Caterpillar's Headquarters Raided By Federal Authorities Including The DoJ And IRS

March 3, 2017

The headquarters of machinery giant Caterpillar were raided by federal law enforcement authorities over possible tax fraud. (For more: How A Swiss Caterpillar Affiliate Led To Thursday's Raid)

Authorities seized documents and electronic information that could escalate a grand jury investigation into the company's tax avoidance strategies by way of complex cash and equipment transfers between its U.S. and foreign subsidiaries. The raid pummeled Caterpillar's shares by over 4% and creates a legal headache for CEO James Umpleby, who replaced Doug Oberhelman at the beginning of 2017.

This morning the U.S. Attorney's Office in the Central District of Illinois and three other federal agencies, the Federal Deposit Insurance Corporation office of inspector general, the Internal Revenue Service criminal investigation division and the Department of Commerce office of export enforcement, raided three Caterpillar offices. Those included Caterpillar's Peoria, Ill. corporate headquarters, its offices in neighboring East Peoria, and the company's Morton, Ill. parts distribution center.

"On March 2, 2017, law enforcement authorities entered three Peoria-area Caterpillar Inc. facilities, including the corporate headquarters, to execute a search and seizure warrant. The warrant is focused on the collection of documents and electronic information. Caterpillar is cooperating with law enforcement," the company said in a press release after the market close.

"While the warrant is broadly drafted, we believe the execution of this search warrant is regarding, among other things, export filings that relate to the CSARL matter first disclosed in Caterpillar's Form 10-K filed on February 17, 2015, and updated in Caterpillar's most recent Form 10-K filed with the SEC on February 15, 2017," the company added.

Caterpillar shares, which have risen 35% over the past 12-months, fell by more than 4% and closed at $94.36.

Last year, Caterpillar disclosed a grand jury subpoena from the U.S. Attorney in Central Illinois requesting documents pertaining to its movement of cash between its U.S. and foreign subsidiaries. The company furthermore received subpoenas requesting information on its purchases and resale of replacement equipment parts, and its dividend payments made between various foreign subsidiaries, including Switzerland-based Caterpillar SARL.

In its most recent annual report, made on Feb. 15, Caterpillar said it was cooperating in these investigations and had not provisioned for any potential loss. "We currently believe that this matter will not have a material adverse effect on the Company’s consolidated results of operations, financial position or liquidity," Caterpillar stated.

For years, Caterpillar's tax rate and its treatment of replacement parts sales has been the subject of scrutiny in Washington. The machinery company has been dogged by accusations of using sham transactions to shift profits to low tax jurisdictions like Switzerland where its tax rate is as low as 4%, saving billions. At year-end Caterpillar had $16 billion in undistributed profits held in its non-U.S. subsidiaries. It also had $5 billion in cash in those non-U.S. subsidiaries, both of which would be subject to significant taxes if repatriated.

In 2014, a Senate Permanent Subcommittee on Investigations Hearing headed by Michigan Senator Carl Levin detailed a program Caterpillar designed in 1999 with the help of auditor PricewaterhouseCoopers to use machinery parts sales to shift company profits to low-tax jurisdiction Switzerland. The Senate investigation concluded these parts sales cut Caterpillar's U.S. tax bill by $2.4 billion between 2000 and 2012. Caterpillar and PwC cooperated in the Senate probe.

A year ago, an IRS Revenue Agent's Report (RAR) called for Caterpillar to face a proposed $2 billion in back-taxes and penalties resulting from its tax avoidance strategies. The IRS deemed some Caterpillar transactions between subsidiaries as invalid based on doctrines of "substance-over-form" and "assignment of income," thus creating new taxable income. It also disallowed roughly $125 million of foreign tax credits from financing arrangement between subsidiaries.

Caterpillar has been contesting these IRS findings. "We believe that the relevant transactions complied with applicable tax laws and did not violate judicial doctrines," the company said in its annual filing.

A week ago, former Caterpillar CEO Doug Oberhelman met with President Donald Trump alongside two dozen manufacturing CEOs to discuss policies such as tax reform, increased infrastructure spending and a loosening of regulations aimed at bolstering employment in the sector. "I love Caterpillar. I've been driving them for a long time," Trump said at the Feb. 23 meeting.

For now, however, Caterpillar's recently appointed CEO Umpleby is not feeling the love. Just two months on the job, he is now managing the uncertainty of a federal probe, which targets Caterpillar's strategies to minimize its hefty tax bill.