abdel-Latif. His father began the company.
Caterpillar lost business with DAL Group when Sudanese sanctions were imposed in 1997, according to a trove of diplomatic cables released by Wikileaks. The organization has a long track record of releasing top secret government documents, and experts who sifted through the material said it appeared legitimate.
“(Abdel-Latif) noted that when blanket U.S. sanctions first were imposed in 1997, Sudan was forced to drop plans to purchase Caterpillar equipment for the Nile oil pipeline pumping stations,” the September 2007 correspondence noted. “Instead, Rolls Royce equipment was substituted, at a 25 (percent) higher cost.”
It’s not clear when Caterpillar sales in Sudan resumed, but the company was regularly recording revenue there, with knowledge of sales to the government, for several years leading up to the 2011 response to the SEC.
From 2008 through the first quarter of 2011, the company recorded $256.5 million in sales in Sudan alone.
“Sales to Sudan during the same period consisted principally of earthmoving and construction machinery, engines, and generator sets, along with replacement parts sold by CSARL, Perkins, and F.G. Wilson to their respective dealers and distributors,” Rapp wrote to the SEC.
Rapp concluded: “The dealers and distributors of Caterpillar’s non-U.S. subsidiaries have in some cases sold products to the government of Sudan or entities controlled by it.”
The March 2 raid occurred six years after Rapp’s statement. It could be months or years until the federal investigation concludes.