Ways of Seeing – Senate Hearings on Caterpillar

I’ve been re-reading a book by John Berger about how we see and describe art – “Ways of Seeing”. The book starts :

“Seeing comes before words. The child looks and recognises before it can speak. But there is also another sense in which seeing comes before words. It is seeing which establishes our place in the surrounding world; we explain that world with words, but words can never undo the fact that we are surrounded by it. The relation between what we see and what we know is never settled.”

When reading this I was struck by the relevance of this for the current debate about corporate tax and the “fair allocation of tax”. In particular “It is seeing which establishes our place in the surrounding world; we explain that world with words, but words can never undo the fact that we are surrounded by it.”

The US Senate’s hearings on Caterpillar on April 1st pose some interesting questions about both what we see and the words which are used to explain what is seen. I’m going to focus here on the run up to the hearings. The report has been extensively covered by the FT.

“The company moved $8bn in profits from the US to Switzerland to take advantage of a special 4 per cent to 6 per cent corporate tax rate it negotiated with the Swiss government, according to the report from Mr Levin, chairman of the Senate Permanent Subcommittee on Investigations.

Caterpillar had paid PwC more than $55m since 1999 to develop a tax strategy aimed at redirecting profits to Switzerland, the report said. In exchange for a small royalty, Caterpillar transferred rights to the profits from an international parts distribution business to a wholly controlled Swiss affiliate, CSARL.”

“Caterpillar is an American success story that produces phenomenal industrial machines, but it is also a member of the corporate profit-shifting club that has shifted billions of dollars in profits offshore to avoid paying US taxes,” Mr Levin said. The report cited Caterpillar officials praising the decrease in its US tax burden.

Julie Lagacy, Caterpillar’s vice-president of finance services, and Robin Beran, the company’s chief tax officer, are among the witnesses for the hearing, along with representatives of PwC, its tax consultant and auditor.

Two Caterpillar tax officials had warned the strategy had no business purpose other than to avoid taxes and raised these concerns through an anonymous letter to top company officials in 2004, according to the report.

“In her testimony, Ms Lagacy plans to say that Caterpillar pays a 29 per cent effective tax rate, which is higher than the average 26 per cent US corporate rate. For the past three years, the company paid $1.8bn in federal income taxes.

She will emphasise that the Senate focus is on the sale and purchase of replacement parts by Caterpillar’s non-US affiliates, which by law are not subject to US taxes or in other cases subject to deferred US taxes.”

“This is a standard multinational business structure entirely consistent with the letter and spirit of US tax law,” Ms Lagacy said in her written testimony, adding that the company stands by its structure.

The Senate report emphasised that no personnel or business activities were moved from the US to Switzerland and most of the parts business remained in the US after the tax strategy shifted in 1999.

Now this is fascinating, we explain the world with words and here there seems to be such a disparity in perceptions. Now one might argue that the politicians are responsible for the law (they after all pass it into law) and that some of this noise is about concerns that they shouldn’t have passed the laws they did.

But let’s examine what is at stake here. Clearly Caterpillar is concerned about its reputation, as you would expect any well run corporation to be, and is responding robustly to the allegations made.

The interesting quote is:

“This is a standard multinational business structure entirely consistent with the letter and spirit of US tax law,”

Now a corporation would say this as it would otherwise be in breach of the tax provisions in the OECD Multinational Guidelines. So what we appear to have is that the letter and the spirit of the US tax code permit the exchange for a small royalty, of the  rights to the profits from a significant international parts distribution business to a wholly controlled Swiss affiliate, CSARL which is not subject to US tax, so those profits less the small royalty are no longer subject to US tax. This is treated as an arms length transaction which passes the arms length standard of the OECD.

Now some people might see this as a strange treatment for the letter and the spirit of the US tax code to permit regardless of how many words are used to describe it. Some might think that the right area of focus would be on whether that is good law and if that was the case whether the politicians should review it and make changes. You might also wonder what the officials and politicians were doing when they were making the laws and regulations involved that permit this treatment?

Of course what the letter and the spirit of the US tax code actually do is reduce the tax rate which US corporations pay compared to non US corporations pay on the same geographical split of sales. Maybe that was the purpose?  But of course the tax rate is a number not a word and we can all see that.

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