Caterpillar's Offshore Tax Practices Detailed in Senate PSI Report

For the last decade, the Permanent Subcommittee on Investigations of the U.S. Senate Homeland Security and Government Affairs Committee has examined how U.S. multinational corporations have exploited and, at times, abused or violated U.S. tax statutes, regulations, and accounting rules to shift profits and valuable assets offshore to avoid U.S. taxes. The Subcommittee's ongoing investigation has resulted in a series of hearings and reports.¹ Two recent hearings presented case studies of how some U.S. multinational corporations have employed complex transactions and licensing agreements with offshore affiliates to exploit tax loopholes, shift taxable income away from the United State to tax haven jurisdictions, and indefinitely defer paying their U.S. taxes, even when using some of that offshore income to run their U.S. operations.

This investigation offers another detailed case study of a U.S. multinational shifting taxable profits to a foreign affiliate in a tax haven to defer or avoid paying U.S. taxes. While the earlier investigations focused on corporations in the high tech field, this inquiry focuses on a manufacturing company with a substantial U.S. presence. It shows how an iconic American corporation, Caterpillar Inc., a U.S. manufacturer of construction equipment, power generators, and sophisticated engines, paid millions of dollars for a tax strategy that shifted billions of dollars in profits away from the United States and into Switzerland, where Caterpillar had negotiated an effective corporate tax rate of 4% to 6%.

Where Caterpillar once reported on its U.S. tax returns the vast majority of its worldwide profits from the sale of Caterpillar-branded replacement parts to non-U.S. customers -- parts that were manufactured by third party suppliers located primarily in the United States -- after the adoption of a Swiss tax strategy in 1999, it reported 15% or less of those profits in the United States and shifted 85% or more of the profits to Switzerland. Caterpillar accomplished that profit shift without making any real changes in its business operations. It continued to manage and lead the parts business from the United States.

Caterpillar also executed that profit shift despite the fact that its U.S. operations continued to play a far larger role in the parts sold to non-U.S. customers than its Swiss operations. The company's U.S. presence as a whole is far larger than its Swiss presence. Caterpillar's worldwide headquarters has long been in Peoria, Illinois, and all of its most senior executives are located there. Of its 118,500 employees worldwide, about 52,000, or nearly half, work in the United States, while only 400 employees, less than one-half of one percent, work in Switzerland. Of its 125 manufacturing facilities worldwide, 54 are in the United States, while none are located in Switzerland. In 2012, of the $2 billion Caterpillar spent on research and development, 80% was spent in the United States, while less than 10% was spent in Switzerland.

The same contrast applies to Caterpillar's parts business. Of the nearly 8,300 Caterpillar employees specializing in parts, about 4,900 work in the United States, including almost all of the senior parts executives. Switzerland has about 65 employees working on parts, with one division head managing parts distribution in Europe and one worldwideparts manager who reports to a division head in the United States. Of the Caterpillar replacement parts manufactured by third parties for sale outside of the United States, nearly 70% are manufactured in and shipped from the United States; none are manufactured in or shipped from Switzerland. Of the company's 19 parts warehouses and distribution facilities worldwide, 10 are located in the United States storing 1.5 billion parts, including its largest distribution center in Morton, Illinois; no warehouses are located in Switzerland. Caterpillar's parts inventory is also managed and operated primarily from the United States using U.S.-run worldwide parts tracking, forecasting, and delivery systems that have no counterparts in Switzerland. In 2012, Caterpillar Board minutes described its parts distribution business as "U.S. centric."

Despite the fact that its parts business is managed and led primarily from the United States, Caterpillar used a series of complex transactions to designate a new Swiss affiliate called CSARL as its "global parts purchaser," and license CSARL to sell Caterpillar third party manufactured parts to Caterpillar's non-U.S. dealers. Caterpillar also signed a servicing agreement with CSARL in which it agreed to keep performing the core functions supporting the non-U.S. parts sales, including overseeing the U.S. parts supplier network, forecasting parts demand, managing the company's worldwide parts inventory, storing the parts, and shipping them from the United States. Caterpillar agreed to perform those functions in exchange for a service fee equal to its costs plus 5%. As a result of those licensing and servicing agreements, over the next thirteen years from 2000 to 2012, Caterpillar shifted to CSARL in Switzerland taxable income from its non-U.S. parts sales totaling more than $8 billion, and deferred or avoided paying U.S. taxes totaling about $2.4 billion.

Within the company itself, two professionals in the tax department warned that the Swiss tax strategy lacked economic substance and had no business purpose other than tax avoidance, raising their concerns to officers at the highest levels of the company through an anonymous letter in 2004, and a series of emails and memoranda by the company's Global Tax Strategy Manager beginning in 2007. In 2008, the Global Tax Strategy Manager wrote to the head of the Caterpillar tax department: "With all due respect, the business substance issue related to the CSARL Parts Distribution is the pink elephant issue worth a Billion dollars on the balance sheet." By 2010, Caterpillar's finance department calculated that, as a result of the Swiss tax strategy, the company's "Effective Tax Rate ha[d] dropped to lowest in the Dow 30."

Caterpillar paid over $55 million to PricewaterhouseCoopers (PWC), one of the largest accounting firms in the world and Caterpillar's longtime auditor, to develop and implement the Swiss tax strategy, which was designed explicitly to reduce the company's taxes. In the 1999 planning documents, under a benefits analysis, PWC wrote that the CSARL transaction "will migrate profits from CAT Inc. to low-tax marketing companies." PWC added that, by doing so: "We are effectively more than doubling the profit on parts." In 2010, Caterpillar's tax department touted the company's lower tax rate, explaining company operations had been structured so that: "Losses in high-tax rate countries, Profits in low." By simultaneously acting as both auditor and tax consultant for the company, PWC audited and approved the very tax strategy sold by the firm to Caterpillar, raising significant conflict of interest concerns.

According to the lawsuit, when Caterpillar designated CSARL as the company's global parts purchaser, it made no changes in its business operations to justify shifting the parts profits to Switzerland, but retained management and control of the replacement parts business in the United States. The lawsuit further alleged that the CSARL transaction was improper, because it had no legitimate business purpose, but was done solely for tax reasons. The lawsuit also alleged that Caterpillar executives were well aware of the tax risks associated with aspects of the CSARL transaction, noting that senior tax officials had rated the risk as "high." In 2012, the lawsuit was settled out of court, for an undisclosed sum.

As part of its investigation, the Subcommittee reviewed numerous corporate documents filed and depositions taken in connection with the lawsuit. In addition, the Subcommittee collected and reviewed over 150,000 pages of documents from Caterpillar and its auditor PricewaterhouseCoopers (PWC), obtained additional detailed information from Caterpillar through a questionnaire and other information requests, and reviewed publicly available information, including the company's SEC filings. The Subcommittee also conducted 15 interviews of current and former Caterpillar executives and managers, as well as PWC partners, including two PWC tax consultants who helped design the Swiss tax strategy and the PWC audit partner who reviewed Caterpillar's tax status. The Subcommittee also spoke with academic tax experts and reviewed materials related to offshore profit shifting and transfer pricing issues. Both Caterpillar and PWC cooperated with Subcommittee requests for information.

The Subcommittee's investigation shows how Caterpillar paid over $55 million to PWC to develop and implement a tax strategy designed to lower its taxes by sending more profits from its parts business to Switzerland, where the company had negotiated an effective tax rate between 4% and 6%. As part of that tax strategy, Caterpillar replaced its leading Swiss affiliate with a new Swiss affiliate, CSARL, and then used a series of licensing transactions with CSARL to enable it to sell Caterpillar's third party manufactured replacement parts to its non-U.S. dealers and customers without showing the parts profits as U.S. income. Caterpillar had previously purchased those parts directly, primarily from its U.S. third party suppliers, and sold the parts to its Swiss affiliate which, in turn, had sold the parts to Caterpillar's non-U.S. dealers in Europe, Africa, and the Middle East. After the Swiss tax strategy was implemented, Caterpillar was removed from the legal title chain for the non-U.S. parts. Instead, its U.S. third party suppliers typically sold Caterpillar brand parts directly to CSARL which then sold them either to Caterpillar or Caterpillar's non-U.S. dealers.

The removal of Caterpillar from the legal title chain did not, however, otherwise change how Caterpillar's replacement parts business functioned on the ground. Caterpillar retained the central role in managing its parts supply chain, and its replacement parts business continued to function as a U.S.-centric business that was led and managed primarily from the United States, with little operational assistance from Switzerland. Today, over 70% of the third party manufactured parts sold abroad are manufactured in, stored in, and shipped from the United States. Most parts are designed and have their patents registered in the United States, and carry the Caterpillar brand. Caterpillar's U.S. personnel continue to develop, support, and oversee its U.S. supplier network. They also forecast parts demand, monitor inventory levels, and store and ship parts abroad to meet customer orders and the company's pledge to deliver replacement parts anywhere in the world within 24 hours. Caterpillar's U.S. personnel also continue to develop, support, and oversee its worldwide dealer network and, in coordination with its marketing companies such as CSARL, help those dealers stock and sell parts to Caterpillar customers. The documents associated with CSARL's licensing transactions show that they were not designed to change those operational details or to achieve any business advantage other than lowering Caterpillar's effective tax rate.

For a transfer between related parties of valuable assets, such as licensing rights, to be valid under the tax code, the transfer must meet an arm's-length standard, including compensating the transferring party as though the transfer were a sale to an unrelated third party. In this case, Caterpillar received royalty payments that resulted in its receiving only 15% or less of the profits from the sale of those replacement parts, while 85% or more of the profits went to CSARL in Switzerland. Prior to the CSARL transaction, those percentages were essentially reversed, with Caterpillar receiving 85% or more of the non-U.S. parts profits.

Caterpillar's replacement parts business was described internally as a "perpetual profit machine" analogous to an "annuity" that would continue to generate profits for as long as Caterpillar machines were in operation, a time period that averages 20 years per machine. Caterpillar Inc., which created, designed, and developed its replacement parts business over a period of nearly 90 years, not only gave up its right to 85% or more of the profits from its non-U.S. parts sales, it did so without receiving any compensation, such as a super royalty or lump sum payment, for turning over to CSARL the replacement parts business it had spent decades building and for foregoing future profits.

At the same time it gave away the vast majority of its profits from the non-U.S. parts sales and declined to seek compensation from CSARL for turning over that business, Caterpillar Inc. continued to perform the core business functions in exchange for a service fee equal to its costs plus 5%. Caterpillar Inc. also continued to bear the ultimate economic risks associated with the non-U.S. parts business because, even though CSARL took paper ownership of the parts inventory, CSARL's financial results were consolidated with those of the U.S. parent, which meant Caterpillar Inc. would be responsible for any CSARL losses. It is difficult to understand how these arrangements, when viewed in their totality, meet the arm's-length standard.

The purpose of the Subcommittee's investigation and this Report is to describe Caterpillar's offshore tax strategy and its relation to the company's non-U.S. parts business, compare the resulting U.S.-Switzerland profit split to the business functions performed in each country, and examine the policy implications of its transfer pricing arrangements. The investigation also examines the role and policy implications of PricewaterhouseCoopers' acting as both Caterpillar's auditor and tax consultant. In addition, the Report offers recommendations to close some of the offshore tax loopholes and address some of the transfer pricing weaknesses that enable some U.S. multinational corporations to defer or avoid paying substantial U.S. taxes.

In a globalized world where some U.S. corporations conduct much of their business in multiple countries and draw revenues from overseas as well as from U.S. sales and services, it has become increasingly difficult to determine appropriate allocations of taxable income between U.S. parents and their overseas subsidiaries. At the same time, while the percentage of tax revenues collected from corporations has declined for years, the U.S. federal debt has continued to swell, now surpassing $16 trillion. The result is a greater burden on individual taxpayers and future generations. According to a report prepared for Congress:

The decline in corporate tax revenues is due in part to more corporate income being reported abroad in low-tax jurisdictions. A number of studies show that U.S. multinational corporations are moving income out of or away from the United States into low or no tax jurisdictions, including tax havens such as Ireland, Bermuda, and the Cayman Islands.⁵

One study showed that foreign profits of controlled foreign corporations (CFCs) of U.S. multinationals significantly outpaced the total GDP of some tax havens.⁶ For example, profits of CFCs in Bermuda were 645% and in the Cayman Islands were 546% as a percentage of GDP, respectively. In a recent research report, JPMorgan expressed the opinion that the transfer pricing of intellectual property "explains some of the phenomenon as to why the balances of foreign cash and foreign earnings at multinational companies continue to grow at such impressive rates."⁷

The erosion of the corporate tax base caused by the shifting of profits into tax havens is not just a U.S. tax problem. In July 2013, the Organisation for Economic Co-operation and Development (OECD), which consists of 34 member countries with advanced economies including the United States, developed an action plan to assist governments with the growing challenge of multinational corporations engaging in base erosion and profit shifting to avoid paying tax where profits are earned.⁸ The OECD noted that profits reported in tax havens or low-tax jurisdictions were becoming increasingly disproportionate to the location of actual business activity. The action plan was endorsed by the G20 world leaders during the global G20 Summit in September 2013; they stressed the importance to all developing and developed economies of combating multinational corporate tax avoidance.⁹

Deferral has created incentives for U.S. firms to report earnings offshore by subsidiaries in low-tax or no-tax jurisdictions to defer or avoid U.S. taxes and increase their after tax profits.¹¹ Many U.S. multinational corporations have become engaged in finding ways to shift large amounts of income in low-tax foreign jurisdictions, according to a 2010 report by the Joint Committee on Taxation.¹² Current estimates indicate that U.S. multinationals have more than $1.7 trillion in undistributed foreign earnings and keep 50% to 60% of their cash overseas.¹³ The large amounts of undistributed foreign earnings contribute to greatly-reduced corporate effective tax rates.¹⁴

Transfers between different subsidiaries of a single multinational corporation can happen for a variety of reasons. One part of the company may need to make use of an asset owned by a different portion of the company, for example. In order to account for the value transferred, Congress and the IRS set up a system of transfer pricing regulations to ensure that multinational corporations accurately assess the value of what is being transferred and do not use such transfers to avoid taxation.

Because of the complexity of intangible asset transfers, companies can be tempted to use intangible asset transfers to circumvent transfer pricing regulations and lower their tax liability. One common tactic is for a U.S. parent to transfer the rights to intangible property to a related party in a low-tax jurisdiction in exchange for a royalty or other payment. Intangible property transfers can involve patents, brand names, marketing rights, the right to use certain business practices, or similar assets. If the royalty payment is lower than the true value of the license, income will effectively be shifted to the low-tax jurisdiction, where U.S. income tax payments can then be deferred or avoided. Principles addressing these transfers are codified under Section 482 and Section 367 of the Internal Revenue Code and largely build upon the requirement that the transfers must be conducted as if they were arm's length dealings between unrelated parties.¹⁵

IRS regulations provide various economic methods that can be used to test the arm's length nature of transfers between related parties as well as evaluate any exchange of value or allocation of profits.¹⁶ In many cases, the U.S. parent will transfer intangible property to an offshore subsidiary in exchange for an upfront payment or ongoing revenue stream. For some types of intangible property, such as the right to use established business practices, comparable values may have been established in the market and can guide proper valuation of the transfer. However, many intangibles relate to unique inventions or business assets, practices, or operations for which comparable transactions do not exist, making it very difficult to establish an arm's length price. Transfers involving unique intangible property are therefore difficult for the IRS to evaluate and challenge.

The Joint Committee on Taxation has stated that a "principal tax policy concern is that profits may be artificially inflated in low-tax countries and depressed in high-tax countries through aggressive transfer pricing that does not reflect an arms-length result from a related-party transaction."¹⁷ A study by the Congressional Research Service raised the same issue: "In the case of U.S. multinationals, one study suggested that about half the difference between profitability in low-tax and high-tax countries, which could arise from artificial income shifting, was due to transfers of intellectual property (or intangibles) and most of the rest through the allocation of debt."¹⁸ A Treasury Department study found that the potential for improper income shifting was "most acute with respect to cost sharing arrangements involving intangible assets."¹⁹

The transfer pricing regulations permit taxpayers to use several methods to satisfy the arm's-length standard. The valuation techniques can produce highly variable results, often because of the unique nature of the assets involved. This pricing variability is used by some multinationals to skew transfer pricing analyses in such a way as to increase reported income in low-tax jurisdictions. For example, if a technique provides a range of acceptable prices, the company may choose the lower end of the range for compensation to the U.S. parent corporation or use other aggressive transfer pricing practices. The Economist has described these aggressive transfer pricing tax strategies as a "big stick in the corporate treasurer's tax-avoidance armoury."²⁰ Edward Kleinbard, a professor at the University of Southern California and former chief of staff at the Joint Committee on Taxation, has described the valuation problems as "insurmountable."²¹

There are several ways intangible property can be transferred to a foreign affiliate, and the method chosen frequently dictates whether the authority for determining the compensation received by the U.S. person in the transaction is under Section 482 or Section 367(d) of the tax code. Generally, a license or a sale of intangible property, or the provision of a service that uses intangible property, is subject to Section 482. However, an exchange of intangible property from one controlled foreign corporation to another is subject to Section 367(d).²² Section 367(d) applies, for example, if the transfer of intangible property involves an exchange of stock under Sections 351 and 361. Where Section 367(d) applies, the transfer must include imputed income from annual payments over the useful life of the intangible as though the transferor had sold the intangible, a payment that is colloquially referred to as a "super royalty."²³ The appropriate amounts of those imputed payments are determined under Section 482 and its regulations.

The Subcommittee's previous investigations, as well as government and academic studies, have shown that some U.S. multinationals use transfer pricing to move income associated with intangible property to CFCs in tax havens or low tax jurisdictions, while they continue to attribute expenses to their U.S. operations, further lowering their taxable income at home.²⁴ This ability to artificially shift income to a tax haven can provide multinationals with an unfair advantage over U.S. domestic corporations by providing the multinationals not only with lower taxes, but also a taxpayer subsidy for their onshore operations.

Although the Kennedy Administration initially proposed to end deferral of foreign source income altogether, a compromise was struck instead, which became known as Subpart F.²⁸ Under the Subpart F compromise, in general, "passive" income generated through investments or funds transfers (such as royalty payments, dividends, or interest) would be taxed currently in the United States, while "active" income (such as revenue from overseas manufacturing activities) would not be taxed until the money was brought into the United States. Subpart F was enacted by Congress in 1962, and was designed in substantial part to address the tax avoidance techniques being utilized today by U.S. multinationals in tax havens. In fact, to curb tax haven abuses, Congress enacted anti-tax haven provisions, despite extensive opposition by the business community.²⁹

Subpart F explicitly restricts the types of income whose taxation may be deferred. The Subpart F rules are codified in tax code Sections 951 to 965, which apply to certain income of CFCs.³⁰ When a CFC earns Subpart F income, the U.S. parent as shareholder is treated as having received the current income. Subpart F was enacted to deter U.S. taxpayers from using CFCs located in tax havens to accumulate earnings that could have been accumulated in the United States.³¹ "[S]ubpart F generally targets passive income and income that is split off from the activities that produced the value in the goods or services generating the income," according to the Treasury Department's Office of Tax Policy.³² In contrast, income that is generated by active, foreign business operations of a CFC is permitted to continue to be deferred. But, again, deferral is not permitted for passive, inherently mobile income such as royalty, interest, or dividend income, as well as income resulting from certain other activities identified in Subpart F.³³ Income reportable under Subpart F is currently subject to U.S. tax, regardless of whether that income has been formally repatriated.

At the same time, regulations, temporary statutory changes, and certain statutory exceptions have undercut the intended application of Subpart F. For example, "check-the-box" tax regulations issued by the Treasury Department in 1997, and the CFC "look-thru rule" first enacted by Congress as a temporary measure in 2006 and subsequently renewed, have significantly reduced the effectiveness of the anti-deferral rules of Subpart F and have further facilitated the increase in offshore profit shifting which has gained significant momentum over the last 15 years. In addition, certain statutory exceptions have also weakened important provisions of the law, including regulations implementing the "manufacturing exception."

The purpose of taxing FBCS income under Subpart F was to discourage multinationals from splitting their manufacturing function from their sales function and then assigning the sales function to a subsidiary in a tax haven. The legislative history, in fact, describes precise scenarios intended to be included under Subpart F. For instance:

Through deferral and various regulatory and statutory exceptions, the tax code has created multiple incentives for multinational corporations to move income offshore to low or no tax jurisdictions and provided multiple methods to avoid current tax on those offshore transfers. A key objective of the Subcommittee's ongoing investigation is to examine these exceptions and loopholes in action, and find an effective way of closing them where transactions have little or no economic substance other than tax avoidance.

In 2010, Congress codified the judicial doctrine.⁴¹ Using the case law as its guide in determining whether a transaction had economic substance, the statute established a two part test: the transaction must change the taxpayer's economic position in a meaningful way, and the transaction must have a substantial non-tax purpose.⁴² The statute harmonized a split in the federal circuits as to whether both prongs had to be satisfied, or only one of them. It did not change the applicability of the economic substance doctrine, stating in 26 U.S.C. § 7701(o)(1) that the statute would apply "[i]n the case of any transaction to which the economic substance doctrine is relevant," while leaving the determination of relevance to the common law tests.⁴³ Under common law, the courts have held that the economic substance doctrine was not relevant in some circumstances.⁴⁴ One of those circumstances was described in a Joint Committee on Taxation analysis which said the doctrine may not be relevant to the "decision to utilize a related-party entity in a transaction, provided that the arm's length standard of section 482 and other applicable concepts are satisfied."⁴⁵

In July 2011, the IRS issued guidance to help its examiners determine when a transaction had economic substance under the statute.⁴⁶ The guidance provided 18 indicia and four circumstances indicating when a transaction had economic substance and 17 indicia indicating when it did not. For example, the IRS guidance recommended concluding that transactions between related parties that met the arm's length pricing standards of Section 482 were likely to meet economic substance requirements.⁴⁷ The guidance also recommended finding that a transaction lacked economic substance if the transaction had been "promoted/developed/ administered" by the corporation's tax department or outside tax advisors.

Because the economic substance doctrine was codified less than four years ago and applies only to transactions after March 2010, only a limited number of cases have interpreted the statute to date.⁴⁸

III. CATERPILLAR CASE STUDY

Caterpillar is an iconic American company with a strong U.S. presence. Its worldwide headquarters is in Peoria, Illinois, the heartland of the country. Out of 118,500 employees worldwide, about 52,000, or roughly 44%,are located in the United States.⁵² Out of 125 manufacturing facilities worldwide, 54 are located in the United States, far more than in any other country; the remaining71 manufacturing facilities are located overseas⁵³ The majority of the company's research and development activity and information technology planning and development occurs in the United States.⁵⁴ In 2012, Caterpillar spent about $2 billion on research and development, 80% of which was conducted in the United States.⁵⁵ Caterpillar also holds title to most of the intellectual property for its products in the United States, where it coordinates its global registration and enforcement strategy.⁵⁶ Most of Caterpillar's senior executives are in the United States, including its Chief Executive Officer (CEO), Chief Financial Officer (CFO), and Chief Legal Officer, as well as most of the heads of its business segments and divisions.⁵⁷ The current Chairman of the Board and CEO is Douglas Oberhelman.⁵⁸

Caterpillar is the world's leading manufacturer of construction and mining equipment, diesel and natural gas engines, industrial gas turbines, and diesel-electric locomotives.⁵⁹ In 2012, Caterpillar generated record revenues of $65.9 billion, earning it a ranking of number 46 on the Fortune 500 list of the largest American corporations.⁶⁰ In 2013, Caterpillar's revenues dropped to $55.7 billion, a 16% decline.⁶¹ Even with that drop, over that two-year period, Caterpillar's revenues exceeded $120billion. At of the end of 2013, Caterpillar had total assets of $85 billion, of which $17 billion, or 20%, were indefinitely reinvested earnings held offshore.⁶²

The entity that became Caterpillar Inc. was organized in 1925, in the State of California, when the Holt Manufacturing Company and the C.L. Best Tractor Company merged to form the Caterpillar Tractor Company.⁶³ By 1931, Caterpillar had perfected the diesel tractor engine and redesigned many of its old tractors, and witnessed a steady growth in its sales throughout the decade.⁶⁴ In 1967, Caterpillar's worldwide headquarters moved to Peoria, Illinois. On its website, the company has written that "Caterpillar has deep roots in Peoria," and "[s]ince the beginning when the company expanded its manufacturing from the West coast to the Midwest, [its] presence has deepened across the region."⁶⁵ In 1986, the U.S. parent company was reorganized as Caterpillar Inc. in the State of Delaware.⁶⁶

Caterpillar has five principal business segments: Construction Industries, Energy and Power Systems, Resource Industries, Financial Products, and Customer and Dealer Support.⁶⁷ Construction Industries (CI) is focused on producing machinery used to construct infrastructure and buildings, such as railways, roads, schools and hospitals.⁶⁸ Caterpillar equipment produced by this segment includes backhoe loaders, small tractors, and mini-excavators. Energy and Power Systems (EP) produces energy-related engines, turbines, and related equipment. Its products include power plant generators, turbines, and locomotives serving such industries as the electric power, petroleum, and rail businesses. Resource Industries (RI) focuses on producing equipment that harvests natural resources such as coal, minerals, and lumber.⁶⁹ Its products include large mining trucks, underground mining equipment, and tunnel boring equipment.⁷⁰ The responsibilities of CI, EP, and RI include the design, manufacturing, marketing, and sales of their respective products.⁷¹ Caterpillar's Financial Products segment is involved in the financing of dealers, suppliers, and customers to support the producing, purchasing, and leasing of Caterpillar products.

The fifth and final business segment, Customer and Dealer Support, focuses on customer service and dealer development.⁷² The head of Customer and Dealer Support is Stuart Levenick, a Caterpillar group president based in Illinois.⁷³ Among other responsibilities, the segment is responsible for key aspects of Caterpillar's parts business, including supplying both third party replacement parts and Caterpillar's own worked parts for the machines sold by the CI, EP, and RI segments. Within the segment, the current head of the Customer Services Support Division is Stephen Gosselin, who is charged with "growing Caterpillar's aftermarket parts and services business."⁷⁴ He is based in Illinois. Another key person is Barbara Hodel, Director of Parts Distribution, who is also based in Illinois.⁷⁵

Since the early 1990s, Caterpillar's five business segments have been further organized into various Business Divisions, each of which is led by a Vice President who reports to the Caterpillar Executive Office.⁷⁶ "[A] Business Division can include several subsidiaries or branches ('legal entities') or a legal entity can contain the activities of several Business Divisions."⁷⁷ The scope and role of Caterpillar's individual Business Divisions have evolved over time.⁷⁸ As of 2013, Caterpillar had 30 Business Divisions, which can be categorized into seven types including: Construction Industries, Resource Industries, Energy and Power Systems, and Customer and Dealer Support.⁷⁹ The Customer & Dealer Support divisions include a number that play key roles in the replacement parts business, including the Customer Services Support Division and the Distribution Divisions for the Asia Pacific region, the Europe, African and Middle East region, and the Americas.⁸⁰

Caterpillar credits its business model as "the foundation of [its] success."⁸¹ The company's business model focuses on the maintenance, repair, and operations component of its business, which the company views as helping to smooth its revenue stream and lock in its customer base.⁸² Caterpillar's describes its business model as operating in three phases: seed, grow, and harvest.⁸³ It seeds the business with its initial sale of its products, taking a "life cycle perspective" during product development, with Caterpillar's differentiated and proprietary parts being a key part of that perspective.⁸⁴ During the grow phase, Caterpillar grows the business by building the largest global field population of products, which in turn helps the company sell parts and services.⁸⁵ Caterpillar states that, by supporting its customers in the long run, it then harvests the opportunities created in the first two phases of the model.⁸⁶ Commenting on the company's seed, grow, harvest business model, Stuart Levenick, head of the Customer and Dealer Support business segment, recently said: "The harvest part of that is once you create all this population, we're much more vertical and we have a much more captive control of components and parts than anyone else in our business."⁸⁷ Caterpillar's strong focus on aftermarket parts and service is a vital element in all three phases of its business model.⁸⁸

Caterpillar is a leading U.S. exporter, providing more than 300 products to customers in approximately 180 countries around the world.⁸⁹ From 2008 through 2012, Caterpillar exported more than $82 billion in products from the United States.⁹⁰ In 2011, exports from the U.S. made up $19.4 billion or about one-third of its $60 billion in consolidated sales.⁹¹ While in 1963, only 43% of the company's consolidated sales and revenues came from international customers, in recent years most of Caterpillar sales come from international sales.⁹² In 2013, the company reported that 67% of Caterpillar's revenues came from sales outside of the United States.⁹³ While most sales now occur outside the United States, most of Caterpillar's machines and parts are still built in the United States; for example, as discussed below, in 2012, about 70% of finished Caterpillar replacement parts sold offshore were manufactured in the United States.⁹⁴

On average, Caterpillar dealers have been in operation for 50 years, and turnover is rare.⁹⁵ In 1993, Caterpillar had a total of 183 Caterpillar dealers worldwide, with 65 dealerships located in the United States and 118 located outside the United States.⁹⁶ The overall number of dealers is now slightly lower, with 178 dealers worldwide, of which 48, or 27%, are located in the United States and four, or about two percent, located in Switzerland.⁹⁷

Caterpillar's Customer and Dealer Support business segment, headed by Stuart Levenick in Illinois, is responsible for supporting and overseeing Caterpillar's worldwide dealer network. Among other responsibilities, it evaluates dealer performance and determines whether a dealer should be added or dropped from the network. In February 2014, the Customer and Dealer Support segment announced an initiative to improve the sales performance of Caterpillar's independent dealers. A media article described that initiative as follows:

Several divisions within the Customer and Dealer Support business segment provide dealer support. For example, the Customer Services Support Division is responsible, among other tasks, for handling "dealer operational capability development and deployment support."¹⁰¹ That division is headed by Stephen Gosselin who is located in Illinois.¹⁰²

Also within the Customer and Dealer Support segment, Caterpillar has three regional "Distribution Services" divisions, each headed by a Vice President located in the relevant region, and each responsible for dealer support and market development in the region in which it is based.¹⁰³ The "Americas Distribution Services" Division is headed by Pablo Kozner, who is located in the United States. The "EAME Distribution Division" is headed by Nigel Lewis, who is located in Switzerland at CSARL. The "Asia Pacific Distribution" Division is headed by James Johnson, who is located in Singapore. These three divisions are also often referred to as "marketing companies" since they focus on market development in their respective regions. In its most recent business re-alignment, the three marketing companies were part of a business group within Caterpillar's Customer and Dealer Support segment known as the Center of Excellence.¹⁰⁴ Like their division heads, the key marketing company personnel for North and South America are located in the United States. The key marketing company personnel for Europe, Africa, and the Middle East are located in Switzerland at CSARL. The key marketing company personnel for Asia and the South Pacific are located in Singapore.

Caterpillar prides itself on its dealers having superb local knowledge of their markets and maintaining superior customer service in the areas in which they operate. Overseas dealers are recommended and also developed, administered, and supported by CSARL and its subordinate companies.¹⁰⁵ According to Caterpillar, dealer recommendations from CSARL and other marketing companies are almost never overruled; one Caterpillar employee intimately involved in the dealer network said that he had never seen the Customer and Dealer Support personnel in Illinois challenge a locally made dealer decision.¹⁰⁶

The marketers at Caterpillar in most instances do not sell directly to customers.¹⁰⁷ Instead, the marketers serve as local Caterpillar representatives responsible for administering and maintaining local dealer relationships. For example, they assist dealers with sales calls, help handle delivery of service issues, and communicate Caterpillar sales goals and other objectives.¹⁰⁸ Another responsibility is helping local dealers develop marketing programs and providing training to their sales personnel as well as training on dealer information systems.¹⁰⁹ Marketing companies may also help a dealer address import or export issues, or apply for financing from Caterpillar or the marketing companies themselves to purchase more inventory or expand its facilities. In addition, they oversee dealer compliance with the terms and conditions of their sales and service agreements with Caterpillar.

While its marketing companies, including CSARL's predecessor in Switzerland, Caterpillar Overseas, S.A. (COSA) which was formed in 1960, helped develop its dealer network, Caterpillar Inc., the U.S. parent, played the largest role in developing the company's worldwide network.¹¹⁰ The majority of the 178 dealers in operation today were established prior to the 1990s.¹¹¹ Using identical language, Caterpillar's 1994, 1995, 1996, and 1997 transfer pricing reports described the relative roles of the U.S. parent and its marketing companies in developing its dealer network as follows:

Replacement parts also represent a critical aspect of Caterpillar's profitability. Caterpillar machines are often sold at low profit margins, and the company then depends upon the machine's long service life to create long-term customer demand for replacement parts which Caterpillar can sell at higher profit margins.

Donald Fites, Chairman and CEO of Caterpillar between 1990 and 1999, has characterized the sale of a Caterpillar machine to a customer as analogous to the generation of an annuity that continues to pay dividends over time, due to the revenues generated from machine repair and parts.¹²¹ A 2012 company presentation given to the Caterpillar Board of Directors put it this way:

Demand for replacement parts for a Caterpillar machine can last for decades. For example, one 2007 analysis showed that roughly half of all replacement parts sold by Caterpillar went to service machines that had been in the field for ten years.¹²⁵ In addition, a substantial amount replacement parts sold by Caterpillar were used to service machines that were 20 years old or more.¹²⁶ Since some Caterpillar machines have parts that wear out and require frequent replacement, as much of 90% of some parts' total production is sold in the aftermarket, rather than in new equipment.¹²⁷

A 2014 book about Caterpillar observed that Caterpillar's customers may frequently spend two to three times more on service and parts than they spend on the original equipment itself.¹²⁸ The book also cited a recent analysis which determined that, during the financial crisis of 2008-2009, parts revenue proved vitally important to both Caterpillar and its dealers as sales of some machines dropped by as much as 62%, but parts sales continued.¹²⁹ Stuart Levenick, Customer and Dealer Support head, has said: "That's the good thing about the parts business -- it's really steady when you're in the bottom of a cycle. It's a very important business for us and for the dealers, it really helps even out those swings in the business cycles."¹³⁰

Parts Design. Because of the revenue implications, aftermarket parts sales for a machine represent a very important set of design considerations for the company.¹³¹ The Subcommittee was told that Caterpillar machines are designed on an individual basis, with a single Product Manager ultimately responsible for the design and production of all components of a particular machine.¹³² The majority of Caterpillar's worldwide Product Managers are located in the United States.¹³³ To protect Caterpillar's replacement part revenue stream, Product Managers are encouraged to incorporate proprietary parts into Caterpillar machines whenever possible and to prevent Caterpillar machines from being repaired with generic parts from competitors.¹³⁴ According to a 2012 presentation to the Caterpillar Board of Directors, product design emphasizing proprietary parts was a key factor driving the company's future parts growth.¹³⁵ Caterpillar has registered numerous patents for its parts, most of which are in the United States.

Third Party Parts Suppliers. Caterpillar's aftermarket machine parts are produced primarily by third party suppliers as "purchased finished replacement parts" (PFRPs).¹³⁶ Parts produced by third party suppliers in the United States almost always carry the Caterpillar brand and are packaged as Caterpillar products. While Caterpillar does not own most of its major parts suppliers, it exercises oversight of them to maintain parts quality and protect its brand. At times, it stations Caterpillar personnel on site at supplier plants to oversee operations and promote Six Sigma compliance.¹³⁷ Currently, approximately half of Caterpillar's 48,000 third-party suppliers that produce purchased finished replacement parts are located in the United States.¹³⁸

In some cases, Caterpillar itself produces the replacement parts needed in some of its machines. When Caterpillar manufactures the part, they are referred to as "worked parts," to distinguish them from the "purchased finished replacement parts" manufactured by third party suppliers. Most of Caterpillar's worked parts are manufactured by its plants in the United States. However, the majority of Caterpillar replacement parts are produced by third parties rather than by the company itself.¹³⁹

24-Hour Parts Delivery. Caterpillar also maximizes its parts business by offering to its customers best in class parts replacement services. A 2012 Caterpillar Year in Review Report stated: "A key strength is [the company's] . . . ability to manufacture parts [and] . . . deliver unmatched parts availability to dealer and customers anywhere in the world."¹⁴⁰ The 2012 report highlighted the company's focus on quick delivery of parts by citing an instance in which a Caterpillar dealer delivered a part to a customer only one hour after the customer called in.¹⁴¹

Caterpillar has set a goal of delivering its parts anywhere in the world within 24 hours of a request and views its ability to meet that goal as differentiating it from its competitors.¹⁴² Caterpillar tracks its delivery performance and manages dealer inventory levels to assist with parts delivery.¹⁴³ According to Caterpillar, its dealers are able to fill 85% to 90% of parts orders immediately upon request from parts kept on site, and 95% of the remaining parts are delivered anywhere in the world within 24 hours.¹⁴⁴ Other similar industries, such as automobiles, can take 2-7 days to ship parts that are not held in stock at a dealership.¹⁴⁵ According to Caterpillar's transfer pricing documentation, "Caterpillar's guarantee to deliver parts anywhere in the world on very short notice enables it to sell more machines, since customers know that they will not be idled long by missing parts."¹⁴⁶

Caterpillar has been performing functions critical to the parts side of its business for decades. In the 1990s, for example, U.S. personnel were warehousing parts, setting stocking levels, forecasting parts usage and demand, managing support systems, invoicing, overseeing the parts introduction process, and working on parts delivery.¹⁴⁷ According to other Caterpillar documentation during the 1990s:

Key Parts Personnel. A number of organizations within Caterpillar Inc. manage key aspects of its replacement parts business. The Customer and Dealer Support business segment, headed by Stuart Levenick of Illinois, performs a number of the key functions, including parts logistics and distribution, inventory management, and parts pricing.¹⁵⁴ A key division is the Customer Services Support Division, which is charged with "growing Caterpillar's aftermarket parts and services business" and handling "parts distribution," among other tasks.¹⁵⁵ It is headed by Stephen Gosselin, who is based in Illinois. Within his division, Barbara Hodel, also located in Illinois, is the Director of Parts Distribution and oversees the company's warehouses and distribution centers.¹⁵⁶ Two additional key employees are Joseph Van Wassenhove, Parts Pricing Manager, and Timothy Gryl, Service Parts Manager and head of Caterpillar's Inventory Management Group. Both are Illinois residents.

Another key organizational unit is the Caterpillar Enterprise System Group, headed by David Bozeman who reports directly to CEO Douglas Oberhelman. Mr. Bozeman, too, is based in Illinois. This new "order-to-delivery organization" was formed in 2013.¹⁵⁷ A key employee is Frank Crespo, the head of Purchasing, which is responsible for developing and overseeing the company's supplier base which manufactures the purchased finished replacement parts sold abroad. Another key employee is Edward O'Neil, manager of Manufacturing Logistics.¹⁵⁸ Both are located in Illinois. Among other responsibilities, the new group is responsible for transporting Caterpillar parts around the world.

A former key member of the company's parts leadership was Steven Larson, who was head of the parts logistics division for the last nine years until he retired in February 2014.¹⁵⁹ Mr. Larson was also based in Illinois. After his retirement, the parts logistic division was dissolved and its functions integrated with the Customer Services Support Division.¹⁶⁰

The following chart depicts Caterpillar organizations and executives who lead and manage key business functions supporting its non-U.S. parts sales.

 

Caterpillar Organizations

 

Performing Key Functions Related to Parts

 

 

 

Managing Parts Inventories. Inventory supply levels at the Morton warehouse as well as Caterpillar's other warehouses and distribution centers around the world are monitored and managed by the Inventory Management Group, which is headquartered in the United States.¹⁶⁸ This group is included within the Customer Services Supports Division, headed by Timothy Gryl, and managed out of Illinois.¹⁶⁹ Caterpillar uses this group to monitor and determine the number and types of parts it should order from its suppliers and keep on hand at various locations. Under Caterpillar's obligations in its service agreement with CSARL, this group monitors and manages inventory levels for parts needed on a worldwide basis.¹⁷⁰

The Inventory Management Group operates a global inventory monitoring system that tracks parts inventory levels around the world in Caterpillar's distribution network, forecasts demand for particular parts, and transports parts on an emergency basis.¹⁷¹ Its state-of-the-art inventory management software, which is at the heart of the company's logistics capabilities, was developed in and is administered from Caterpillar operations in Illinois. The group predicts demand for parts by evaluating historical demand patterns using sophisticated algorithms and generates recommended stocking levels for Caterpillar's worldwide distribution facilities.¹⁷² On the issue of predicting future parts demand, Stuart Levinick, Customer and Dealer Support head, explained:

Although the Inventory Management Group is managed from the United States, it is assisted by Caterpillar parts and service representatives located in distribution centers and marketing companies around the world. Those representatives assist dealers in monitoring and managing their parts inventories to facilitate sales. According to Caterpillar, the representatives spend roughly 50% of their time at dealer sites, and occasionally are co-located at a dealership.¹⁷⁴ Parts and service representatives help dealers maximize aftermarket part sales by systematically evaluating and predicting when parts will wear out, when they should be ordered and in what quantities, as well as helping dealers prevent counterfeit parts from entering their markets.¹⁷⁵ Representatives also assist in training dealer technicians on proper service and maintenance of Caterpillar machines.¹⁷⁶ Service manuals for parts and machines are designed by Caterpillar personnel in the United States and shipped to dealers around the world.¹⁷⁷ In addition, Caterpillar provides marketing consulting services, and creates and supports dealer marketing programs for replacements parts.¹⁷⁸

Customers needing replacement parts typically turn first to their local Caterpillar dealer, which keeps a parts inventory on site and is able to provide the requested part 85-90% of the time.¹⁷⁹ If the part is not available on site, the dealer, or occasionally the customer, can place an order for the replacement part which is sent to the appropriate Caterpillar distribution facility, generally the closest location geographically. Inventory systems at the facility automatically check for availability of the part in the facility's onsite inventory. If the part is available it will be pulled from the facility's inventory and prepared for shipment. If the part is not available at the facility, the order will automatically be sent to the next closest warehouse or distribution center, the largest being the Morton warehouse in Illinois.¹⁸⁰ When the part is located, it is prepared for immediate shipment with the goal of delivering the part to the local dealer or customer within 24 hours of the order.

Caterpillar uses numerous inventory systems to monitor parts supplies in its warehouses. These systems anticipate what parts will be needed when and where to replenish inventories around the world. Its general parts inventory system was designed in and is run from the United States.¹⁸¹ Caterpillar's U.S. software engineers developed the algorithms and other software elements integral to that system, which tracks inventory quantities throughout Caterpillar's worldwide distribution network.¹⁸² Other systems keep track of orders, purchases, sales, and inventory pricing, and also generate parts invoices for dealers. Historically, distribution centers in Grimbergen and Singapore have had personnel to expedite and schedule orders, but all parts forecasting and ordering was done from Morton, Illinois, even for parts sourced in Europe.¹⁸³

Manufacturing Parts. In connection with its parts business, Caterpillar not only has to forecast the types and numbers of replacement parts needed, but also order their manufacture in time to meet customer demand. Caterpillar Inc. has sophisticated proprietary ordering systems, which were developed and are mainly administered out of the United States and function worldwide.¹⁸⁴ While Caterpillar manufacturers a portion of the required replacement parts itself, most of its replacement parts must be ordered from its third-party suppliers.¹⁸⁵

The company dedicates significant resources to managing its relationships with its third-party parts suppliers. The company's Purchasing group, led by Frank Crespo of Mossville, Illinois, has been assigned primary responsibility for managing those relationships.¹⁸⁶ The Purchasing group works closely with the suppliers to ensure they build parts that meet Caterpillar's quality standards and price requirements.¹⁸⁷ Its duties include working with suppliers to procure materials and services, forecasting demand for materials and parts, and monitoring the business viability of the supply base, with the overall goal of ensuring parts orders will be filled on time. Purchasing personnel visit suppliers in the United States and abroad to ensure capability and quality control in compliance with Six Sigma management principles.¹⁸⁸ In some cases, Caterpillar personnel are embedded at supplier sites to oversee manufacturing, and suppliers undergo rigorous financial audits by Caterpillar personnel.¹⁸⁹

In addition, under the service agreement signed between Caterpillar Inc. and CSARL referenced earlier, Caterpillar Inc. agreed to manage third-party suppliers within the United States that produce parts sold around the world. Under this agreement, Caterpillar Inc. consults with CSARL on identifying potential U.S. suppliers, visits those suppliers, negotiates terms with them, arranges for the transportation and delivery of specified parts, and inspects those parts for quality.¹⁹⁰

Once parts manufactured in the United States by Caterpillar or a third-party supplier are produced, they may be packaged by a third party contractor. Third-party packaging companies take delivery of the parts and package them under the Caterpillar brand so they are suitable for storage at warehouses and subsequent sale. The relationship with these third-party packaging companies in the United States is also managed by the Purchasing group in the United States. Packaged parts have historically been delivered to the Morton distribution center in Illinois prior to being shipped to the company's regional distribution centers.¹⁹¹ Today, some parts are also packaged and shipped from points outside of the United States.

Transporting Parts. Caterpillar also typically arranges for the transportation of parts from its third-party suppliers to its regional distribution facilities, a service managed by Caterpillar's Transportation Division, which is headquartered at the Morton distribution center in Illinois.¹⁹² The Transportation Division, which is part of the Caterpillar Enterprise System Group, assists in delivering parts to Caterpillar's 19 global storage and distribution centers, including the warehouses in Grimbergen and Singapore.¹⁹³ As the goods arrive, Caterpillar personnel here and abroad are responsible for conducting quality inspections to ensure the parts meet the company's standards. The distribution centers are also responsible for conducting ongoing oversight over the life of a product, in part to evaluate the performance of the replacement parts.¹⁹⁴ The head of Caterpillar's quality division is also located in the United States and operates out of the Morton distribution center.¹⁹⁵

Thousands of Parts Personnel. In response to questions from the Subcommittee,Caterpillar provided information about how many of its U.S. employees are involved with the "purchase, storage, movement, and sales of replacement parts."¹⁹⁶ Caterpillar indicated that of the 8,300 Caterpillar employees involved in those functions in 2012, about 4,900 worked in the United States. Of those 4,900 U.S. employees, Caterpillar indicated that about 3,600 were involved with "[p]arts [d]istribution ([l]ogistics)," about 1,035 were involved with "[g]lobal [p]urchasing," about 35 were involved with "parts pricing," about 115 were involved with "[p]arts [m]arketing [s]upport," and about 100 worked for the "Distribution Services Division."¹⁹⁷

Caterpillar's replacement parts business is a complex and demanding undertaking that requires expertise in forecasting parts demand, managing inventory supply levels, ordering the manufacture of needed parts, exercising quality control, packaging parts for shipment, and delivering parts as needed. Senior leadership for the Caterpillar parts business has been and continues to be located primarily in the United States. Key inventory management systems and controls, as well as ordering systems, were developed in the United States and continue to be managed from there. The company's largest and most important distribution center and parts warehouse operates out of Illinois. The majority of Caterpillar parts manufacturing takes place in the United States. To date, Caterpillar's replacement parts business has been and continues to be led and managed primarily from the United States.

COSA. For forty years, from 1960 to 1999, Caterpillar's leading Swiss affiliate was Caterpillar Overseas, S.A. (COSA), which was based in Geneva.¹⁹⁹ COSA acted as Caterpillar's lead marketing company for the Europe, Africa, and Middle East (EAME) region.²⁰⁰ COSA's responsibilities included purchasing machines and parts from Caterpillar for resale to EAME dealers, developing and maintaining the EAME dealer network, providing logistics support for parts delivery; providing EAME dealers with marketing information and sales training; acting as a liaison between EAME dealers and Caterpillar on product performance and service issues; helping EAME dealers obtain financing from Caterpillar or private banks to purchase inventory and improve their dealerships; and conducting oversight of EAME dealers to ensure their compliance with Caterpillar sales and service agreements. COSA worked with Caterpillar's U.S. employees who were in charge of approving new dealers, designing machines and their replacement parts, developing marketing campaigns and sales training materials for dealers, and providing dealer financing.²⁰¹ COSA had a regional focus, and was one of several offshore marketing companies that Caterpillar sponsored around the world.²⁰²

Aside from COSA's marketing work, Caterpillar had a very limited presence in Switzerland. Of its 125 manufacturing plants, none were or are located there.²⁰³ Of its 19 distribution centers, none were or are in Switzerland. When EAME dealers needed replacement parts, the parts were generally shipped from Caterpillar's primary warehouse in Morton, Illinois or from other Caterpillar distribution centers, such as its warehouse in Grimbergen, Belgium. Very few replacement parts have ever been shipped from Switzerland to another country. In addition, during COSA's tenure, no worldwide or regional Product Managers were based in Switzerland.²⁰⁴

In addition to its headquarters in Switzerland, COSA also operated a branch office that was first in Hong Kong and later in Singapore, providing marketing support for Caterpillar dealers in Asia and the South Pacific.²⁰⁵ Unlike Switzerland, in addition to the marketing office, Caterpillar maintained a parts distribution center and some manufacturing facilities in Singapore to serve Asian dealers.²⁰⁶

For years, Caterpillar's foreign marketing companies that helped support the sale of parts, including COSA's marketing operations in Switzerland and Singapore, were allocated a share of Caterpillar's non-U.S. parts profits. Although the amount fluctuated over time, the baseline apportionment was 50-50 on a legal entity basis prior to 1992.²⁰⁷ During this time, Caterpillar had little incentive to have a more precise apportionment because all profits on parts were immediately taxable in the United States by operation of Subpart F. In 1992, the marketing companies' share was set at 4% of the profit of the 30% profit margin for non-U.S. parts sold in their region, which translated into roughly 13% of those non-U.S. parts profits.²⁰⁸ That profit allocation for COSA continued until 1999.

CSARL. In 1999, as part of the Swiss tax strategy that is the focus of this Report, COSA and several other Swiss affiliates' assets and business activities were consolidated into a renamed Swiss entity, Caterpillar SARL (CSARL).²⁰⁹ Since then, CSARL has served as Caterpillar's leading Swiss affiliate. It has continued to perform the same marketing functions as COSA, and the EAME regional marketing work is the focus of the vast majority of CSARL employees in Switzerland today.²¹⁰ In 2000, Caterpillar made the head of the EAME Distribution Division a Vice President reporting to the Customer and Dealer Support Group President.²¹¹ That division head has been located in Switzerland at CSARL. The division head's duties were described by Caterpillar as "in charge of marketing of all Caterpillar Products, parts and services in the Europe, Africa, Middle East and Commonwealth of independent States Region."²¹² As part of that marketing work, CSARL has continued to support Caterpillar's non-U.S. dealer network with respect to parts. Its duties have included helping to ensure dealer inventories have the parts they need, supporting Caterpillar's commitment to deliver needed parts within 24 hours, and acting as a liaison between the dealers and Caterpillar parts personnel in the United States.²¹³ CSARL has also maintained the Singapore branch which, today, has about 400 employees.²¹⁴

In addition, as part of the 1999 transaction, CSARL was designated as Caterpillar's "global purchaser" of purchased finished replacement parts (PFRPs), the Caterpillar replacement parts manufactured by third-party suppliers. It took over that role from Caterpillar Inc., the U.S. parent corporation. Acting as the initial purchaser of parts, CSARL either instantaneously resold the PFRPs to Caterpillar in the United States or sold them over time to non-U.S. independent dealers, Caterpillar affiliates, or customers, as explained in more detail below.

Initially, CSARL became the nominal PFRP purchaser for the EAME region. Then, from 1999 to 2003, Caterpillar, the U.S. parent, designated CSARL as the nominal PFRP purchaser for more and more of its geographical regions, executing a series of licensing agreements with its Swiss affiliate.²¹⁵ The licensing agreements generally directed that between 4% and 6% of the sales of licensed products by CSARL be paid to Caterpillar as a royalty.²¹⁶ In addition, CSARL entered into a servicing agreement with Caterpillar Inc. to pay Caterpillar's costs plus a 5% markup, for the U.S. parent to continue to perform a number of core parts functions, including managing the worldwide parts inventory, supervising suppliers, forecasting parts demand, supervising parts logistics, and storing CSARL-owned parts in the United States.²¹⁷ CSARL was unable then or now to perform those parts functions itself, lacking the necessary personnel, infrastructure, and expertise.

After the CSARL transaction, in 2000, Caterpillar relocated three regional Product Managers who worked on machines and products used in the EAME region, moving them from France and Belgium to Switzerland.²¹⁸ Most of the company's Product Managers, however, have continued to work in the United States. In 2009, after the IRS issued new regulations requiring foreign affiliates of U.S. manufacturers to meet certain requirements to avoid Subpart F taxation, Caterpillar assigned one global Product Manager to CSARL.²¹⁹ In addition, Caterpillar created a new position at CSARL for a "Worldwide Parts Manager" which was filled by Quentin de Warlincourt, who was already working in Switzerland.²²⁰ Mr. de Warlincourt was the first worldwide parts manager stationed in Switzerland. He was charged with establishing an "overall parts strategy" in consultation with Caterpillar Inc.'s Executive Office and acting as a liaison among Caterpillar business units involved with parts management, as explained in more detail below.²²¹ He reported to Stephen Gosselin, head of the Customer Services Support Division, in the United States. Over the next five years, Mr. de Warlincourt assembled a staff of five to twelve persons in Switzerland.²²² Caterpillar witnesses told the Subcommittee that having a more localized worldwide parts manager resulted in operational efficiencies due to greater knowledge and awareness of local supply needs.²²³ He was recently replaced by Thomas Zihlmann, who is located in Switzerland and whose job title has been changed to Worldwide Parts Strategy Manager.²²⁴

At the Subcommittee's request, Caterpillar provided information about the total number of its Swiss employees involved with the "purchase, storage, movement, and sales of replacement parts."²²⁵ Caterpillar indicated that, of the 8,300 Caterpillar employees involved with those functions in 2012, about 66 were located in Switzerland. Caterpillar indicated that, of those 66 Swiss employees, 10 were involved with "parts pricing" and about 56 worked for the EAME Distribution Services Division.²²⁶

IV. EMPLOYING A SWISS TAX STRATEGY TO AVOID U.S. TAXES

Since the company's inception, Caterpillar's replacement parts business has operated as a "U.S. centric" business, led and managed primarily from the United States. Prior to 1999, Caterpillar reported 85% or more of the profits from the sale of its replacement parts to non-U.S. customers as taxable U.S. income, while attributing 15% or less of the profits to its Swiss affiliate and other marketing companies. At that time, even the portion of the profits attributed to its market companies was included on Caterpillar's U.S. tax return as taxable income under Subpart F. Beginning in 1998, however, Caterpillar's tax department paid millions of dollars to PricewaterhouseCoopers (PWC) and McDermott Will & Emery to develop and implement a tax strategy to lower the company's global taxes. PWC designed a Swiss tax strategy to direct the lion's share of Caterpillar's non-U.S. purchased finished replacement parts (PFRP) profits away from the United States to Switzerland, where Caterpillar had negotiated an effective tax rate of 4% to 6%,²²⁷ lower even than the Swiss federal statutory rate of 8.5%.²²⁸

In 1999, Caterpillar implemented the Swiss tax strategy, which it called the Global Value Enhancement or "GloVE" program.²²⁹ As part of that program, it renamed a Swiss subsidiary Caterpillar SARL (CSARL) which became the nominal recipient of the purchased finished parts profits and enabled Caterpillar to direct those profits away from the United States to Switzerland.²³⁰ Like its predecessor, CSARL also served as a marketing company, supporting Caterpillar's independent dealers in Europe. Over time, CSARL was also assigned responsibility for other Caterpillar marketing companies around the globe, and Caterpillar directed their parts revenues to Switzerland as well. 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.²³¹ As a result, over the next thirteen years, from 2000 to 2012, Caterpillar shifted U.S. taxable income of more than $8 billion offshore to Switzerland and deferred or avoided paying U.S. taxes totaling about $2.4 billion.

GTOP Review. In the late 1990s, PWC offered clients a program through its tax consulting services group known as the "Global Tax Optimization Program" (GTOP).²³³ As part of that program, PWC offered to review a client's business operations to identify potential tax savings. The goal of GTOP was to conduct a comprehensive assessment of the company's tax practices at the state, national, and international levels, identify tax inefficiencies, and recommend ways to change its operations to lower its overall tax payments.²³⁴ PWC described the program as "a coordinated, tailored approach to achieving [a company's] lowest sustainable tax rate."²³⁵

In 1997, PWC tax consulting services and Caterpillar began discussions regarding a potential GTOP review of Caterpillar's business and tax practices.²³⁶ In 1998, Caterpillar agreed to conduct the GTOP review, but did so by engaging a law firm, McDermott Will & Emery, which in turn engaged PWC on Caterpillar's behalf to conduct the review.²³⁷ Caterpillar relied on McDermott Will & Emery for tax advice. PWC initiated the GTOP review that same year. Internally, Caterpillar called the PWC tax reduction program the Global Value Enhancement (GloVE) program.²³⁸

Five Year Effort. PWC's tax review and tax reduction strategy for Caterpillar took about a year to complete; implementing the tax strategy took several more years, for a total of nearly five years, from 1998 to 2003. Caterpillar's tax department was the driving force behind the company's decision to adopt PWC's recommended tax strategy.²³⁹ The tax department paid for the tax consulting services provided by PWC and McDermott Will & Emery as well as the business division costs associated with the CSARL structure.²⁴⁰ Caterpillar has estimated the total five-year cost at over $55 million.²⁴¹

The bulk of PWC's substantive work occurred in the first two phases of the program: the "analyze phase" and the "develop phase."²⁴² The "analyze phase" involved PWC's examining Caterpillar's tax practices and the business and operational factors driving its value and tax liability and identifying ways to lower its effective tax rate. The "develop phase" involved PWC's providing a specific set of recommendations as well as an operational feasibility analysis and a cost-benefit analysis of its proposals.²⁴³

According to PWC, during the initial analyze phase in 1998, PWC conducted an extensive set of interviews with Caterpillar's executive office and business unit leaders to assess the views of Caterpillar's corporate officials regarding the direction of the company.²⁴⁴ This process also involved on-site visits to Caterpillar facilities, both inside and outside the United States.

Swiss Tax Strategy Proposed. Sometime in 1998, PWC submitted a report to Caterpillar containing a summary of ideas to reduce Caterpillar's tax liability.²⁴⁵ In the report, PWC presented Caterpillar with a list of 49 potential strategies to lower the company's effective tax rate.²⁴⁶ One of the report's key proposals focused on Caterpillar's replacement parts business, which produced a steady stream of taxable profits for the company. Under the then existing system, third party manufacturers made the replacement parts and sold them to the U.S. parent company, which then sold the parts to its marketing companies for subsequent resale to Caterpillar's non-U.S. independent dealers. The inclusion of the U.S. parent in the transactions meant that the parts' sales revenues were included on Caterpillar's U.S. tax return and also subject to tax under Subpart F. PWC proposed deferring or avoiding that tax by "remov[ing] Caterpillar Inc. from the chain of title passage for purchased finished parts (from U.S. or foreign sources) sold to foreign marketers," and replacing the U.S. parent with a new Swiss entity as the direct purchaser of the third party manufactured replacement parts.²⁴⁷

PWC explained to the Subcommittee that, by removing the U.S. parent, Caterpillar Inc., from the chain of title for third party manufactured parts sold to non-U.S. customers, Caterpillar would no longer have two related entities transacting business with each other in the supply chain.²⁴⁸ According to PWC, if Caterpillar Inc. were removed and replaced by a non-U.S. entity, such as a Swiss corporation, Subpart F's foreign base company sales rules would no longer apply, and the offshore income would no longer be immediately attributed to Caterpillar Inc. as a sale and therefore taxed in the United States. Instead, the funds could be attributed to Switzerland, and Caterpillar would be able to defer paying any U.S. taxes on that income simply by keeping it offshore, avoiding the Subpart F provision that was intended to capture this kind of income. Moreover, by attributing the income to Switzerland, PWC reasoned that Caterpillar could take advantage of the very low tax rate of 4% that the company had negotiated with that country.²⁴⁹

PWC documents proposing the tax strategy stated that it involved only "relatively simple re-invoicing requirements."²⁵⁰ Caterpillar and PWC told the Subcommittee that the tax strategy required few changes in the company's business operations, because its non-U.S. marketing companies were already selling the third party manufactured replacement parts to its non-U.S. dealers. They characterized the tax strategy as aligning the company's tax structure with sales practices already in place.

Caterpillar, with the approval of its executive steering committee, which was comprised of business executives including the CFO, adopted PWC's recommended tax strategy.²⁵¹ Caterpillar also decided, at the same time, to realign its European manufacturing operations, moving their headquarters to Geneva. Its decision led to the execution of a series of licensing and servicing agreements between Caterpillar Inc., the U.S. parent, and CSARL, its Swiss affiliate, as described below.

Auditing Its Own Tax Strategy. At the same time PWC was providing Caterpillar with tax consulting services and advocating the Swiss tax strategy, PWC continued to act as Caterpillar's independent auditor. Independent auditors are typically charged with reviewing a corporation's financial statements and expressing an opinion on whether they fairly present the corporation's financial position under generally accepted accounting principles.²⁵² PWC performed that function with respect to Caterpillar's financial statements, which included reviewing Caterpillar's estimates of the company's tax liabilities. As part of that review, PWC auditors were responsible for auditing and approving the company's use of the very tax strategy developed, advocated, and sold to Caterpillar by their PWC colleagues.

PWC's actions occurred prior to enactment of the Sarbanes-Oxley Act of 2002, which targeted various conflicts of interests that arise when a public accounting firm performs auditing and other services for a client, including tax consulting services, for the same corporation at the same time.²⁵³ Prior to its enactment, federal regulations did not place any restriction on accounting firms providing both audit and tax consulting services contemporaneously. After its enactment, a public accounting firm was permitted to perform those services concurrently only if approved in advance by the client corporation's Board of Directors Audit Committee.²⁵⁴ PWC told the Subcommittee that, both before and after enactment of the Sarbanes-Oxley Act, the Caterpillar Audit Committee approved PWC's contemporaneous delivery of auditing and tax consulting services for the company.²⁵⁵

At PWC, the auditing team included a tax partner, James Bowers, who was responsible for assisting the audit team in auditing Caterpillar's financial statements, including Caterpillar's estimates of the company's tax liabilities based in part on its implementation of the Swiss tax strategy. Mr. Bowers told the Subcommittee that he initially introduced PWC's GTOP team to Caterpillar and attended the initial presentation.²⁵⁶ He also indicated that, for a three-year period from 1999 to 2002, while he was assisting with the audit of Caterpillar's financial statements, he also spent up to one-third of his time working on "GloVE implementation," meaning implementation of the Swiss tax strategy.²⁵⁷ He said that his primary role involved explaining the details of Caterpillar's business operations and structure to PWC's tax consultants. Mr. Bowers said that, by 2003 or 2004, his work level on the Swiss tax strategy had "dropped significantly." In addition, he told the Subcommittee that, during the course of his audit work at Caterpillar, he conferred on issues related to the Swiss tax strategy with the same PWC tax consultants who had helped to design and implement it. According to Mr. Bowers, he performed an independent analysis of the Swiss tax strategy and concluded that it complied with the U.S. tax code.²⁵⁸ He also told the Subcommittee that he did not memorialize his analysis of the Swiss tax strategy by putting it in writing.²⁵⁹

$55 Million Tax Strategy. From 1998 to 2004, Caterpillar paid PWC over $80 million in tax consulting fees, including over $55 million related to the development and implementation of the Swiss tax strategy involving CSARL.²⁶⁰ From 2000 to 2012, Caterpillar also paid PWC another $200 million in auditing fees.²⁶¹

The Swiss tax strategy immediately lowered Caterpillar's effective tax rate. A 2010 "Global Tax & Trade Update" prepared by Caterpillar's Global Finance and Strategic Support Division reported that the company's "Effective Tax Rate ha[d] dropped to lowest in the Dow 30."²⁶² It summarized the effective tax rate "drivers" as "Losses in high-tax countries, Profits in low."²⁶³ According to Caterpillar, to date, the Swiss tax strategy has enabled the company to defer paying U.S. taxes of at least $2.4 billion.²⁶⁴

Original Legal Title Chain. Prior to the creation of CSARL in 1999, Caterpillar Inc.,the U.S. parent corporation, bought the purchased finished replacement parts (PFRPs) needed for Caterpillar machines directly from the third party suppliers that manufactured the parts for the company.²⁶⁵ Caterpillar often designed replacement parts that fit only Caterpillar machines, retained ownership of and patented the designs, and contracted with third party suppliers to manufacture them.²⁶⁶ Many of the PFRP third party suppliers were located in the United States in close proximity to the Caterpillar manufacturing plants that produced its machines.²⁶⁷ In fact, at the time of the CSARL transaction in 1999, according to a Caterpillar document, it appears that out of $853 million in parts sales, $712 million or 83%, were obtained from the United States.²⁶⁸ Although Caterpillar has since taken steps to globalize its supplier base, in 2012, nearly 70% of the finished parts purchased by CSARL for sale to foreign customers still came from the United States.²⁶⁹

Prior to 1999, Caterpillar was the initial buyer of its third party manufactured replacement parts, and if the replacement parts were to be sold in Europe, Africa, or the Middle East (EAME region), Caterpillar typically sold the parts to its affiliated marketing company, Caterpillar Overseas S.A. (COSA), which was incorporated in Switzerland.²⁷⁰ COSA, in turn, sold the parts to Caterpillar's independent foreign dealers in the EAME region.²⁷¹ The non-U.S. PFRP legal title and supply chain was typically as follows:

Caterpillar also manufactured some of its own replacement parts, which it referred to as "worked parts" to distinguish them from the purchased finished replacement parts manufactured by unrelated third party suppliers. The legal title and supply chain for the worked parts was as follows:

Caterpillar's standard practice was to compensate the internal Business Divisions involved with the sales of its non-U.S. parts. Its practice was to assign a routine profit to the divisions that performed routine business services and the residual profits -- sometimes called "entrepreneurial" profits -- to the divisions that contributed directly to the creation of those residual profits.²⁷³ According to Caterpillar, in its internal management books, Caterpillar treated COSA, the marketing company, as a routine parts distributor and gave it only a routine share of the non-U.S. parts profits.²⁷⁴ Other U.S. divisions were awarded the residual profits. At the same time, almost all of the profits, no matter which division received them, were typically included in Caterpillar's U.S. tax return and taxed.²⁷⁵ The end result was that, from about 1994 to 1999, Caterpillar's internal management books matched Caterpillar's tax books in terms of profit allocations.²⁷⁶

Forming CSARL. CSARL was first formed under another name in 1997.²⁷⁸ When Caterpillar decided to implement the Swiss tax strategy, CSARL was selected as the key Swiss entity and given a new name. According to PWC, CSARL is treated as a limited liability corporation -- a Swiss SARL -- for Swiss tax purposes, but as a limited liability partnership for U.S. tax purposes.²⁷⁹ In connection with the tax strategy, CSARL was set up with six members or partners, all of which were Caterpillar foreign affiliates.²⁸⁰ The six were COSA, Caterpillar Overseas Credit Corporation SARL, Caterpillar Overseas Investment Holding SARL, Caterpillar Commercial Holding SARL, Caterpillar Asia Pacific LP, and Caterpillar Product Development SARL. In 1999, each of the six partners contributed assets and business activities to CSARL, which emerged as Caterpillar's leading Swiss affiliate.²⁸¹ Later, Caterpillar added a seventh CSARL member, Caterpillar International Investment SARL.²⁸²

In 2006, Caterpillar reorganized its affiliates and added several new intermediate owners between itself and CSARL. The new owners were generally shell corporations located in tax havens, including Bermuda, Luxembourg, and Switzerland; all were affiliated with and ultimately owned by Caterpillar Inc. in the United States.²⁸³ They included, in addition to COSA, Caterpillar International Ltd. of Bermuda; Caterpillar Holding Ltd. of Bermuda; Caterpillar Luxembourg SARL of Luxembourg; and Caterpillar Commercial Holding SARL.²⁸⁴ The following chart depicts CSARL's current ownership.

 

Caterpillar Ownership of CSARL

 

 

 

Designating CSARL as Global Parts Purchaser. In 1999, in accordance with the tax strategy designed by PWC, Caterpillar designated CSARL as the purchaser of its third party manufactured parts intended for sale outside of the United States. According to PWC, that designation resulted in two key changes.²⁸⁵ First, Caterpillar Inc., the U.S. parent corporation, was removed from the non-U.S. parts supply chain, and replaced with CSARL which became the nominal "global purchaser" of PFRP parts.²⁸⁶ The new parts legal title chain was as follows:

The tax consequences, however, were significant, according to PWC and Caterpillar. Because Caterpillar Inc. was removed from the legal title chain altogether, and CSARL bought the parts from and sold the parts to unrelated parties, PWC and Caterpillar claimed that the profits from those sales were no longer subject to Subpart F's foreign base company sales rules, were not immediately taxable, and if kept outside of the United States could be protected from U.S. taxation through deferral.²⁸⁷ In the 1999 planning documents for the CSARL transaction, under a benefits analysis, PWC wrote that the CSARL transaction "will migrate profits from CAT Inc. to low-tax marketing companies."²⁸⁸ PWC added that, by doing so: "We are effectively more than doubling the profit on parts."²⁸⁹

Executing Two Tolling Agreements. The second key change, according to PWC, was that CSARL entered into "tolling agreements" with Caterpillar's two main European manufacturing operations in France and Belgium.²⁹⁰ Those tolling agreements required Caterpillar's French and Belgian affiliates to provide manufacturing services to CSARL in exchange for the cost of their operations plus 7%. By limiting their profit margins to 7%, the tolling agreements shifted the residual or entrepreneurial profits for the manufactured goods from the two manufacturing facilities in France and Belgium to CSARL in Switzerland.²⁹¹ In addition, the Product Managers for the machines produced by the French and Belgian facilities moved to CSARL. The primary effect of the tolling agreements was to shift French and Belgian profits to Switzerland; they had relatively little effect on Caterpillar's U.S. tax savings.²⁹²

Caterpillar and PWC told the Subcommittee that, as a result of the tolling agreements and CSARL's new role as a "global parts purchaser," and because of the increasing importance of non-U.S. sales and its foreign dealer network, CSARL had become more than a routine distributor of parts entitled to a routine share of the profits. Instead, according to Caterpillar and PWC, CSARL was also entitled to the residual profits associated with the parts it purchased and sold.

In addition, Caterpillar and PWC claimed that CSARL had "newly recognized intangibles" associated with its marketing duties that had been present when COSA performed those duties, but had not been appropriately compensated. As a result, Caterpillar and PWC claimed that, as of 1999, Caterpillar could appropriately allocate 85% or more of the non-U.S. replacement parts profits to CSARL, instead of the 15% or less allocated to its predecessor, COSA. At the same time, as detailed below, Caterpillar decided not to change its internal allocation of profits, which decided employee incentive pay and bonuses; on Caterpillar's internal management books, CSARL continued to receive credit only for the type of routine profits allocated to a parts distributor. For years after the CSARL transaction, as explained further below, Caterpillar's internal profits allocation for business purposes no longer matched its profits allocation for tax purposes.²⁹³

First License Agreement. On September 1, 1999, Caterpillar Inc. and CSARL entered into their first license agreement for PFRPs and worked parts.²⁹⁵ The license gave CSARL certain exclusive and nonexclusive rights to buy PFRPs from third party suppliers and worked parts from Caterpillar, as well as the right to sell those replacement parts to non-U.S. customers in the Europe, Africa, and Middle East (EAME) region.²⁹⁶ In exchange for those rights, CSARL agreed to a pay a 15% royalty for PFRPs and a 7% royalty for worked parts to Caterpillar Inc. on net sales in the EAME region.²⁹⁷

As a temporary aside, Caterpillar and CSARL also entered into a year-long purchasing agency agreement in which Caterpillar agreed to act as the purchasing agent for parts purchased from third party suppliers.²⁹⁸ That agreement permitted Caterpillar Inc.'s name to continue to appear on the PFRP purchase orders and invoices by making it clear that Caterpillar Inc. was acting on behalf of CSARL in relation to the third-party suppliers.²⁹⁹ That purchasing agency agreement, which ended after a year, provided Caterpillar with time to make systems changes so that the name on the purchase order and invoices could be changed to CSARL.

Service Agreement. In addition to the licensing agreement, Caterpillar Inc. and CSARL entered into a service agreement under which Caterpillar Inc. agreed to provide certain services for CSARL relating to the management and sales of replacement parts.³⁰⁰ The services specified by the agreement were extensive and included: developing service manuals, performing parts logistics and warehousing services; engaging in strategic parts planning; managing third-party suppliers within the United States (including visiting suppliers, negotiating terms, arranging for transportation, and conducting quality inspections); managing part flows such as inventory management worldwide; performing parts pricing determinations; maintaining accounting, shipping, customs and other records; processing parts returns; providing marketing consulting services for dealers; and covering inland freight charges for materials destined for U.S. contract packagers.³⁰¹ In essence, the service agreement required Caterpillar to continue to manage the parts business, since CSARL did not have the personnel, infrastructure or expertise to perform those functions. In exchange for providing those services, CSARL agreed to pay Caterpillar a fee equal to the cost of the services plus 5% of the costs.³⁰²

Bundled License Agreement and Royalty Rate. Following that first licensing agreement for the EAME region, CSARL entered into several similar agreements covering nearly all of Caterpillar's offshore regions including Latin America, Canada, Mexico, India, Asia, Australia, and the South Pacific.³⁰³ The resulting tax planning led to the creation of 37 partnerships between CSARL and other Caterpillar affiliates.³⁰⁴ Ultimately, Caterpillar Inc. cancelled the individual licensing agreements and bundled all of the licenses and royalty payments into a single agreement resulting in a combined royalty rate for replacement parts and its prime products, including Caterpillar machines.³⁰⁵ The bundled royalty payment to Caterpillar Inc. involved a sliding scale that ranged from 4% to 6% of the combined net sales of Caterpillar parts and machines.³⁰⁶ The sliding scale was constructed so that the higher the total net sales, the higher the royalty rate. For the first five years of the bundled royalty agreement, CSARL paid a combined royalty of just under 4%, which then increased to 5% and ultimately to 6%.³⁰⁷ By entering into this license agreement, Caterpillar U.S. gave up rights to 85% or more of the finished replacement parts profits in exchange for a royalty of less than 15% for finished replacement parts.³⁰⁸

The adequacy of the royalty paid by CSARL to Caterpillar was cited as a concern on several occasions by the Caterpillar tax department and PWC tax advisors. In 2002, a PWC presentation noted that CSARL was experiencing such high profits, it raised questions about the 4% royalty it was paying to Caterpillar: "High profit in Licensed Business puts pressure on 4% bundled royalty."³⁰⁹ The 4% royalty nevertheless remained in place for another three years. PWC's transfer pricing subject matter expert told the Subcommittee that every CSARL licensing fee percentage point was worth approximately $100 million in parts profits that could be kept in Switzerland with U.S. taxes deferred.³¹⁰ Another 2006 PWC email reported:

In 2008, Rodney Perkins, Caterpillar's International Tax Manager who worked on CSARL, sent an email to PWC expressing concern about CSARL's continuing to pay the 6% royalty rate on Caterpillar products with a high profit margin:

At the Subcommittee's request, Caterpillar provided data on the annual parts profits reported by CSARL and the annual royalty payments made to Caterpillar related to parts over an eight year period. The data showed that the parts profits reported by CSARL over that eight-year period totaled about $8 billion, while the royalty payments paid by CSARL to Caterpillar totaled about $1 billion.³¹⁴ When the annual royalty payments were compared to the annual parts profits each year during the eight-year period, the data showed that the royalties paid to Caterpillar Inc. ranged from 9% to 16% of the total parts profits, with an overall eight-year average of 14%. The data also showed that CSARL retained 84% to 91% of the parts profits each year, leading to an overall eight-year average of 86%. This data confirmed that, overall, Caterpillar obtained 15% or less of the non-U.S. parts profits, while CSARL obtained 85% or more.

Caterpillar takes the position that, rather than focus on the division of profits related to parts alone, the appropriate focus is on the division of profits resulting from the single bundled royalty rate under the latest licensing agreement, which aggregates both parts and machine profits. Over an eight-year period, that aggregated royalty rate leads to total gross profits of $11 billion, reflecting both parts and machine sales, and a total royalty payment of $3 billion. The resulting profit split directs about 31% of the combined profits to Caterpillar Inc. in the United States, and about 69% to CSARL in Switzerland. Aggregating the two types of profits, however, disregards the fact that the planning and motivation for the Swiss tax strategy that produced the licensing agreement focused solely on parts profits and did not mention machines.

Purchaser for Caterpillar Inc. In addition to CSARL's acting as Caterpillar's "global purchaser" for its non-U.S. affiliates, CSARL also became the initial purchaser of PFRPs for its U.S. parent, Caterpillar Inc., even for PFRPs manufactured by third party suppliers located in the United States. Caterpillar's outside tax expert explained: "[B]ecause U.S. suppliers did not want to deal with more than one purchaser, CSARL purchased not only outbound PFRP but also goods destined for U.S. dealers and customers."³¹⁵ CSARL purchased and then automatically and instantaneously resold the PFRPs to Caterpillar Inc. in paper transactions referred to as "flash title" transactions. CSARL performed the flash title transactions at cost, with no markup or profit for the role played by the Swiss affiliate.³¹⁶ While Caterpillar did not permit CSARL to make a profit on the parts sold to it in the United States, Caterpillar continued to allocate 85% or more of the non-U.S. parts profits to CSARL in Switzerland.

While the licensing agreements designated CSARL as the company's "global parts purchaser," they did not lead to CSARL's hiring a significant number of new personnel. CSARL continued to operate with less than one percent of Caterpillar's worldwide employees.

The ITAS software system was created to exist in addition to Caterpillar's general global inventory system, which ITAS drew upon for data. Caterpillar's general global inventory system tracked parts on an individual basis, so that the company knew exactly how many parts it had, what types of parts they were, and where they were located. ITAS did not alter or replace the inventory tracking system Caterpillar used in its day-to-day business operations; instead, for tax purposes only, it tracked "virtual parts bins" consisting of commingled parts owned by Caterpillar Inc. and CSARL.

Before initiation of the Swiss tax strategy in 1999, Caterpillar Inc. owned all of the replacement parts in its U.S. warehouses prior to selling them to its marketing companies.³¹⁸ With the designation of CSARL as the nominal "global purchaser" of the company's third party manufactured replacement parts, however, Caterpillar had to create a system to show CSARL as the owner of the relevant replacement parts in the U.S. warehouses that were expected to be exported to foreign countries, including Canada and Mexico. The ability to show CSARL as the owner of the parts was needed to enable Caterpillar and CSARL to take advantage of the export tax exemption under tax code Section 956(c)(2)(B), which allows foreign affiliates to store goods in a U.S. warehouse without creating a taxable U.S. presence.³¹⁹ 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.³²⁰

According to PWC, Caterpillar tax and accounting personnel conceived of the ITAS approach, and then worked with PWC and McDermott Will & Emery personnel to design the system to track ownership of parts kept in a "physically commingled inventory" while ensuring technical tax compliance.³²¹ ITAS was supposed to show that CSARL had separate ownership of parts stored in Caterpillar's U.S. warehouses, even though the CSARL parts were completely commingled with the Caterpillar Inc. parts, there were no separate ownership labels, and Caterpillar employees did not and could not distinguish between the two sets of parts in any way.³²²

ITAS attempted to solve the problem by declaring that Caterpillar and CSARL each owned a portion of the parts in a "virtual bin," that the parts could be treated on an interchangeable basis, and that CSARL's ownership of a particular part could be determined at a particular point in time, such as after the part was sold and shipped to a non-U.S. customer.

If either CSARL or Caterpillar ran out of parts in a "virtual bin" as tracked in the ITAS system, ITAS assumed that each party could automatically borrow needed parts from the other and return those borrowed parts when future parts deliveries came in.³²³ The virtual borrowing took place without notice and without either party charging or paying a fee to the other. Caterpillar's tax director explained the ITAS system this way: "[I]t was designed to reflect that the parts are basically common parts and to the extent that CSARL or [Caterpillar] Inc. would have parts in the same bin, they might be shared back and forth and replaced."³²⁴

Caterpillar and PWC personnel advised the Subcommittee that it was not uncommon for each entity to engage in that type of virtual borrowing. According to Caterpillar, over a five-year period between 2008 and 2013, Caterpillar and CSARL borrowed from one another more than three million parts with a collective value of more than $800 million.³²⁵ Caterpillar also calculated that, on average each year, more than 10% of the parts stored in Caterpillar's U.S. warehouses were borrowed between the two related companies.³²⁶

The end result was that instead of segregating the Caterpillar versus CSARL parts,³²⁷ 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. The ITAS system then retroactively determined, for all parts shipped to non-U.S. customers, that those parts had belonged to CSARL. As Caterpillar's auditor observed:

The ITAS system was an artificial inventory system created solely for tax purposes. It existed outside of and in addition to Caterpillar Inc.'s general global inventory system, which provided the data for ITAS. The second inventory book created by the ITAS system did not change how any of Caterpillar's parts were warehoused, tracked, or shipped. The tax consequences of the ITAS system are discussed in more detail below.

The 1998 and 1999 planning documentation prepared by PWC and Caterpillar indicated that altering the invoices was the primary change needed to implement the Swiss tax strategy, and that no other substantive changes in Caterpillar's parts operations were planned or expected. The original PWC proposal, for example, described the "Benefits/Costs" of the Swiss tax strategy has involving "[r]elatively simple re-invoicing requirements."³²⁹ Another PWC document offered these "Main Implementation Observations":

In interviews, Caterpillar and PWC personnel told the Subcommittee that, at the time of the 1999 transaction, no substantive changes were made in how the replacement parts business actually functioned, and no Caterpillar personnel were moved to CSARL with respect to parts.³³² William Springer, former Caterpillar Vice President of Product Support, told the Subcommittee that he was unaware of any changes in business function related to parts as a result of the CSARL transaction.³³³ Sally Stiles, a senior Caterpillar tax manager, provided the same information, telling the Subcommittee that there was no substantive change in Caterpillar's purchased finished replacement parts business as a result of the CSARL transaction.³³⁴ A 2006 PWC document explained the lack of operational changes at the time by stating that the CSARL transaction was intended simply to reflect what was already occurring and "better align the taxation of transaction flows with how Caterpillar actually manages those operations."³³⁵

None of the sworn deposition testimony provided by Caterpillar's personnel contradicted the information provided to the Subcommittee. When asked about the changes required in Caterpillar's business operations, for example, Caterpillar's tax department head, Robin Beran, said under oath:

Caterpillar's Chief Accounting Officer also indicated in a Subcommittee interview that the 1999 transaction resulted in no change before tax in the total amount of Caterpillar profits from third party manufactured replacement parts sales.³³⁸ That information matched her earlier deposition testimony in which she said that the operating profit for parts sales was the same both before and after the 1999 transaction.³³⁹

Several Caterpillar representatives explained that, beginning in 1999 and continuing to the present, CSARL paid Caterpillar Inc. a service fee for Caterpillar personnel to continue to perform key business functions supporting non-U.S. parts sales, including parts design, parts forecasting, inventory management, supplier oversight, and parts storage and delivery.³⁴⁰ Caterpillar's ongoing role in performing those parts functions was described in a report prepared for the Subcommittee by Caterpillar's outside tax expert as follows:

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. 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.

In 2005, Caterpillar's tax director, Robin Beran, notified the company's Chief Financial Officer about CSARL's offshore cash buildup:

In 2010, Caterpillar's finance department identified a "Crossover" cash buildup problem which it defined as "when offshore cash no longer can be accessed in the U.S. without incremental U.S. tax cost,"³⁴⁸ meaning having to pay the U.S. corporate tax rate when the funds were repatriated to the United States. The finance department noted the "[h]igh enterprise tax cost of repatriation -- 25% additional tax," and stated that it was "[d]eveloping tax efficient repatriation strategies" to return $3 billion to the United States.³⁴⁹ It listed several possible strategies for returning funds to the United States, including making "[l]oans to U.S. with minimal tax impact . . . [p]repay[ing] royalties . . . [and] [e]xpand[ing] goods prepayment -- CSARL purchases from U.S. affiliates."³⁵⁰

Caterpillar appears to have executed at least one of these strategies. According to a memorandum prepared by Caterpillar's auditor, PWC, in 2011, Caterpillar Inc. entered into an agreement with CSARL "whereby CSARL made $4 billion of advance payments for certain prime product up to 2 years in advance and received a discount for orders placed against this advance payment."³⁵¹ As of the end of 2013, Caterpillar's offshore cash assets totaled $17 billion, giving the company the 33^rd largest offshore amount of 1,000 corporations reviewed.³⁵²

Tax Reserves. One sign of Caterpillar's recognition that its new Swiss tax strategy was high risk was the action taken by the company at one point to set aside a "tax reserve" equal to 50% of CSARL's profits in case the IRS challenged the strategy.³⁵³ A tax reserve is a position recorded in a company's audited financial statements to set aside money in case an uncertain tax position taken by the company on a tax return is successfully challenged by the IRS. The PWC auditor who reviewed Caterpillar's tax issues, James Bowers, told the Subcommittee that the tax reserve was established due to uncertainties associated with the complex transaction flows, the adequacy of the royalty rates, and accounting issues related to CSARL.³⁵⁴ That reserve was later reduced, after adoption of new tax accounting rules, to reflect 5% of the CSARL profits in each tax year.³⁵⁵

Adopting the Tax Risk Guard Rails System. Another sign of Caterpillar's concerns about the risky nature of its Swiss tax strategy was action taken by an internal council of senior tax and accounting personnel, during the course of developing and implementing a new tax risk management process, to rate aspects of the Swiss tax strategy as "higher" risk.

The Swiss tax strategy was evaluated for risk at Caterpillar in connection with a new tax risk management tool known as the "Tax Risk Guard Rails" (TRGRs) project. The objective of the TRGRs project was to "develop a documented, more objective process" to identify and convey the business risks associated with uncertain tax positions to both company executives and the Audit Committee of the Board of Directors "in a non-technical manner."³⁵⁶ Current and former Caterpillar employees interviewed by the Subcommittee attempted to downplay the significance of the TRGRs tax risk rating, but the evidence shows it was used to inform senior levels of the company about the risks associated with two critical elements of the Swiss tax strategy. The TRGRs system was developed at the direction of Caterpillar's former CFO, David Burritt, its ratings were assigned by consensus of company tax and accounting experts, and remained in place for two years.

In 2004, when Mr. Burritt became Caterpillar Inc.'s CFO, he took steps to improve the company's tax risk management processes.³⁵⁷ Mr. Burritt had previously worked with Daniel Schlicksup in Caterpillar's Geneva office. When he took over as CFO, Mr. Burritt brought Mr. Schlicksup back to Caterpillar's tax department in the United States to assist with tax risk management and improve the company's global tax practices. Upon his return, Caterpillar announced the following concerning Mr. Schlicksup's new position as its "Tax Strategy Manager":

In September 2005, Mr. Burritt shared the TRGRs concept with Douglas Oberhelman who was then Group President of the finance department, explaining that "[w]e will follow a process based on research done by the Corporate Executive Board that enables us to better analyze and understand our risks."³⁶⁶ Mr. Burritt also asked Mr. Schlicksup to present the TRGRs concept to Caterpillar's Audit Committee Chairman, Eugene Fife.³⁶⁷ Mr. Fife responded positively and asked for the TRGRs concept to be included on the agenda for a December Audit Committee meeting.³⁶⁸ In December 2005, Robin Beran, Caterpillar's tax director, presented the TRGRs concept to the full Audit Committee and identified several deliverables for the February 2006 Audit Committee meeting, including identifying the tax risk categories and defining low, medium, and high risks.³⁶⁹

Assigning Tax Risk Ratings. Caterpillar's Tax Council began its initial substantive work on the TRGRs project in January 2006 and continued through March.³⁷⁰ The Tax Council was a group of senior personnel from Caterpillar's tax and accounting departments, formed at the suggestion of Mr. Burritt, to address key tax issues for the company.³⁷¹ According to Caterpillar's Tax Director and Senior International Tax Manager for CSARL, the Tax Council reviewed, identified, and evaluated a broad range of Caterpillar tax risks, acting by consensus and in "good faith" with deference given to individuals with a higher level of expertise.³⁷²

In March 2006, the Tax Council evaluated two critical elements of the Swiss tax strategy which raised concerns: CSARL's bundled royalty rate and the ITAS virtual inventory system.³⁷³ The Tax Council assigned multiple 5 ratings -- meaning the highest risk rating -- to several criteria related to the CSARL's bundled royalty rate, including with respect to "industry practice," "business purpose and substance," and "magnitude of cash impact."³⁷⁴ The Tax Council assigned even more 5 ratings to the ITAS virtual inventory system, including a 5 high-risk rating for the legal advice provided in connection with the system and for the reputational risk associated with the "WSJ test." Overall, when those and other individual ratings were combined, averaged, and weighted, the Tax Council ranked those two elements of the Swiss tax strategy as among the highest risk tax issues it examined.³⁷⁵

Although the Tax Council's TRGRs findings were planned to be presented to the Audit Committee in earlier meetings,³⁷⁶ they were actually included on a meeting agenda in June 2006. On June 13, 2006, it appears that the Audit Committee was not presented with the TRGRs findings, but instead with a description of the TRGRS process including the steps to be taken to identify and define risks categories and the associated criteria, although Caterpillar officials who attended that meeting told the Subcommittee that they could not remember any details about the presentation.³⁷⁷

Caterpillar's tax department also shared the TRGRs findings with PWC partner James Bowers who assisted in the audit of the company's financial statements, including Caterpillar's estimates of its tax liabilities. Mr. Bowers advised the Subcommittee that he had received the TRGRs risk ratings and believed that they were later presented to the company's Audit Committee.³⁷⁸ He said that the TRGRs process had identified risks associated with the Swiss tax strategy, but recalled that they were similar to the risks identified when Caterpillar increased its tax reserves.³⁷⁹ He said that he had been unaware that the Tax Council had rated certain CSARL tax elements as "high" risk.³⁸⁰

On August 11, 2006, Mr. Schlicksup wrote CFO Burritt that he was being pressured to lower the TRGR risk ratings for some tax positions. Mr. Schlicksup advised the following about the TRGRs status:

2008 TRGRs Report to Audit Committee. The Tax Risk Guard Rails project remainedin place for approximately two years, from 2006 to 2008.³⁸⁴ Its risk ratings were reviewed twice each year by the Tax Council which retained the high risk ratings assigned to the royalty and virtual inventory issues associated with CSARL.³⁸⁵ As late as April 8, 2008, a presentation with a "Global Tax Update" touting implementation of the TRGRs tax risk management tool was prepared for the Audit Committee.³⁸⁶ The presentations noted that the "Tax Risk Guards Rails" risk ratings were part of Caterpillar's "robust" tax risk management process.³⁸⁷ It also advised the Audit Committee that Caterpillar's "risks are actively managed."³⁸⁸

One of the slides in the 2008 presentation identified the "CSARL -- Parts Distribution -- Management & Reputation" as one of the "Higher Risk Areas."³⁸⁹ The Audit Committee was also advised in the presentation that the company had developed a plan with outside counsel to mitigate this risk.³⁹⁰ The presenter's note to this presentation stated, with regard to parts distribution:

Downplaying the TRGR High Risk Ratings. When asked about the TRGR risk ratings related to the Swiss tax strategy, Caterpillar downplayed their significance. During interviews with the Subcommittee, senior executives from Caterpillar's tax department, as well as Caterpillar's CFO at the time they were implemented, told the Subcommittee that the TRGRs risk ratings were of limited value in informing either the Board of Directors or the Audit Committee about Caterpillar's tax risks, and the risk ratings were therefore abandoned in 2008. During interviews, these executives recalled little detail about the tax risks or ratings identified during TRGRs process or how they were used. The Audit Committee Chairman at the time, Eugene Fife, told the Subcommittee he had no recollection of the phrase "Tax Risk Guard Rails," despite the fact that he appeared to have played an active role in their adoption.³⁹² The Caterpillar Tax Director, Robin Beran, said that he had been skeptical of the usefulness of the risk ratings from the beginning,³⁹³ and viewed the ratings as flawed because anything involving a large amount of money would lead to a high risk rating.³⁹⁴ He told the Subcommittee that rather than rely on the TRGRs ratings assessed by his senior staff, he relied on expert tax advice from PWC and McDermott Will & Emory. Another senior tax department official, Rodney Perkins, told the Subcommittee that the TRGRs process was not a useful tool and that he didn't remember the risks associated with CSARL.³⁹⁵ Former CFO David Burritt acknowledged that he was originally in favor of implementing the TRGRs process, but later concluded that the process was too "heavy" and time and resource-intensive. He told the Subcommittee that he did not recall any specific risks that the TRGRs identified.³⁹⁶

Anonymous Letter. In 2004, an anonymous letter was received by Caterpillar's CEO and the tax department alleging that the CSARL transaction lacked any business purpose other than tax avoidance.³⁹⁷ The letter stated in part:

Tax Strategy Manager Concerns. Three years later, in 2007, Daniel Schlicksup,Caterpillar's Global Tax Strategy Manager, began raising similar concerns inside the company. In January 2007, Mr. Schlicksup wrote an email to Caterpillar's Tax Director raising questions about the CSARL transaction and the "economic substance" tax doctrine. He wrote: "To my knowledge there is no one in CSARL managing the parts business or managing the subcontracting of all the activity to [Caterpillar] Inc."⁴⁰² He suggested that a review of the facts and case law would be prudent, sending several recent cases from the Seventh Circuit.⁴⁰³ From July through September, Mr. Schlicksup repeated his concerns to the company's legal department about the lack of business substance in the CSARL transaction, as well as raising concerns about other aspects of Caterpillar's business.⁴⁰⁴ In September 2007, Mr. Schlicksup sent an email to Caterpillar's ethics officer reiterating his concerns. He wrote:

In April 2008, when Mr. Schlicksup was preparing a presentation for the Caterpillar Board of Directors discussing CSARL among other high risk tax strategies, he sent an email to the head of the tax department, Robin Beran, again raising the economic substance issue and urging that it be discussed with the Board:

Another senior tax manager in Caterpillar's tax department, Rodney Perkins, when asked about the CSARL transaction in a deposition, made statements that raised further questions about the tax strategy's business purpose. Mr. Perkins, Caterpillar's Senior International Tax Manager with direct responsibility for CSARL, was asked in a deposition about whether the CSARL transaction had any "business advantage" other than "the avoidance or deferral" of U.S. tax and said under oath the following:

Moreover, Caterpillar's profit before tax on a consolidated basis remained essentially unchanged compared to before the CSARL transaction. At the same time, only a small portion of those consolidated profits were reported in the United States as taxable income.⁴¹³ In short, the point of the CSARL transaction was not to increase Caterpillar's earnings, but simply to send more of its profits abroad to lower the company's effective tax rate.

Caterpillar contends that the CSARL transaction, while tax motivated, reflected the changing nature of its parts business, which included increasing sales outside of the United States. According to the company's 2013 annual report, for example, about 67% of Caterpillar's total revenues were generated by non-U.S. sales.⁴¹⁴ Caterpillar executives attribute that increased sales activity to its marketing companies, including CSARL, whose job is to re-sell Caterpillar products and parts to its non-U.S. dealer network. Caterpillar asserts that the CSARL transaction was simply a matter of removing the unnecessary presence of the U.S. parent company from the legal title chain for third party manufactured parts sold abroad. However, of the Caterpillar finished replacement parts sold abroad, nearly 70% were manufactured in the United States, and the U.S. parent company continued to manage and lead the company's parts business primarily from the United States. The ongoing dominant role of Caterpillar's U.S. personnel in the company's parts business raises questions about whether the CSARL transaction, and the resulting allocation of non-U.S. parts profits to Switzerland, accurately reflects the economic reality of Caterpillar's parts business.

2007 Review and Report. In 2007, the same year Mr. Schlicksup raised concerns about the CSARL transaction, a PWC document shows that Caterpillar's tax department initiated a review to determine whether CSARL had sufficient "operational substance" to support Caterpillar's decision to direct most parts profits to Switzerland.⁴¹⁵ A PWC chronology of events related to the CSARL transaction noted that the Caterpillar tax department's review had concluded in a written report that "sufficient substance was maintained by CSARL" so that no "material exposure" existed for the company.⁴¹⁶ When the Subcommittee requested a copy of that report from both Caterpillar and PWC, however, neither provided one. Caterpillar told the Subcommittee that it was unable to identify any responsive document other than documents for which it was asserting attorney-client privilege, and PWC advised it was unable to locate a copy in its files.⁴¹⁷

2009 Review and Actions to Preserve $300 Million Annual Tax Benefit. In late 2008,the IRS proposed a regulation creating a new test to allow a manufacturer to claim that a controlled foreign corporation (CFC) was exempt from U.S. taxation under a manufacturing exception to Subpart F.⁴¹⁸ To meet the new test and qualify for the tax exemption, a CFC had to show that it made a "substantial contribution" to the manufacturing process.⁴¹⁹ During that 2008 time period, Caterpillar was also conducting an unrelated realignment of its business operations. At that time, PWC and Caterpillar's tax department conducted another review of CSARL to determine whether it met the new IRS requirements, whether CSARL's parts business had adequate substance to preserve its annual parts tax benefit, and whether it would need to increase the royalty paid to Caterpillar.

In November 2008, an email exchange between two PWC transfer pricing experts assigned to Caterpillar discussed the possible problems with CSARL.⁴²⁰ Steven Williams, a PWC Managing Director, wrote:

The presentation then described the new IRS requirements for qualifying a foreign affiliate to claim the manufacturing exception to Subpart F, which required a showing that the affiliate made a "substantial contribution" to the manufactured goods being sold. The presentation expressed doubt that CSARL had the entrepreneurial or substantive manufacturing operations called for by the IRS requirements. The presentation stated: "IRS insisted on substantial local entrepreneurial decision-making."⁴²⁵

To meet the IRS requirements and preserve CSARL's tax benefits, the presentation recommended that four worldwide product managers be moved to Geneva.⁴²⁶ It warned that "[r]egional product managers will not be sufficient under the proposed IRS regulations," and the "failure to take action weakens current CSARL structure," which meant its "$250 million tax benefit would be at risk."⁴²⁷ Another presentation in January 2009, urged that worldwide product managers and a "Global Parts Management" organization be located in Geneva to address "optics concerns" related to "[t]axation in CSARL with minimal business substance."⁴²⁸

On December 4, 2008, Rodney Perkins, Caterpillar's Senior International Tax Manager for CSARL, sent an email copying Caterpillar's Tax Director and CFO and forwarding a message to PWC expressing concern about the potential impact of the proposed IRS regulations on CSARL and urging that steps be taken to expand CSARL beyond a regional role and give it more "entrepreneurial substance."⁴²⁹ He wrote in part:

During this same period, Caterpillar also created a new worldwide parts position at CSARL, the first in Switzerland. In November 2009, the company created the position of "Worldwide Parts Manager," which was filled by a non-U.S. employee, Quentin de Warlincourt, at CSARL.⁴³² According to Caterpillar's outside legal counsel, the new Worldwide Parts Manager was "in charge of WW [worldwide] parts management" and "[a]ccountable for the after market strategy for all Machine Business Divisions, and Engine Business Divisions."⁴³³ The presentation also stated: "Runs the WW Parts Roundtable, [d]rives implementation through other groups that impact after market business sales and strategy ((Components, Logistics, Distribution Services, Purchasing, etc.)."

Mr. Warlincourt's position was made part of the Customer Services Support Division, and he reported to the division head, Stephen Gosselin, in the United States.⁴³⁴ The resulting position fit into Caterpillar's organization as follows:

 

CSARL's Worldwide Parts Manager

 

 

 

In March 2010, an internal draft PWC report included Caterpillar materials describing additional details about the new CSARL position. It noted that the Worldwide Parts Manager was the "global steward" of a Worldwide Parts Strategy Roundtable, which was comprised of senior personnel representing all of the machine and engine business divisions.⁴³⁷ At the same time, neither the Worldwide Parts Manager nor the Roundtable appears to have been given any key decision-making authority with regard to parts. For example, the Roundtable was empowered to provide advice, but apparently not to exercise decision-making authority, with respect to parts margin targets, sale targets, cost targets, or pricing.⁴³⁸

Over the following five years, Mr. Warlincourt assembled a small staff of five to twelve persons in Switzerland.⁴³⁹ He continued to report to the Customer Services Support Division head in the United States. He was not joined by other senior parts executives.⁴⁴⁰ Mr. Warlincourt has since been replaced by Thomas Zihlmann, who is located in Switzerland and whose job title has been changed to Worldwide Parts Strategy Manager.⁴⁴¹

Caterpillar's Response to Allegations of Lack of Economic Substance. Caterpillar disagrees with the claim that the CSARL transaction lacked economic substance and had no business purpose other than to reduce the company's taxes. The company provided the Subcommittee with a report prepared by an outside tax expert, New York University School of Law Professor John Steines, who was hired by Caterpillar to analyze the economic substance issue and who concluded the CSARL transaction did not offend that doctrine:

Caterpillar's Tax Director and its Senior International Tax Manager told the Subcommittee that the key analysis was, not whether the CSARL transaction lacked economic substance, but whether the licensing transactions were executed in conformance with U.S. transfer pricing laws and regulations, under the arm's length standard.⁴⁴³ They assert that the company complied with all U.S. transfer pricing requirements.

Prior to the 1999 CSARL transaction, approximately 15% of the company's parts profits were attributed to Caterpillar's Swiss affiliate, COSA, an allocation which represented what had previously been a routine share of the profits for the Swiss affiliate's work in servicing Caterpillar's foreign dealers.⁴⁴⁶ COSA profits were reported as subpart F income and taxed in the United States.⁴⁴⁷ Nearly all of the remaining 85% of the parts profits were attributed to Caterpillar and also taxed in the United States.⁴⁴⁸ After the CSARL transaction, in 2000, however, Caterpillar gave a significant portion of the profits from its non-U.S. finished replacement parts business to CSARL in exchange for a licensing fee.

In its final form, the Caterpillar licensing agreement required CSARL to pay a bundled royalty rate for selling both parts and machines. According to data provided by Caterpillar, the aggregated royalty rate ended up providing Caterpillar Inc. with an amount equal to about 31% of the total combined non-U.S. replacement parts and machine profits, while the other 69% or more of the combined profits went to CSARL.⁴⁴⁹ When just the parts profits are considered, the profit split is even more dramatic: instead of 85% or more of the profits from non-U.S. parts sales going to Caterpillar Inc. in the United States as it had for decades prior to 1999, the licensing agreement directed 15% or less of those profits to Caterpillar in the United States and 85% or more of the parts profits to CSARL in Switzerland. While Caterpillar contends that the aggregated royalty rate is the more appropriate rate to consider, since that is the rate contained in the final license agreement which covers both parts and machines, it is notable that the Swiss tax strategy that led to the licensing agreement targeted only the company's non-U.S. parts profits, without mentioning machines. In any event, both profit splits have resulted in lopsided profits allocations in favor of CSARL over Caterpillar.

At the same time, Caterpillar continued to perform key functions supporting the non-U.S. sales of Caterpillar branded parts, including much of the parts design, parts forecasting, inventory management, parts ordering, supplier oversight, quality control, parts pricing, and parts storage and delivery. It did so for cost plus a 5% markup, which produced only limited income for the U.S. parent. Caterpillar also continued to bear the ultimate economic risk for the parts business, since its consolidated financial statements included CSARL's financial results. Whether profitable or unprofitable, CSARL necessarily affected Caterpillar's overall financial results.

It defies logic that Caterpillar would have entered into a licensing transaction with an unrelated party in which it gave away 69%, 85%, or more of its business profits on an annual basis in exchange for a 31%, 15%, or smaller share of the profits, while continuing to perform core functions to support those profits and continuing to bear the ultimate economic risk. Caterpillar only engaged in the CSARL transaction, because the profits sent to Switzerland went to CSARL, a related party, and enjoyed a low Swiss tax rate of 4%. In addition, CSARL's profits were included in Caterpillar's consolidated financial statements, so that CSARL's financial success contributed directly to Caterpillar's positive results.

It is also notable that CSARL paid nothing to Caterpillar Inc. to compensate the company for the decades Caterpillar spent developing its parts business before turning it over to CSARL, including developing a third party supplier base, designing a large selection of proprietary parts, and creating a world class logistics system to store and deliver those parts anywhere in the world within 24 hours. Nor did CSARL compensate Caterpillar Inc. for the right to the future profit streams associated with the non-U.S. parts business -- billions of dollars in parts "annuities" that would last as long as Caterpillar's durable machines. In fact, CSARL made no "buy-in" or other payment or provided any super royalty to compensate Caterpillar Inc. for the business it had built or for the future profits that would be generated. Instead, CSARL paid Caterpillar Inc. only an annual royalty equal to 15% or less of the profits produced by the non-U.S. parts business each year plus a service fee for performing key parts functions on a cost plus 5% basis.⁴⁵⁰ It is hard to understand how Caterpillar would ever have entered into such an arrangement with an unrelated party.

Caterpillar contends, however, that CSARL fully compensated Caterpillar Inc. for all property and services provided by Caterpillar Inc. related to its parts business, in accordance with the transfer pricing rules.⁴⁵¹ Caterpillar also contends that the CSARL transaction's profit split was an appropriate arm's length result under current transfer pricing regulations and case law, highlighting the aggregated royalty rate that produced a 69/31% profit split. In a letter to the Subcommittee, Caterpillar wrote:

The arm's length principle provides the bedrock upon which U.S. transfer pricing regulations are built. In this case study, Caterpillar replaced an 85/15% profit split with a 15/85% profit split of the non-U.S. parts profits, while continuing to perform the core functions of the parts business and retaining the economic risks. It makes little business sense for Caterpillar to take those actions without receiving any compensation for the future revenue stream or the value of the parts business that Caterpillar had built up over decades.⁴⁵⁵ The Caterpillar case study provides, in a manufacturing setting, a transfer pricing agreement between a U.S. parent and foreign subsidiary that seems to be less about constructing an arm's length transaction to divide economic contributions and risk, and more about shifting billions of dollars in profits to an offshore tax haven in ways designed to lower the U.S. parent's U.S. taxes.

When Caterpillar sells a machine, it often does so at extremely low profit margins.⁴⁵⁷ At the same time, the replacement parts used to service that Caterpillar machine can bring profit margins that are multiple times larger. In some years, as much as 80% of CSARL's profits from its licensed business have come from parts sales, despite only making up 20% of its sales revenues.⁴⁵⁸ CSARL has itself recognized that Caterpillar's "sale of replacement parts is dependent on the sale of machines."⁴⁵⁹ In fact, at the time of the 1999 CSARL transaction, Caterpillar's tax consultants observed that "the field population of CAT prime products, which is created as CSARL markets prime products in its territory, creates the demand for CAT replacement parts."⁴⁶⁰ However, as a result of the transaction, the profits for Caterpillar's parts business were split off from the profits of the machine business, without CSARL's offering any compensation for Caterpillar's development of the underlying business.

Historically, the majority of Caterpillar's machines have been built in the United States and then sold around the world. In addition, the majority of all research and development for the machines is conducted in the United States, and nearly all of the intellectual property is retained here as well.⁴⁶¹ In 1997, 75% of Caterpillar's consolidated machine sales came from machinery and engines manufactured in the United States.⁴⁶² Although Caterpillar has since globalized its manufacturing operations and two-thirds of its sales now come from overseas, the majority of Caterpillar machines and replacement parts are still manufactured in the United States.⁴⁶³

Due to the Swiss tax strategy, however, the initial purchaser of all of Caterpillar's purchased finished replacement parts is CSARL in Switzerland. That means, for example, that for a mining truck designed and built in the United States and exported to Canada, the majority of the profits from that machine sale would be allocated to the United States and result in taxable U.S. income. In contrast, for any Caterpillar branded parts manufactured by third party suppliers to repair that mining truck and shipped to Canada from Caterpillar's U.S warehouse, the majority of the parts profits would go to Switzerland, thereby splitting the parts profits from the machine profits in a way that does not reflect the business reality that the same company is responsible for both profit streams.

When Caterpillar builds a machine in the United States and exports it, it creates a years-long stream of income that results from the selling of the replacement parts. By executing the CSARL transaction, the company transferred its parts annuity to a foreign affiliate without receiving any compensation for the forfeited income stream or for the development and of the underlying business, thus separating the parts fruit from the machine tree. The Assignment of Income Doctrine may require those parts profits to be reassigned to Caterpillar Inc., which continues to design, manufacture, and sell the original machines.

According to Caterpillar, the third party manufactured replacement parts that are attributed to CSARL are stored in U.S. warehouses and shipped from the United States directly to Caterpillar's foreign dealers or customers, without ever passing through Switzerland. In 2012, CSARL held nearly $525 million worth of replacement parts (PFRPs) in Caterpillar's U.S. warehouses, which made up over 35% of all PFRPs located in those U.S. warehouses and 40% by value of CSARL's worldwide parts inventory.⁴⁶⁴

In addition, on paper, CSARL routinely acquires replacement parts from third party suppliers for instantaneous pass-through resale to Caterpillar Inc. in the United States. According to Caterpillar, CSARL sells 40 to 50% of its total PFRP purchases immediately to Caterpillar Inc. using what is referred to as a "flash title." A flash title simply means that CSARL makes the initial purchase of the part and automatically and instantaneously transfers the ownership title to Caterpillar Inc. CSARL's purchases the flash-titled parts using Caterpillar's internal forecasts of the quantities of parts that will be sold to U.S. customers.⁴⁶⁵ When CSARL flash-titles parts to Caterpillar Inc., it does so at cost and without charging any fee,⁴⁶⁶ which suggests the sales are little more than paper transactions between related parties, as opposed to arm's-length transactions.

Caterpillar provided the Subcommittee with dollar figures over a three year period showing the volume of replacement parts CSARL has purchased from third party suppliers, the amounts flashed-titled to Caterpillar Inc., the amounts retained by CSARL after the flash-titling, and the amounts of CSARL-owned parts stored in U.S. warehouses. Caterpillar indicated, for example, that in 2012, CSARL acquired about $2.3 billion worth of parts from third-party suppliers and immediately flash-titled $1 billion of those parts to Caterpillar Inc. CSARL then retained apparent ownership of the remaining $1.3 billion of parts inventory, storing nearly $525 million of those parts in U.S. warehouses.

As explained earlier, CSARL and Caterpillar Inc. parts are commingled in storage bins in the U.S. warehouses, and U.S. warehouse personnel have no way to differentiate between the parts owned by the two companies. Instead, warehouse employees simply fill orders as they come in, with no regard for paper ownership of particular parts. For instance, if an order came in for a quantity of air filters to service Caterpillar equipment at a mine in Canada, the warehouse would pull the requested filters from the storage bins and ship them to the customer, a nearby dealer, or a nearby Caterpillar distribution center. After the sale, since the order was destined for Canada, ITAS, the virtual inventory system, would retroactively determine that the order was filled using CSARL-owned parts. However, if at the time of the order, all of the air filters in the U.S. warehouse bin were already allocated to and owned by Caterpillar Inc., ITAS would automatically "borrow" the parts from Caterpillar Inc.'s inventory, and credit them to CSARL on the virtual inventory system. When the next supply of air filters was delivered by the third-party manufacturer, the ITAS system would automatically and virtually "replenish" the parts CSARL had borrowed from Caterpillar.

The ITAS virtual inventory system does not operate like a normal inventory system. It places groups of parts in "virtual bins," determines what percentage of the parts in each bin belongs to CSARL, and then decides whether a particular part shipped from the U.S. warehouse should be viewed as a CSARL-owned part. As explained earlier, while the inventory system arguably functions similar to the way a grain silo mixes fungible grains deposited by various owners and then dispenses the grain without tracking its precise ownership, in those circumstances the grain owners typically pay market rates if they draw grain in excess of the amount they deposited; there is no wholesale borrowing with no notice and no cost. ITAS' virtual approach to tracking CSARL's parts in the United States is not only unusual, it operates as a second set of books in addition to Caterpillar's regular inventory program, which tracks individual parts.

Under the U.S. tax code, while foreign entities like CSARL are allowed to hold goods awaiting export in U.S. warehouses without creating a taxable presence in the United States,⁴⁶⁷ if those goods are commingled, co-owned, or co-managed as a joint enterprise, they may create a taxable U.S. presence for the foreign company.⁴⁶⁸ CSARL's parts, which are intended for export, have never been physically segregated in the U.S. warehouses from the Caterpillar parts intended for domestic sales. In fact, according to PWC, when its tax consultant suggested establishing that practice at Caterpillar's U.S. warehouses, he was "laughed out of the room."⁴⁶⁹

Rather than being physically segregated, CSARL and Caterpillar parts are routinely commingled in the warehouse storage bins. In addition, "ownership" of particular parts can transfer back and forth between CSARL and Caterpillar as needed while stored in the U.S. warehouses, including through flash-titling and automatic borrowing. According to information provided by Caterpillar, hundreds of thousands of parts worth millions of dollars and involving as much as 10% of the parts stored in Caterpillar's U.S. warehouses are borrowed through the ITAS system each year.⁴⁷⁰

When a common pool of inventory is jointly managed for the mutual benefit of two entities, the courts have long held that a de facto U.S. partnership may exist.⁴⁷¹ While an argument could be made that the Caterpillar-CSARL arrangement did not create a common pool of inventory in the sense that ownership of particular parts was ultimately assigned, the facts are plain that, on the warehouse floor, the two companies shared commingled parts without regard to which company owned which parts. Another argument is that the inventory practices do not involve joint management in the sense that CSARL pays Caterpillar to manage its parts while stored in U.S. warehouses, but the service agreement between CSARL and Caterpillar says nothing about flash-titling, borrowing parts back and forth, or assigning parts ownership after sales are made, practices that provide evidence of joint management of the parts inventory. At the least, the facts suggest a review is warranted to determine whether Caterpillar Inc. and CSARL, in fact, have a common pool of inventory that is jointly managed for the benefit of both parties.

If a de facto U.S. partnership exists between Caterpillar Inc. and CSARL, it would, in turn, create a taxable U.S. presence for each partner. The inventory profits of each partner, including those attributed to CSARL, would then become subject to U.S. taxation.⁴⁷² Caterpillar's tax consultants were well aware that using the ITAS virtual inventory potentially created that type of tax risk, warning in one 2009 presentation:

COSA Intangibles. Caterpillar told the Subcommittee that CSARL's predecessor Swiss entity, COSA, which began operating in Switzerland in 1960, had valuable "marketing intangibles" that were transferred to CSARL, and that those intangibles were previously unrecognized but valuable enough that they warranted the company's attributing most of the non-U.S. parts profits to Switzerland. For 40 years, until 1999, COSA was the locus of Caterpillar's operations in Switzerland. It was the shareholder for many of Caterpillar's foreign marketing companies, acted as a marketing company itself, and supported the Caterpillar dealer network in the Europe, Africa, and Middle East (EAME) region.⁴⁷⁵ A COSA branch office in Singapore provided the same marketing and support services for the Caterpillar dealer network in Asia and the South Pacific.

In the planning documentation supporting the 1999 CSARL transaction, PWC wrote that, for years, COSA had been undercompensated for its marketing intangibles. PWC noted that COSA had been allocated 4% of the cumulative 30% profit margin on non-U.S. parts, meaning it had received only about 13% of the total parts profits.⁴⁷⁶ PWC depicted that level of compensation as appropriate for a routine parts distributor or marketer, but not for a marketing company that also supported and helped to develop the Caterpillar dealer network.

In 1998, PWC wrote: "[U]p through 1998, we have characterized COSA (and other marketers[)] as routine marketers. . . . This will change and our documentation reports will rely on greater discussion of the value of the marketers['] contribution."⁴⁷⁷ PWC also observed: "We are not transferring an intangible, we are just recognizing an intangible they had already."⁴⁷⁸ PWC's Managing Director explained to the Subcommittee that, without the added valuable intangibles, Caterpillar could not have justified shifting so much profit to its Swiss affiliate, which would otherwise have been entitled to only the routine profits of a routine parts distributor.⁴⁷⁹ Instead, after finding that COSA had previously unrecognized "significant marketing intangibles," PWC concluded that COSA should have been awarded a higher percentage of the parts profits and proposed dramatically increasing the previous allocation of parts profits for COSA's successor, CSARL.⁴⁸⁰

Intangibles Already Recognized. PWC's claim that COSA had previously unrecognized, valuable marketing intangibles is contradicted by other documents showing that Caterpillar was well aware of and had long acknowledged the valuable work of its marketing companies. For example, three years earlier, in 1996, PWC had cited the role of Caterpillar's marketing companies in helping to distribute its prime products and parts to the Caterpillar network of dealers.⁴⁸¹ Its 1996 transfer pricing documentation, which is required to be maintained by law to defend transfer pricing positions, stated:

Justifying the Higher Value. Other documents suggest that PWC realized it needed to change Caterpillar's transfer pricing documentation to justify attributing greater value to CSARL's "marketing intangibles." One PWC analyst framed the issue this way:

The analyst then identified several of the intangibles that had supposedly escaped previous recognition as valuable. One was the marketing companies' potential contribution to cost efficiencies through the company's worldwide network of dealers. The analyst explained: "[B]y having a worldwide network already established, CAT can increase its cost advantages due to the economies of scale over competitors who lack such an extensive network." He also noted that the Caterpillar distribution network was already capable of replacing almost any part within 24 hours for a machine anywhere in the world, which was a valuable asset that marketing companies could help support.⁴⁹⁰ He also theorized that "the dealer network may contribute to the design of better products through customer feedback that is essential to the design process."⁴⁹¹ He concluded that Caterpillar's dealer relationships set it apart from its competitors, and that its marketing companies contributed to the well-being of that network.⁴⁹²

It is difficult to see how this analysis identified new marketing intangibles that had previously escaped recognition. In addition, while the analysis described how marketing companies contributed to Caterpillar's success, what the analysis left out was how Caterpillar itself had significantly contributed to the development and maintenance of its worldwide dealer network and to the design, management, and delivery of its parts. That Caterpillar, as U.S. parent of the global company, had itself made a major contribution to its worldwide dealer network had long been recognized. For example, in 1994 transfer pricing documentation, written prior to the CSARL transaction, PWC wrote:

Inconsistent Valuation. Still another set of documents that contradict the claims about the value of the marketing intangibles held by CSARL date from 2001, when CSARL acquired a related U.S. marketing company responsible for Caterpillar's marketing efforts in Latin America, the Caribbean, and Canada, and treated its intangible assets as having little economic value.

In 2001, Caterpillar expanded CSARL's reach to include parts sold in the Americas region, outside of the United States. Later that year, CSARL entered into a complicated, restructuring transaction with a related entity known as Caterpillar Americas (CACO), a U.S. company wholly owned by Caterpillar.⁴⁹⁵ CACO had served as Caterpillar's marketing company for Latin America, the Caribbean, and Canada for the prior forty years.⁴⁹⁶ Like CSARL and its predecessor COSA, CACO had purchased machines and parts from Caterpillar Inc. and its affiliates for resale to dealers in Latin America, the Caribbean, and Canada, and helped develop and support the dealer network in its assigned region.⁴⁹⁷

CACO's activities appear to have been nearly identical to those performed by COSA for the EAME region. Its responsibilities included:

PWC listed and described CACO's marketing intangibles, which included its dealer relationships and contracts, marketing brochures and website, procedures and manuals, good will, and a going-concern value. PWC then concluded that CACO's intangibles were "routine in nature and easily reproducible by another comparable marketing and distribution company."⁵⁰¹ PWC further noted that "the value of the Intangible Asset Transferred had only limited legal protection and economic life."⁵⁰² PWC found nothing particularly valuable in the intangibles transferred to CSARL.

Subsequent PWC and Caterpillar documentation took note of that analysis. For example, in 2007, when a PWC managing director was considering how to value CSARL's marketing intangibles, he noted: "CSARL (or its predecessor COSA, or CFEL, or CACO) has spent decades building up the dealer network around the world. And has spent decades building brand name through advertising." But, he wrote: "Caveat is that in 2001, we said in another transaction [CACO] that there is no significant marketing intangibles."⁵⁰³ An internal Caterpillar document from 2005, analyzing CSARL's profit split, put it even more bluntly: "Should we expand profit split analysis -- additional income to CSARL for part[s] responsibility, dealers/marketing intangibles (but consider agreements in LAD [Latin America Division] restructuring stating that dealer IP is not very valuable)?"⁵⁰⁴

The bottom line is that when CSARL acquired marketing intangibles from CACO in 2001, it assigned almost no value to them. Yet when CSARL was created, Caterpillar claimed it had found "newly recognized" marketing intangibles that were so valuable they justified dramatically increasing the portion of non-U.S. parts profits sent to Switzerland. Those two positions are irreconcilable. The larger policy issue is that valuing intangibles held by foreign affiliates is an inherently subjective exercise undertaken by transfer pricing parties like Caterpillar that are less interested in getting the valuation profits offshore to a low-tax jurisdiction to defer and avoid U.S. taxes.

For tax purposes, beginning in 1999, Caterpillar claimed that the majority of its non-U.S. parts profits should go to its Swiss affiliate, CSARL, because of CSARL's valuable marketing intangibles, and accordingly sent billions of dollars over the years to Switzerland. Internally, however, Caterpillar's business divisions kept track of their individual operating profits, which were known across the company as "accountable profits." The accountable profits were tracked and used to calculate incentive pay awarded to individual business divisions and their employees.⁵⁰⁵ In contrast to the profits recorded for tax purposes, since at least 1992, the company's accountable profits allocated the majority share of the parts profits to business divisions in the United States, and only a routine distributor's share to CSARL in Switzerland, which was the same share that its predecessor COSA as well as Caterpillar's other marketing companies had traditionally received.

For years prior to the CSARL transaction, Caterpillar's internal and external profits reports did not diverge. From 1992 to 1999, CSARL's predecessor COSA, as well as all of Caterpillar's other foreign marketing companies, were awarded the same amount of accountable profits. Their share was set at 4% of the profit of the total 30% profit margin for non-U.S. parts, which translated into roughly 13% of the overall non-U.S. parts profits.⁵⁰⁶ The remainder of the parts profits went to Caterpillar's commercial entities or product groups (16%), its manufacturing plants (3%), component profit centers (4%), and the U.S. Parts Division (3%).⁵⁰⁷ Any residual or entrepreneurial profits were typically awarded to the product groups responsible for the parts or underlying machines. According to Caterpillar, the 4% share of accountable profits attributed to the foreign marketing companies was set by former CEO Donald Fites in 1992, to avoid disputes over the accountable profits. The percentage apparently reflected Mr. Fite's view of the marketing companies as routine parts distributors and marketers. In addition, historically, Caterpillar's internal accountable profits matched the profits reported by its legal entities for tax purposes.⁵⁰⁸

In 1999, when the CSARL transaction was being designed, the PWC tax consultants were told that the business lines did not want any changes to how accountable profits were calculated.⁵⁰⁹ The end result was that the company changed how the profits were split for tax purposes, but not how they were reported for internal business purposes, such as assigning bonuses. PWC observed before the CSARL transaction would eliminate the company's ability to show that its external and internal profit allocations matched. In 1998, PWC wrote:

As PWC predicted, after the CSARL transaction, the accountable profits no longer matched the legal entity profits, and the difference at CSARL continued to grow with each additional parts license it signed. CSARL's accountable profits remained at the 4% level,⁵¹² while its legal entity profits increased dramatically to reflect all of the third party manufactured non-U.S. parts income it was receiving, including residual and entrepreneurial profits (but minus the royalty fee and cost plus 5% service fee paid to Caterpillar Inc.). Despite the increase in CSARL's profit allocation for tax purposes, CSARL's accountable profits within Caterpillar remained the same. For years, its employees' incentive pay continued to be calculated with reference to the 4% accountable profits assigned to marketing companies. In other words, Caterpillar did not change its internal view of which business functions created value and profit for the company, but maintained that same view until the accountable profits system ended in the mid-2000's.⁵¹³

In correspondence with the Subcommittee, Caterpillar explained that the CSARL transaction was simply a restructuring of the company's supply chain resulting in Caterpillar having a more closely aligned business and legal structure.⁵¹⁴ Caterpillar wrote:

Caterpillar also told the Subcommittee that it was not a necessary participant in the parts legal title chain for non-U.S. customers, and the company had every right to arrange it affairs to minimize its taxes, including by forming CSARL and designating it as the company's global purchaser of parts.

Caterpillar's assertions that it is allowed to arrange its affairs to minimize its taxes and is free to change its operations over time are, of course, true. But those permissible activities do not provide license for the company to engage in a transaction which has no economic substance other than tax avoidance or which violates arm's length principles.

Caterpillar's focus on its compliance with U.S. transfer pricing regulations, rather on the substance of its offshore transfers, also lays bare the contradiction at the center of the transfer pricing system. General tax principles -- including the principle that U.S. multinational corporations are supposed to pay tax on their worldwide income -- too often get lost in an analysis of whether a transfer pricing agreement was properly priced and can be justified under existing regulations and case law. Missing from that analysis is the overarching fact that related parties do not operate as if they were unrelated and so rarely engage in a true arm's length transaction. Instead, corporate affiliates often act in concert, using dubious transfer pricing agreements, to shift profits offshore and defer and avoid paying U.S. taxes on those profits.

Caterpillar has been and remains an American success story. Its headquarters, corporate leadership, and manufacturing facilities, as well as its profitable parts business, are still based primarily in the United States, but it now sends 85% or more of its non-U.S. parts profits to Switzerland. While Caterpillar claims it is sending the profits there because its Swiss affiliate has valuable marketing intangibles, the facts show that the real reason is a Swiss tax strategy -- bought and paid for by the company's tax department -- to take advantage of a 4% Swiss corporate effective tax rate while deferring and avoiding U.S. taxes. That Swiss tax strategy has so far enabled Caterpillar to defer paying U.S. taxes totaling $2.4 billion.

The facts also raise questions about whether the CSARL transaction could meet a true arm's length standard. Caterpillar shifted billions of dollars in parts profits to a related party offshore without being compensated for developing its parts business over decades or for surrendering its right to future parts profits. It appears to have done so for tax reasons, while making use of gimmicks like virtual inventories, Swiss intangibles, and internal corporate profit allocations for tax purposes that bore no relationship to profit allocations made for business purposes, such as awarding pay. The Caterpillar case study shows that offshore profit shifting is not reserved for high tech companies transferring intellectual property to tax havens, but is also the province of traditional manufacturers using financially engineered transactions to transfer billions of dollars of profits offshore to a tax haven affiliate.

²Schlicksup v. Caterpillar Inc., Case No. 09-1208 (C.D. Illinois, Peoria Division 2009).

³ 12/8/2011"Reasons for the Decline in the Corporate Tax Revenues," Congressional Research Service, Mark P. Keightley, at 1. See also "Tax Havens and Treasure Hunts," New York Times, Nancy Folbre, (April 4, 2011), http://economix.blogs.nytimes.com/2011/04/04/tax-havens-and-treasure-hunts/.

⁴ "Tax Burden for the Dow 30 Drops," Washington Post, Darla Cameron & Jia Lynn Yang (3/26/2013), http://www.washingtonpost.com/business/economy/post-analysis-of-dow-30-firms-shows-declining-tax-burden-as-a-share-of-profits/2013/03/26/3dfe5132-7b9a-11e2-82e8-61a46c2cde3d_story.html.

⁵ See, e.g., two hearings before the U.S. Senate Permanent Subcommittee on Investigations, "Offshore Profit Shifting and the U.S. Tax Code -- Part 1 (Microsoft and Hewlett-Packard)," S. Hrg. 112-781 (9/20/2012), and "Offshore Profit Shifting and the U.S. Tax Code -- Part 2 (Apple Inc.)," S. Hrg. 113-90 (5/21/2013); See also 3/8/2011 "The Revenue Effects of Multinational Firm Income Shifting," Tax Notes, Kimberly A. Clausing (estimating that "income shifting of multinational firms reduced U.S. government corporate tax revenue by about $90 billion in 2008, approximately 30% of corporate tax revenues"); 6/5/2010 "Tax Havens: International Tax Avoidance and Evasion," Congressional Research Service, Jane Gravelle, at 15 (citing multiple studies); 3/8/2010 "Drug Company Profits Shift Out of the United States," Tax Notes, Martin Sullivan, at 1163 (showing that nearly 80% of pharmaceutical company profits are offshore in 2008, compared to about 33% ten years earlier, and concluding "aggressive transfer pricing practices as the likely explanation for the shift in profits outside the United States"); 2/27/2006 "Governments and Multinational Corporations in the Race to the Bottom," Tax Notes, Rosanne Altshuler and Harry Gruber; 9/13/2004 "Data Show Dramatic Shift of Profits to Tax Havens," Tax Notes, Martin A. Sullivan; "Exporting Profits Imports U.S. Tax Reductions for Pfizer, Lilly, Oracle," Bloomberg, Jesse Drucker, (5/13/2010), http://www.bloomberg.com/news/2010-05-13/exporting-profits-imports-u-s-tax-reductions-for-pfizer-lilly-oracle.html; "Google 2.4% Rate Shows How $60 Billion Lost to Tax Loopholes," Bloomberg, Jesse Drucker, (10/21/2010), http://www.bloomberg.com/news/2010-10-21/google-2-4-rate-shows-how-60-billion-u-s-revenue-lost-to-tax-loopholes.html; "Yahoo, Dell Swell Netherlands' $13 Trillion Tax Haven," Bloomberg, Jesse Drucker, (1/23/2013), http://www.bloomberg.com/news/2013-01-23/yahoo-dell-swell-netherlands-13-trillion-tax-haven.html; "IBM Uses Dutch Tax Haven to Boost Profits as Sales Slide," Bloomberg, Alex Barinka & Jesse Drucker, (2/3/2014), http://www.bloomberg.com/news/2014-02-03/ibm-uses-dutch-tax-haven-to-boost-profits-as-sales-slide.html; and "G.E.'s Strategies Let It Avoid Taxes Altogether," New York Times, David Kocieniewski, (3/24/2011), http://www.nytimes.com/2011/03/25/business/economy/25tax.html?ref=butnobodypaysthat&_r=0.

⁶ 6/5/2010 "Tax Havens: International Tax Avoidance and Evasion," Congressional Research Service, Jane Gravelle, at 14.

⁷ 5/16/2012 "Global Tax Rate Makers," JPMorgan Chase, at 2 (based on research of SEC filings of over 1,000 reporting issuers).

⁸ See "About BEPS," on the OECD website, http://www.oecd.org/tax/beps-about.htm. BEPS stands for "Base Erosion and Profit Shifting," which was the subject of two OECD reports in 2013. The OECD website explains that the BEPS project is intended to address issues related to gaps in national laws that "can be exploited by companies who avoid taxation in their home countries by pushing activities abroad to low or no tax jurisdictions." Id. The OECD has issued an "Action Plan" to "develop a new set of standards to prevent double non-taxation" by corporations operating in multiple countries, and "a multilateral instrument to amend bilateral tax treaties" to quickly implement BEPS solutions. Id. See also 5/29/2013 "Declaration on Base Erosion and Profit Shifting," OECD, http://www.oecd.org/tax/C-MIN(2013)22-FINAL-ENG.pdf.

⁹ 9/6/2013 "G20 Leaders' Declaration" after St. Petersburg Summit, at 12. https://www.g20.org/sites/default/files/g20_resources/library/Saint_Petersburg_Declaration_ENG.pdf.

¹⁰ See, e.g., 5/2013 "Corporate Income Tax: Effective Tax Rates Can Differ Significantly from the Statutory Rate," Government Accountability Office (finding that, in tax year 2010, profitable U.S. corporations that filed a Schedule M-3 had an effective U.S. federal income tax rate of about 13%), http://gao.gov/products/GAO-13-520.

¹¹ See, e.g., 12/2000 "The Deferral of Income Earned through U.S. Controlled Foreign Corporations," Office of Tax Policy, U.S. Department of Treasury, at 12 (finding tax haven deferral was done for tax avoidance purposes).

¹² 7/20/2010 "Present Law and Background Related to Possible Income Shifting and Transfer Pricing," Joint Committee on Taxation, (JCX-37-10), at 7. See also studies cited in footnote 5.

¹³ See, e.g., 5/16/2012 "Global Tax Rate Makers," JP Morgan Chase, at 1; see also 4/26/2011"Parking Earnings Overseas," Credit Suisse; U.S. Senate Permanent Subcommittee on Investigations, "Offshore Funds Located Onshore," 12/14/2011 Addendum to "Repatriating Offshore Funds: 2004 Tax Windfall for Select Multinationals," S.Prt. 112-27 (Oct. 11, 2011).

¹⁴ See 5/2013 "Corporate Income Tax: Effective Tax Rates Can Differ Significantly from the Statutory Rate," Government Accountability Office, http://gao.gov/products/GAO-13-520.

¹⁵ An "arm's length transaction" is a transaction that is conducted as though the parties were unrelated, thus avoiding any semblance of conflict of interest, Barron's Dictionary of Finance and Investment Terms (7^th ed. 2010).

¹⁶ 26 CFR § 1.482-4.

¹⁷ 7/20/2010 "Present Law and Background Related to Possible Income Shifting and Transfer Pricing," Joint Committee on Taxation, (JCX-37-10), at 5.

¹⁸ 6/5/2010 "Tax Havens: International Tax Avoidance and Evasion," Congressional Research Service, Jane Gravelle, at 8 (citing 3/2003 "Intangible Income, Intercompany Transactions, Income Shifting and the Choice of Locations," National Tax Journal, vol. 56.2, Harry Grubert, at 221-42).

¹⁹ See 7/20/2010 "Present Law and Background Related to Possible Income Shifting and Transfer Pricing," Joint Committee on Taxation, (JCX-37-10), at 7 (citing November 2007 "Report to the Congress on Earnings Stripping, Transfer Pricing and U.S. Income Tax Treaties," U.S. Treasury Department).

²⁰ 2008 "An Introduction to Transfer Pricing," New School Economic Review, vol. 3.1, Alfredo J. Urquidi, at 28 (citing "Moving Pieces," The Economist, (2/22/2007).

²¹ See, e.g., "IRS Forms 'SWAT Team' for Tax Dodge Crackdown," Reuters, Patrick Temple-West, (3/20/2012), http://www.reuters.com/article/2012/03/20/us-usa-tax-irs-transfer-idUSBRE82J10W20120320.

²² See 7/20/2010 "Present Law and Background Related to Possible Income Shifting and Transfer Pricing," Joint Committee on Taxation, (JCX-37-10), at 21.

²³ Id., at 22-23.

²⁴ See, e.g., U.S. Senate Permanent Subcommittee on Investigations, "Offshore Profit Shifting and the U.S. Tax Code -- Part 1 (Microsoft and Hewlett-Packard)," S.Hrg.112-781 (Sept. 20, 2012).

²⁵ See, e.g., 6/26/2006 "The Evolution of U.S. International Tax Policy -- What Would Larry Say?," Tax Notes International, Paul Oosterhuis, at 2.

²⁶ Id.

²⁷ Id. (citing 1/11/1962 "Annual Message to Congress on the State of the Union," President John F. Kennedy,1 Pub. Papers, at 13-14).

²⁸ 6/26/2006 "The Evolution of U.S. International Tax Policy -- What Would Larry Say?," Tax Notes International, Paul Oosterhuis, at 3.

²⁹ See, e.g., 12/2000 "The Deferral of Income Earned through U.S. Controlled Foreign Corporations," Office of Tax Policy, U.S. Department of Treasury, at 21.

³⁰ A CFC is a foreign corporation more than 50% of which, by vote or value, is owned by U.S. persons owning a 10% or greater interest in the corporation by vote ("U.S. shareholders"). "U.S. persons" include U.S. citizens, residents, corporations, partnerships, trusts and estates. IRC § 957.

³¹ See, e.g., Koehring Company v. United States of America, 583 F.2d 313 (7th Cir. 1978). See also 12/2000 "The Deferral of Income Earned through U.S. Controlled Foreign Corporations," Office of Tax Policy, U.S. Department of Treasury, at xii.

³² 2/2000 "The Deferral of Income Earned through U.S. Controlled Foreign Corporations," Office of Tax Policy, U.S. Department of Treasury, at xii.

³³ IRC § 954(c).

³⁴ IRC § 954(d)(1).

³⁵ Id.

³⁶ Statement by Hon. Douglas Dillon, Secretary of the Treasury, before the House Committee on Ways and Means, at 163-66 (May 3, 1961).

³⁷ Id.; 26 CFR § 1.954-3(a)(4)(i) (providing that FBCS income excludes the income of a CFC derived in connection with the sale of goods that were "manufactured, produced or constructed" by the CFC).

³⁸ 7/20/2010 "Present Law and Background Related to Possible Income Shifting and Transfer Pricing," Joint Committee on Taxation, (JCX-37-10), at 38. See also 2/2/2009 "Guidance Regarding Foreign Base Company Sales Income," 2009-5 I.R.B., T.D. 9438, http://www.irs.gov/pub/irs-irbs/irb09-05.pdf, in which the IRS describes the manufacturing exception before and after the 2009 amendments as follows:

⁴⁰ See Gregory v. Helvering, 293 U.S. 465 (1935). See also 3/7/2014 "In the Matter of Caterpillar Inc.," Caterpillar Expert Witness Report, John P. Steines, Jr., Professor of Law, New York University, PSI_Caterpillar_17_000003 - 023, at 008 ("[E]conomically meaningless transactions devoid of business purpose other than tax avoidance are generally not respected.").

⁴¹ See § 1409(a) of the Health Care and Education Reconciliation Act of 2010, P.L. 111-152, codified at 26 U.S. § 7701(o).

⁴² IRC § 7701(o).

⁴³ 3/21/2010 "Technical Explanation Of The Revenue Provisions Of The 'Reconciliation Act of 2010,' As Amended, in Combination With The 'Patient Protection and Affordable Care Act,'" prepared by the Joint Committee on Taxation, JCX-18-10, at 152-3.

⁴⁴ Id.

⁴⁵ Id.

⁴⁶ Id.

⁴⁷ Id. See also 26 CFR § 1.482-4.

⁴⁸ In several U.S. Tax Court opinions, the court has noted that "Congress codified the economic substance doctrine mostly as articulated by the Court of Appeals for the Third Circuit in ACM Partnership v. Commissioner, 157 F.3d 231, 247 48 (3d Cir. 1998)." The codified doctrine did not apply, however, to the cases at issue under its effective dates. See Crispin v. Commissioner, T.C. Memo. 2012 70, 2012 WL 858406, at 6, n.14; Blum v. Commissioner, T.C. Memo. 2012 16, 2012 WL 129801, at 17, n.21; Rovakat, LLC v. Commissioner, T.C. Memo. 2011 225, 2011 WL 4374589, at 27, n.11.

⁴⁹ See Commissioner v. Culbertson, 337 U.S. 280 (1949) (stating that relevant inquiry is to determine whether the parties in good faith and acting with a business purpose intended to join together in the present conduct of a joint enterprise for profit). The Tax Court has set forth a list of factors that other courts have used to evaluate this factual inquiry. See Luna v. Commissioner, 42 T.C. 1067 (1964).

⁵⁰ 9/15/2011 "Caterpillar Inc. Transfer Pricing Analysis and Report For fiscal year ended December 31, 2010," PwC_PSI_CAT_00007795 - 204, at 815.

⁵¹ Id.

⁵² Caterpillar Inc. Presentation to the Senate Permanent Subcommittee on Investigations (2/21/2014), at PSI-Caterpillar-14-000001 - 010, at 002.

⁵³ Id. See also Caterpillar Inc. Annual Report (Form-10K), at 20 (12/31/2010).

⁵⁴ Craig T. Bouchard & James V. Koch, The Caterpillar Way, at 91 (2014).

⁵⁵ 8/30/2013 Caterpillar response to Subcommittee Questionnaire, CAT-000066 - 108, at 076.

⁵⁶ Subcommittee interview of Thomas Quinn, PWC, Tax Partner (12/17/2013). See also 1/1/2001 Second Amended and Restated License Agreement, CAT-000306 - 699, at 373; 9/23/2013 letter from Caterpillar to Subcommittee, PSI-Caterpillar-04-000001 - 009 at 004.

⁵⁷ See 10/1/2013 "Chairman's Operating Council Organizational Chart," prepared by Caterpillar Inc. and on its website, http://s7d2.scene7.com/is/content/Caterpillar/C10101108.

⁵⁸ "2010 Year in Review," prepared by Caterpillar, at 18, http://s7d2.scene7.com/is/content/Caterpillar/C10005394.

⁵⁹ Caterpillar Inc. Annual Report (Form-10K), at 1 (2/19/2013).

⁶⁰ See "Fortune 500, Our annual ranking of America's largest corporations," CNN Money, (May 21, 2012), http://money.cnn.com/magazines/fortune/fortune500/2012/full_list/. See also 8/14/2013 Caterpillar response to Subcommittee Questionnaire, CAT-000001 - 065, at 001.

⁶¹ "Caterpillar Popping on Better-Than-Expected Profit, Outlook," Forbes, Maggie McGrath, (1/27/2014), http://www.forbes.com/sites/maggiemcgrath/2014/01/27/caterpillar-popping-on-better-than-expected-profit-outlook/.

⁶² Caterpillar Inc. Annual Report (Form-10K) (2/18/2014); March 2014 "Foreign Indefinitely Reinvested Earnings: Balances Held by the Russell 1000; A Six-Year Snapshot," Audit Analytics, at 4.

⁶³ "Caterpillar Tractor Co. List of Deals," Lehman Brothers Collection, Harvard Business School Baker Library Historical Collections, http://www.library.hbs.edu/hc/lehman/company.html?company=caterpillar_tractor_co.

⁶⁴ Id.

⁶⁵ 10/18/2013 "Peoria -- The Home of Caterpillar," Caterpillar website, http://www.jointeamcaterpillar.com/cda/layout?m=612335&x=333&id=4507617.

⁶⁶ Caterpillar Inc. Annual Report (Form-10K), at 1 (2/19/2013).

⁶⁷ "2012 Year in Review," prepared by Caterpillar and on its website, at 33, http://s7d2.scene7.com/is/content/Caterpillar/C10005383.

⁶⁸ Id.

⁶⁹ Id.

⁷⁰ Id.

⁷¹ Id.

⁷² Id.

⁷³ See "Stuart L. Levenick," Caterpillar officer profile prepared by Caterpillar, http://www.caterpillar.com/en/company/governance/officers/stuart-l-levenick.html.

⁷⁴ See "Stephen A. Gosselin," Caterpillar officer profile prepared by Caterpillar, http://www.caterpillar.com/en/company/governance/officers/stuart-l-levenick/stephen-a-gosselin.html.

⁷⁵ Subcommittee interview of Deborah Kraft, Caterpillar, Accounting Manager (2/5/2014).

⁷⁶ 9/5/2011 "Caterpillar Inc. Transfer Pricing Analysis and Report For fiscal year ended December 31, 2010," PWC_PSI_CAT_00007795 - 204, at 817.

⁷⁷ Id.

⁷⁸ Id.

⁷⁹ See 10/1/2013 "Chairman's Operating Council Organizational Chart," prepared by Caterpillar Inc. and on its website, http://s7d2.scene7.com/is/content/Caterpillar/C10101108.

⁸⁰ Caterpillar's divisions have had a variety of names. For example, the divisions handling parts distribution and logistics have been variously known as the Parts & Services Support Division, CAT Logistics, Parts Distribution & Logistics Division, and Parts Distribution & Diversified Products Division. Subcommittee interview of Deborah Kraft, Caterpillar (2/5/2014); 4/13/2013 "Caterpillar Announces New Organization to Drive Sustained Improvements in Customer Deliveries and Operational Efficiencies and to Build on Recent Product Quality Improvements," Caterpillar press release, http://www.caterpillar.com/en/news/corporate-press-releases/h/caterpillar-announces-new-organization-to-drive-sustained-improvements-in-customer-deliveries-and-operational-efficiencies-and-to-build-on-recent-product-quality-improvements.html.

⁸¹ "2010 Year in Review," prepared by Caterpillar and on its website, at 18, http://s7d2.scene7.com/is/content/Caterpillar/C10005394.

⁸² Craig T. Bouchard & James V. Koch, The Caterpillar Way, at 168 (2014).

⁸³ 2010 Year in Review," prepared by Caterpillar, at 18, http://s7d2.scene7.com/is/content/Caterpillar/C10005394.

⁸⁴ Id.

⁸⁵ Id.

⁸⁶ Id.

⁸⁷ 5/1/2013 "The Big Interview: Caterpillar's Stuart Levenick," Construction Week Online, Stian Overdahl, http://www.constructionweekonline.com/article-22168-the-big-interview-caterpillars-stuart-levenick/1/print/.

⁸⁸ 2010 Year in Review," prepared by Caterpillar, at 18, http://s7d2.scene7.com/is/content/Caterpillar/C10005394.

⁸⁹ 9/23/2013 letter from Caterpillar to Subcommittee, PSI-Caterpillar-04-000001 - 009, at 002.

⁹⁰ Id..

⁹¹ Craig T. Bouchard & James V. Koch, The Caterpillar Way, at 80 (2014); Caterpillar Inc. Annual Report (Form-10K), at 1 (12/31/2011).

⁹² Id. at 50.

⁹³ Caterpillar Inc. Annual Report (Form-10K), at 8 (2/19/2013).

⁹⁴ 3/7/2014 Caterpillar response to Subcommittee Questionnaire, CAT-001866 - 264, at 866 - 867.

⁹⁵ 9/17/2001 "Caterpillar Fiscal Year 2000 Transfer Pricing Documentation Report," PwC_CAT_PSI_00004975 - 162, at 008 and 032.

⁹⁶ Caterpillar Inc. Annual Report (Form-10K), at 2 (12/31/1993).

⁹⁷ 2/21/2014 "Caterpillar Inc. Presentation to the Senate Permanent Subcommittee on Investigations," PSI_Caterpillar_14_000001 - 010, at 002; "Find Your Dealer," Caterpillar worldwide dealer locator service on its website, http://www.cat.com/en_US/support/dealer-locator.html.

⁹⁸ "Caterpillar dealer push may drive some out, Levenick says," Reuters, James B. Kelleher (3/6/2014), http://www.reuters.com/article/2014/03/06/us-caterpillar-dealers-idUSBREA250AZ20140306.

⁹⁹ Id.

¹⁰⁰ Subcommittee interview of David Picard, Caterpillar Product Support and Sales Operations Director for EAME Region (3/4/2014).

¹⁰¹ "Stephen A. Gosselin," profile prepared by Caterpillar, http://www.caterpillar.com/en/company/governance/officers/stuart-l-levenick/stephen-a-gosselin.html.

¹⁰² See "Find Your Dealer," http://www.cat.com/en_US/support/dealer-locator.html.

¹⁰³ 9/17/2001 "Caterpillar Fiscal Year 2000 Transfer Pricing Documentation Report," PwC_CAT_PSI_00004975 - 162, at 028.

¹⁰⁴ 9/15/2011 "Caterpillar Inc. Transfer Pricing Analysis and Report For fiscal year ended December 31, 2010," PwC_PSI_CAT_00007795 - 204, at 819.

¹⁰⁵ Subcommittee interview of David Picard, Caterpillar (3/4/2014).

¹⁰⁶ Id.

¹⁰⁷ 9/17/2001 "Caterpillar Fiscal Year 2000 Transfer Pricing Documentation Report, PwC_CAT_PSI_00004975 - 162, at 029.

¹⁰⁸ Id. at 027.

¹⁰⁹ Id. at 028.

¹¹⁰ 12/19/1996 "Caterpillar Inc. Evaluation of Arm's Length Pricing for Intercompany Transactions Year Ended December 31, 1995," PwC_CAT_PSI_00008881 - 104, at 930; See also 1/26/1998 "Caterpillar Inc. Evaluation of Arm's Length Pricing for Intercompany Transactions Year Ended December 31, 1996," PwC_PSI_CAT_00009105 - 334, at 155; 9/15/1998 "Caterpillar, Inc. 1997 Documentation Report Final Report," PwC_PSI_CAT_00009335 - 612 at 392.

¹¹¹ Caterpillar Inc. Annual Report (Form-10K), at 2 (12/31/1993).

¹¹² 4/18/1996 "Caterpillar Inc. Evaluation of Arm's Length Pricing for Intercompany Transactions Year Ended December 31, 1994," PwC_CAT_PSI_00008634 - 880, at 685.

¹¹³ 11/6/1998 PWC memorandum from John Hatch to Charles Larson and Steven Williams, "Subject: CAT and COSA," PwC_PSI_CAT_00169827 - 838. See also 8/29/2007 email from Steven R. Williams, PWC, to Clifford Mangano, PWC, PwC_PSI_CAT_00024439 - 440 (indicating Caterpillar machines operate for 20 years or longer).

¹¹⁴ Subcommittee interview of William Springer, Caterpillar, Vice President of Product Support (11/7/2013).

¹¹⁵ 11/6/1998 PWC memorandum from John Hatch to Charles Larson and Steven Williams, "Subject: CAT and COSA," PwC_PSI_CAT_00169827 - 838.

¹¹⁶ See, e.g., Caterpillar presentation, "Parts Growth & Distribution Network Transformation," by Caterpillar executives Steve Gosselin and Steve Larson, Feb. 2012 Caterpillar Board of Directors meeting, CAT-001885 - 898, at 856; 4/18/1996 "Caterpillar Inc. Evaluation of Arm's Length Pricing for Intercompany Transactions Year Ended December 31, 1994," PwC_CAT_PSI_00008634 - 880, at 684 ("parts distribution is one of Caterpillar's most important competitive advantages in the marketplace"). At times, Caterpillar has denied to the Subcommittee that it has a "parts business," explaining that "parts" is not one of its reportable business segments. It is clear, however, that Caterpillar views its parts business as critical to the company's success. For example, in minutes from a 2002 board meeting, the parts business was described as "Critical Success Factor #4." The minutes described "the parts business value chain" and stated in part that "the company has recently focused on parts sales and increased investment in parts products development, parts and service systems." 12/11/2002 minutes from Caterpillar Board of Directors meeting, CAT_001855 - 865, at 855. See also, e.g., 12/8/2009 Caterpillar presentation to Caterpillar Board of Directors, CAT-001868 - 884, at 871 (stating, in an update on a business "enterprise alignment," that an "area for continued focus" was the "Parts Business"); 2/8/2012 minutes from Caterpillar Board of Directors meeting, CAT-001855 - 865, at 857 ("Mr. Levenick invited Mr. Gosselin and Larson to discuss the Company's parts business."); 5/1/2013 "The Big Interview: Caterpillar's Stuart Levenick," Construction Week Online, Stian Overdahl, http://www.constructionweekonline.com/article-22168-the-big-interview-caterpillars-stuart-levenick/1/print/ (Mr. Levenick states: "That's the good thing about the parts business -- it's really steady when you're in the bottom of a cycle. It's a very important business for us and for the dealers. . . .").

¹¹⁷ 5/1/2013 "The Big Interview: Caterpillar's Stuart Levenick," Construction Week Online, Stian Overdahl, http://www.constructionweekonline.com/article-22168-the-big-interview-caterpillars-stuart-levenick/1/print/.

¹¹⁸ Id.

¹¹⁹ 10/5/1999 "Caterpillar Inc. Global Value Enhancement Project Draft," PwC_PSI_CAT_00004483 - 530, at 508; Subcommittee interview of William Springer, Caterpillar (11/7/2013).

¹²⁰ 11/14/2005 "Caterpillar SARL 2006-2012 Royalty Rate: Options and Implications," PwC_PSI_CAT_00133127 - 180, at 148.

¹²¹ Craig T. Bouchard & James V. Koch, The Caterpillar Way, at 120 (2014).

¹²² 2/8/2012 minutes from Caterpillar Board of Directors meeting, CAT-001855 - 865, at 857. Caterpillar's auditor, PricewaterhouseCoopers also compared the company's business model to that of "razors and razorblades," referring to companies that give away a razor for free, knowing consumers will pay for the replacement blades. See undated PWC Planning document, PwC_PSI_CAT_00004506 - 631, at 619. PINS is an Caterpillar acronym for "Percent Industry New Sales" and represents market share for new equipment.

¹²³ Subcommittee interview of William Springer, Caterpillar (11/7/2013). But see 5/1/2013 "The Big Interview: Caterpillar's Stuart Levenick," Construction Week Online, Stian Overdahl, http://www.constructionweekonline.com/article-22168-the-big-interview-caterpillars-stuart-levenick/1/print/ ("there are approximately 3.5 million Caterpillar machines and engines in use through-out the world").

¹²⁴ 3/15/2010 "Caterpillar Inc. Worldwide Parts Management Final Closing Book, Draft Version as of March 15, 2010," PwC_PSI_CAT_00003876 - 168, at 912.

¹²⁵ 8/29/2007 email from Steven Williams, PWC, to Clifford Mangano, PWC, PwC_PSI_CAT_00024439 - 440, at 439.

¹²⁶ Id.

¹²⁷ Subcommittee interview of William Springer, Caterpillar (11/7/2013).

¹²⁸ Craig T. Bouchard & James V. Koch, The Caterpillar Way, at 218 (2014).

¹²⁹ Id., at 120, citing "Fall in Sales in the Great Recession: Rachel Potts, Caterpillar Public Affairs."

¹³⁰ 5/1/2013 "The Big Interview: Caterpillar's Stuart Levenick," Construction Week Online, Stian Overdahl, http://www.constructionweekonline.com/article-22168-the-big-interview-caterpillars-stuart-levenick/1/print/.

¹³¹ Subcommittee interview of William Springer, Caterpillar (11/7/2013).

¹³² Id.

¹³³ Id.; Subcommittee interview of Steven Williams, PWC (2/19/2014). See also 11/4/2008 email from Steven Williams, PWC, to Thomas Quinn, PWC, "is tomorrow really the only shot with DBB," PwC_PSI_CAT_00033157 ("Also, just curious -- say they decide most PMs stay in US.").

¹³⁴ Subcommittee interview of William Springer (11/7/2013).

¹³⁵ See Caterpillar presentation, "Parts Growth & Distribution Network Transformation," by Caterpillar executives Steve Gosselin and Steve Larson, Feb 2012 Caterpillar Board of Directors Meeting, CAT-001885 - 898, at 888. See also 2/8/2012 minutes from Caterpillar Board of Directors meeting, CAT-001855 - 865, at 857.

¹³⁶ "2012 Year in Review," prepared by Caterpillar and on its website, at 33, http://s7d2.scene7.com/is/content/Caterpillar/C10005383.

¹³⁷ Craig T. Bouchard & James V. Koch, The Caterpillar Way, at 169 (2014); Subcommittee interview of David Burritt, former Caterpillar CFO (12/4/2013).

¹³⁸ 2/21/2014 Caterpillar Inc. Presentation to the Senate Permanent Subcommittee on Investigations, at PSI-Caterpillar-14-000001 - 010, at 002.

¹³⁹ 12/3/2013 Caterpillar Response to Subcommittee Questionnaire, CAT-000270 - 298, at 277.

¹⁴⁰ "2012 Year in Review," prepared by Caterpillar, at 33, http://s7d2.scene7.com/is/content/Caterpillar/C10005383. See also 12/11/2002 minutes from Caterpillar Board of Directors meeting, CAT_001855 - 865, at 856 ("product support is vitally important to the company and its dealers").

¹⁴¹ "2012 Year in Review," prepared by Caterpillar, at 15, http://s7d2.scene7.com/is/content/Caterpillar/C10005383.

¹⁴² See, e.g., 9/11/2006 "Caterpillar, Inc. Valuation of Caterpillar's 100% Interest in Shareholder's Equity of Caterpillar of Australia Pty. Limited," Ernst & Young, PwC-PSI-CAT-00015198 - 272, at 218; 4/18/1996 "Caterpillar Inc. Evaluation of Arm's Length Pricing for Intercompany Transactions Year Ended December 31, 1994," PwC_CAT_PSI_00008634 - 880, at 684 ("parts distribution is one of Caterpillar's most important competitive advantages in the marketplace"). See also "Building the World -- Caterpillar," article in Access, a publication of Federal Express (May 2012), http://access.van.fedex.com/caterpillar/ (When asked about Caterpillar's commitment to deliver a part anywhere in the world within 24 hours, Stuart Levenick, Group President of Caterpillar's Customer Service and Dealer Support segment, said: "That's a big commitment, and that's worldwide. It means we've got an enormous network of parts distribution. We've got logistics people feeding parts into these depots, dealers carrying inventory. All of this has to work like a clock. . . . Logistics is huge for us."). Komatsu, a key Caterpillar competitor, has made an almost identical guarantee. See http://www.komatsuamerica.com/komatsu-parts.

¹⁴³ Subcommittee interview of William Springer, Caterpillar (11/7/2013).

¹⁴⁴ Id. See also Subcommittee interview of Thomas Quinn, PWC (10/2/2013) (Caterpillar's success rate in meeting its 24-hour delivery standard is typically in the upper 90th percentile); 11/6/1998 PWC memorandum from John Hatch to Charles Larson and Steven Williams, PWC, "CAT and COSA," PwC_PSI_CAT_00169827 - 838, at 833 ("Dealers now provide 80% of parts orders immediately upon request, and 99% are shipped within a day of being requested").

¹⁴⁵ See 11/6/1998 PWC memorandum from John Hatch to Charles Larson and Steven Williams, PWC, "CAT and COSA," PwC_PSI_CAT_00169827 - 838, at 833 ("contrast this to 2-7 days for car dealers that do not have a part in stock").

¹⁴⁶ 4/18/1996 "Caterpillar Inc. Evaluation of Arm's Length Pricing for Intercompany Transactions Year Ended December 31, 1994," PwC_CAT_PSI_00008634 - 880, at 684-685.

¹⁴⁷ Undated interview notes of Craig Barley -- Manager, Peoria, Parts & Services Support Availability & Inventory Management, collected by PwC, PwC_PSI_CAT_00179037 - 038. See also 12/1998, Caterpillar Inc., Global Tax Optimization, Risk Adjusted Benefit Analysis, Working Papers -Draft 1," PWC-PSI-CAT-00001336 - 671, at 415 ("P&SS [Parts & Services Support division] appears to track parts (forecasting, scheduling, purchasing, shipping, inventory levels) on a global basis with great amounts of detail"); Subcommittee interview of Deborah Kraft, Caterpillar (2/5/2014).

¹⁴⁸ 1/26/1998 "Caterpillar Inc. Evaluation of Arm's Length Pricing for Intercompany Transactions Year Ended December 31, 1996," PwC_PSI_CAT_00009105 - 334, at 156. See also 9/15/1998 "Caterpillar, Inc. 1997 Documentation Report Final Report," PwC_PSI_CAT_00009335 - 612 at 393; 9/15/1999 "Caterpillar 1998 Documentation Report," PwC_PSI_CAT_00009613 - 928, at 674.

¹⁴⁹ Subcommittee interview of David Picard, Caterpillar (3/4/2014).

¹⁵⁰ Subcommittee interview of David Burritt, former Caterpillar CFO (12/4/2013).

¹⁵¹ See, e.g., 2/8/2012 minutes from Caterpillar Board of Directors meeting, CAT_001855 - 865, at 857 (describing Caterpillar's parts distribution business as using a "U.S. centric model"); 9/1998 PWC report, "Caterpillar Inc. Global Tax Optimization Case for Action," PwC_PSI_CAT_00004632, at 670 (describing Caterpillar's "U.S. 'centric' role" as a "Negative Tax Rate Driver"); 4/18/1996 "Caterpillar Inc. Evaluation of Arm's Length Pricing for Intercompany Transactions Year Ended December 31, 1994," PwC_CAT_PSI_00008634 - 880, at 686 and 698 (describing Caterpillar Inc. as playing the "greatest strategic role" in after sales service and stating that "Parts & Services Support, a division of Cat Inc. located in Morton, IL is charged with managing the worldwide parts distribution network").

¹⁵² 12/3/2013 Caterpillar response to Subcommittee Questionnaire, CAT-000270-298, at 279.

¹⁵³ 3/7/2014 Caterpillar response to Subcommittee Questionnaire, CAT-001866-264, at 866.

¹⁵⁴ See "Stuart L. Levenick," Caterpillar officer profile prepared by Caterpillar, http://www.caterpillar.com/en/company/governance/officers/stuart-l-levenick.html.

¹⁵⁵ See "Stephen A. Gosselin," Caterpillar officer profile prepared by Caterpillar, http://www.caterpillar.com/en/company/governance/officers/stuart-l-levenick/stephen-a-gosselin.html.

¹⁵⁶ Subcommittee interview of Deborah Kraft, Caterpillar (2/5/2014).

¹⁵⁷ "David P. Bozeman," Caterpillar officer profile prepared by Caterpillar, http://www.caterpillar.com/en/company/governance/officers/david-p-bozeman.html; 4/13/2014 Caterpillar Enterprise System Group press release.

¹⁵⁸ His group is the successor to the Manufacturing Logistics & Transportation Group formerly part of Steven Larsen's parts logistics division. 4/13/2014 Caterpillar Enterprise System Group press release.

¹⁵⁹ See 8/20/2013 "Caterpillar Announces Retirements of Long-Time Officers; Appointments and Changes in Responsibilities for Vice Presidents will Drive Company Strategy," Caterpillar press release, http://www.caterpillar.com/en/news/corporate-press-releases/h/caterpillar-announces-retirements-of-long-time-officers-appointments-and-changes-in-responsibilities-for-vice-presidents-will-drive-company-strategy.html (noting Mr. Larson was head of the division for nine years and "played a critical role in the successful divestiture of a majority interest in Caterpillar Logistics Services in 2012, and . . . guided the build out, modernization and expansion of the Cat® parts distribution network").

¹⁶⁰ Id. ("Concurrent with the announcement of Steve Larson's retirement, Caterpillar is announcing a strategic realignment of the Parts Distribution & Diversified Products Division and the Customer Services Support Division. As part of this realignment, Caterpillar's Parts Distribution business will be integrated into the Customer Services Support Division, which is led by Vice President Steve Gosselin. The Customer Services Support Division is focused on aggressively growing Caterpillar's parts and product support. The division develops and supports deployment of parts and service products, processes and programs for our dealers, enabling them to deliver unmatched product support. Including Caterpillar Parts Distribution this division will form a single global parts organization that will allow a seamless Caterpillar focus on supporting customer requirements for product support.").

¹⁶¹ Subcommittee interview of Thomas Quinn, PWC (12/17/2013)

¹⁶² Id. The next two largest parts warehouses are located in Grimbergen, Belgium and Singapore. Smaller distribution sites are located elsewhere in the United States and in other parts of the world.

¹⁶³ "85% of worldwide parts inventory is managed from Morton-moving toward 100%." Undated interview notes of Craig Barley -- Manager, Peoria, P&SS Availability & Inventory Management, collected by PwC, PwC_PSI_Cat_000179037 - 038. At one point, the Morton distribution center even controlled 100% of the physical parts inventory kept in Caterpillar's main European warehouse. Id.

¹⁶⁴ 11/26/2013 letter from Caterpillar to Subcommittee, CAT-000267 - 269, at 268.

¹⁶⁵ Caterpillar presentation, "Parts Growth & Distribution Network Transformation," by Caterpillar executives Steve Gosselin and Steve Larson, Feb 2012 Caterpillar Board of Directors Meeting, CAT-001885 - 898 at 897 ("Cat Parts Distribution Future Footprint," chart); 2008 "Caterpillar Worldwide Locations," prepared by Caterpillar Inc. (listing 14 distribution centers across the United States), http://pdf.cat.com/cda/files/113505/7/2008%20WW%20location_final.pdf.

¹⁶⁶ Caterpillar presentation, "Parts Growth & Distribution Network Transformation," by Caterpillar executives Steve Gosselin and Steve Larson, Feb 2012 Caterpillar Board of Directors Meeting, CAT-001885 - 898 at 897 ("Cat Parts Distribution Future Footprint," chart). The EAME warehouse is in Grimbergen, Belgium; none of the warehouses or distribution centers have ever been in Switzerland.

¹⁶⁷ 2/8/2012 minutes from Caterpillar Board of Directors meeting, CAT_001855 - 865. See also Caterpillar presentation, "Parts Growth & Distribution Network Transformation," by Caterpillar executives Steve Gosselin and Steve Larson, Feb 2012 Caterpillar Board of Directors Meeting, CAT-001885 - 898.

¹⁶⁸ Subcommittee interview of Deborah Kraft, Caterpillar (2/5/2014).

¹⁶⁹ Id.

¹⁷⁰ 12/3/2013 Caterpillar response to Subcommittee Questionnaire, CAT-000270 - 298, at 296.

¹⁷¹ Subcommittee interview of Deborah Kraft, Caterpillar (2/5/2014).

¹⁷² Subcommittee interview of William Springer, Caterpillar (11/7/2013).

¹⁷³ 5/1/2013 "The Big Interview: Caterpillar's Stuart Levenick," Construction Week Online, Stian Overdahl, http://www.constructionweekonline.com/article-22168-the-big-interview-caterpillars-stuart-levenick/1/print/.

¹⁷⁴ Subcommittee interview of William Springer, Caterpillar, (11/7/2013).

¹⁷⁵ Id.

¹⁷⁶ Id.

¹⁷⁷ Subcommittee interview of Deborah Kraft, Caterpillar (2/5/2014).

¹⁷⁸ 12/3/2013 Caterpillar response to Subcommittee Questionnaire, CAT-000270 - 298, at 296.

¹⁷⁹ Subcommittee interview of William Springer, Caterpillar (11/7/2013).

¹⁸⁰ Subcommittee interview of Edward Simpkins, Caterpillar (1/29/2014).

¹⁸¹ Id. Backup systems are located in Belgium.

¹⁸² Id.

¹⁸³ Undated interview notes of Craig Barley -- Manager, Peoria, Parts & Services Support Availability & Inventory Management, collected by PWC, PwC_PSI_CAT_00179037 - 038.

¹⁸⁴ See "Summary of Orders and Invoicing Systems," PwC_PSI_CAT_00018032 - 036.

¹⁸⁵ 12/3/2013 Caterpillar response to Subcommittee Questionnaire, CAT-000270 - 298, at 277.

¹⁸⁶ Subcommittee interview of Deborah Kraft, Caterpillar (2/5/2014). The Global Purchasing Division was also known, at times, as the Product Support Division.

¹⁸⁷ Id.

¹⁸⁸ See Craig T. Bouchard & James V. Koch, The Caterpillar Way, at 169 (2014); Subcommittee interview of David Burritt, former Caterpillar CFO (12/4/2013).

¹⁸⁹ Id.

¹⁹⁰ 12/3/2013 Caterpillar response to Subcommittee Questionnaire, CAT-000270 - 298, at 296.

¹⁹¹ Subcommittee interview of Deborah Kraft, Caterpillar (2/5/2014). See also undated interview notes of Craig Barley -- Manager, Peoria, Parts & Services Support Availability & Inventory Management, collected by PWC, PwC_PSI_CAT_00179037 - 038 ("Most regional distribution centers are served from Morton, not from contract packagers, because of low volume at regional centers.").

¹⁹² Subcommittee interview of Deborah Kraft, Caterpillar (2/5/2014).

¹⁹³ See undated PwC interview notes of Don Puryear, Caterpillar Purchasing Transportation and Technical Support Manager, PwC_PSI_CAT_00179035 - 036.

¹⁹⁴ Subcommittee interview of Deborah Kraft, Caterpillar (2/5/2014).

¹⁹⁵ Id.

¹⁹⁶ 12/3/2013 Caterpillar response to Subcommittee Questionnaire, CAT-000270 - 298, at 279.

¹⁹⁷ Id.

¹⁹⁸ 3/7/2014 "In the Matter of Caterpillar Inc.," Caterpillar Expert Witness Report, John P. Steines, Jr., Professor of Law, New York University, PSI-Caterpillar-17-000003 - 023, at 006 (CSARL in Switzerland currently has about 400 employees).

¹⁹⁹ 4/18/1996 "Caterpillar Inc. Evaluation of Arm's Length Pricing for Intercompany Transactions Year Ended December 31, 1994," PwC_CAT_PSI_00008634 - 880, at 673.

²⁰⁰ Id.; 12/19/1996 "Caterpillar Inc. Evaluation of Arm's Length Pricing for Intercompany Transactions Year Ended December 31, 1995," PwC_CAT_PSI_00008881 - 104, at 916-17.

²⁰¹ 12/19/1996 "Caterpillar Inc. Evaluation of Arm's Length Pricing for Intercompany Transactions Year Ended December 31, 1995," PwC_CAT_PSI_00008881 - 104, at 930-31.

²⁰² Id. at 917-918.

²⁰³ 2/21/2014 "Caterpillar Inc. Presentation to the Senate Permanent Subcommittee on Investigations," at PSI-Caterpillar-14-000001 - 010 at 002. See also 2008 "Caterpillar Worldwide Locations," prepared by Caterpillar Inc., http://pdf.cat.com/cda/files/113505/7/2008%20WW%20location_final.pdf. In 2004, Caterpillar purchased a local Swiss company that packaged, but did not manufacture, industrial turbines and related systems. "Caterpillar Inc. Completes Acquisition of Turbomach S.A.," (6/17/2004), PRNewswire, http://www.prnewswire.com/news-releases/caterpillar-inc-completes-acquisition-of-turbomach-sa-75032792.html.

²⁰⁴ 12/3/2013 Caterpillar response to Subcommittee Questionnaire, CAT-000270 - 298, at 281-94.

²⁰⁵ 4/18/1996 "Caterpillar Inc. Evaluation of Arm's Length Pricing for Intercompany Transactions Year Ended December 31, 1994," PwC_CAT_PSI_00008634 - 880, at 673; 12/19/1996 "Caterpillar Inc. Evaluation of Arm's Length Pricing for Intercompany Transactions Year Ended December 31, 1995," PwC_CAT_PSI_00008881 - 914, at 916; 3/7/2014 "In the Matter of Caterpillar Inc.," Caterpillar Expert Witness Report, John P. Steines, Jr., Professor of Law, New York University, at PSI-Caterpillar-17-000003 - 023, at 006.

²⁰⁶ 3/7/2014 "In the Matter of Caterpillar Inc.," Caterpillar Expert Witness Report, John P. Steines, Jr., Professor of Law, New York University, at PSI-Caterpillar-17-000003 - 023, at 006.

²⁰⁷ Subcommittee interview of Steven Williams, PWC (2/19/2014).

²⁰⁸ 12/19/1996 "Caterpillar Inc. Evaluation of Arm's Length Pricing for Intercompany Transactions Year Ended December 31, 1995," PwC_CAT_PSI_00008881 - 9104, at 959.

²⁰⁹ 2/16/2010 "Caterpillar Inc. CSARL Permanent File Chronological History: 1999-2010," PwC_PSI_CAT_00003406 - 463, at 407.

²¹⁰ Subcommittee interview of David Picard, Caterpillar (3/4/2014).

²¹¹ 12/3/2013 Caterpillar response to Subcommittee Questionnaire, CAT-000270 - 298, at 284.

²¹² Id.

²¹³ Subcommittee interview of David Picard, Caterpillar (3/4/2014).

²¹⁴ 3/7/2014 "In the Matter of Caterpillar Inc.," Caterpillar Expert Witness Report, John P. Steines, Jr., Professor of Law, New York University, at PSI-Caterpillar-17-000003 - 023, at 006.

²¹⁵ 1/16/2003 Caterpillar's legal counsel memorandum "History of Significant Changes in International Operations (Not Inclusive of Financing Arrangements) 1997 - 2002," PSI-TWLF-02-000423 - 436.

²¹⁶ 3/7/2014 "In the Matter of Caterpillar Inc.," Caterpillar Expert Witness Report, John P. Steines, Jr., Professor of Law, New York University, at PSI-Caterpillar-17-000003 - 023, at 007.

²¹⁷ Id.

²¹⁸ 12/3/2013 Caterpillar response to Subcommittee Questionnaire, CAT-000270 - 298, at 281-2.

²¹⁹ 1/2010, "Caterpillar Inc. CSARL 2009 activities Report to Audit Team," 00003830 - 875, at 832, 847.

²²⁰ 12/3/2013 Caterpillar response to Subcommittee Questionnaire, at CAT-000270 - 298, at 286.

²²¹ 3/15/2010, "Caterpillar Inc. Worldwide Parts Management Final Closing Book, Draft Version as of March 15, 2010," PwC_PSI_CAT_00003876 - 168, at 906-07.

²²² Subcommittee interview of David Picard, Caterpillar (3/4/2014).

²²³ Id.

²²⁴ Information provided by Caterpillar to the Subcommittee (March 27, 2014).

²²⁵ 12/3/2013 Caterpillar response to Subcommittee Questionnaire, at CAT-000270 - 298, at 279.

²²⁶ Id.

²²⁷ 8/30/2013 Caterpillar response to Subcommittee Questionnaire, CAT-000070; 12/3/2013 Caterpillar response to Subcommittee Questionnaire, CAT-000270 - 274. When asked about the tax rate that Caterpillar paid in Switzerland, the PWC partner who led the tax consulting efforts and was also involved in Caterpillar's transfer pricing issues told the Subcommittee that Caterpillar had received a Swiss government ruling that allows it to pay the statutory rate on only 20% of its non-Swiss source income, resulting in an effective tax rate of 4%. Subcommittee interview of Thomas Quinn, PWC (10/2/2013).

²²⁸ 12/3/2013 Caterpillar response to Subcommittee Questionnaire, CAT-000270 - 298, at 270.

²²⁹ 10/5/1999 "Caterpillar Inc. Global Value Enhancement Project Draft," PwC_PSI_CAT_00004483 - 530.

²³⁰ See 8/22/2008 "Delivering Vision 2020 Value Transformation: An After-Tax View," PwC_PSI_CAT_00058419 - 472, at 429 and 449.

²³¹ 7/30/2008 PWC Presentation, "Caterpillar Sarl Overview," PwC_PSI_CAT_00065585 - 610, at 589.

²³² Subcommittee interview of Thomas Quinn, PWC (10/2/2013).

²³³ Id.

²³⁴ Id.

²³⁵ 4/14/1998, PWC presentation to Caterpillar, "Global Tax Optimization," PwC_PSI_CAT_00004892, at 895.

²³⁶ Subcommittee interview of Thomas Quinn, PWC (10/2/2013).

²³⁷ 11/13/2006 PricewaterhouseCoopers National Office memorandum, "Independence Consultation Database," PSI-TWLF-21-000228 - 231, at 229; Subcommittee interview of Thomas Quinn, PWC (10/2/2013).

²³⁸ Subcommittee interviews of Thomas Quinn, PWC (10/2/2013) and James Bowers, PWC (1/23/2014).

²³⁹ Deposition of Sally Stiles in Schlicksup v. Caterpillar, PSI-TWLF-11-000113 - 114, at 106-07; Subcommittee interview of Robin Beran, Caterpillar, Chief Tax Officer (10/18/2013).

²⁴⁰ Subcommittee interview of Robin Beran, Caterpillar (10/18/2013). See also August 2008 email chain among Robin Beran, Rodney Perkins, and others indicating that the tax department paid business unit costs for implementation, management, and inventory ownership related to CSARL. Mr. Perkins, Caterpillar International Tax Manager, wrote: "[C]harges were primarily implementation, then they became primarily maintenance. We've [tax department] been paying for both since Day 1." 8/21/2008 email chain among Caterpillar tax department personnel, PSI-TWLF-02-001625 - 628. It also appears that the tax group in Geneva paid for the software package to keep track of CSARL's legal entities and financial statements. Deposition of Rodney Perkins in Schlicksup v. Caterpillar, PSI-TWLF-10-000004, at 77-78.

²⁴¹ 3/21/2014 email from PWC's legal counsel to Subcommittee, "Response regarding fees," PSI-PWC-22-000001 - 000003.

²⁴² Subcommittee interview of Thomas Quinn, PWC (10/2/2013).

²⁴³ Id.

²⁴⁴ Id.

²⁴⁵ See undated PWC presentation to Caterpillar, "Caterpillar GTOP Summary of Ideas," PwC_PSI_CAT_00004566 - 4631. See also 7/14/1998 email from Steven Williams, PWC, to Thomas Quinn, PWC, and others, PwC_PSI_CAT_00204970 - 974 (listing three initial ideas: removing Caterpillar from the parts supply chain, increasing the profit margin on parts, and reducing the profit margin on machines).

²⁴⁶ See undated PWC presentation to Caterpillar, "CATERPILLAR GTOP Summary of Ideas," PwC_PSI_CAT_00004566 - 4631.

²⁴⁷ Id. See also 9/1998 PWC report, "Caterpillar Inc. Global Tax Optimization Case for Action," PwC_PSI_CAT_00004632, at 674 (describing the proposal as PWC's "Solution #1" to reduce Caterpillar's taxes).

²⁴⁸ Subcommittee interview of Thomas Quinn, PWC (10/2/2013).

²⁴⁹ Id. In addition, if the Swiss affiliate were to receive dividends or royalties from lower tier Caterpillar affiliates, it would be able to use the U.S. check-the-box rules to ensure those entities were disregarded for U.S. tax purposes and, again, avoid Subpart F taxes.

²⁵⁰ Undated PWC presentation to Caterpillar, "Caterpillar GTOP Summary of Ideas," PwC_PSI_CAT_00004566 - 4631, at 618; 9/1998 PWC report, "Caterpillar Inc. Global Tax Optimization Case for Action," PwC_PSI_CAT_00004632, at 674.

²⁵¹ Id.

²⁵² See, e.g., AU Section 110, Responsibilities and Functions of the Independent Auditor, Public Company Accounting Oversight Board (PCAOB) website, http://pcaobus.org/Standards/Auditing/Pages/AU110.aspx "AU" is a reference to "audit" standards.

²⁵³ Sarbanes-Oxley Act of 2002, Pub. L. 107-204, 116 Stat. 745, 107th Cong. (2002).

²⁵⁴ Id. at § 201(a), codified at 15 USC § 78j-1(h). PCAOB auditing standards relating to independence and advising on tax transactions include the following:

²⁵⁶ Id.

²⁵⁷ Id.

²⁵⁸ Id.

²⁵⁹ Id.

²⁶⁰ 3/21/2014 email from PWC's legal counsel to Subcommittee, "Response regarding fees," PSI-PWC-22-000001 - 000003.

²⁶¹ Id.

²⁶² 4/13/2010 "Global Tax & Trade Update," PwC_PSI_CAT_00205974 - 990, at 975.

²⁶³ Id. at 979.

²⁶⁴ 12/3/2013 Caterpillar response to Subcommittee Questionnaire, CAT-000270 - 298, at 298.

²⁶⁵ See 3/7/2014 "In the Matter of Caterpillar Inc.," Caterpillar Expert Witness Report by John P. Steines, Jr., Professor of Law, New York University, at PSI-Caterpillar-17-000003 - 023, at 005-06.

²⁶⁶ 12/19/1996 "Caterpillar Inc. Evaluation of Arm's Length Pricing for Intercompany Transactions Year Ended December 31, 1995," PwC_CAT_PSI_00008881 - 104, at 921.

²⁶⁷ Subcommittee interview of William Springer, Caterpillar (11/7/2013); see also Craig T. Bouchard & James V. Koch, The Caterpillar Way, at 200 (2014).

²⁶⁸ 5/28/1999 "Global Value Enhancement Development Phase Status Report," PwC_PSI_CAT_00004349 - 455, at 365. Caterpillar uses the term "sourced" to indicate that an item was procured from that country or region.

²⁶⁹ 3/7/2014 Caterpillar response to Subcommittee Questionnaire, CAT-001866 - 264, at 866.

²⁷⁰ See 3/7/2014 "In the Matter of Caterpillar Inc.," Caterpillar Expert Witness Report, John P. Steines, Jr., Professor of Law, New York University, at PSI-Caterpillar-17-000003 - 023, at 005-07.

²⁷¹ Id.

²⁷² Id. at PSI-Caterpillar-17-000003 - 004.

²⁷³ 10/29/2007 "Caterpillar Inc. Transfer Pricing Discussion Items," PwC_PSI_CAT_00129637 - 646, at 640. See also Subcommittee interview of Thomas Quinn, PWC (10/2/2013).

²⁷⁴ Id. In comparison, residual non-U.S. parts profits were also assigned to Caterpillar's French and Belgian affiliates, which had manufacturing facilities. See also 10/29/2007 PWC slide presentation "Caterpillar Inc. Transfer Pricing Discussion Items," PwC_PSI_CAT_00129637 - 646, at 640. According to PWC, prior to Mr. Fites' setting the across-the-board share of accountable profits for Caterpillar marketing companies in 1992, Caterpillar had split the non-U.S. residual parts profits with the marketing companies on a 50/50 legal entity basis. The U.S. share of the sales profits were reported as U.S. taxable income on Caterpillar's U.S. tax return, while the marketing companies' share was also reported on Caterpillar's tax return as Subpart F income. Subcommittee Interview of Steven Williams, a PWC Managing Director (2/19/2014).

²⁷⁵ See 3/7/2014 "In the Matter of Caterpillar Inc.," Caterpillar Expert Witness Report, John P. Steines, Jr., Professor of Law, New York University, at PSI-Caterpillar-17-000003 - 023, at 003-04.

²⁷⁶ 8/22/2008 "Delivering Vision 2020 Value Transformation: An After-Tax View," PwC_PSI_CAT_00058419-472.

²⁷⁷ See 2/16/2010 "Caterpillar Inc. CSARL Permanent File Chronological History: 1999-2010," PwC_PSI_CAT_00003406 - 463, at 407.

²⁷⁸ See 3/7/2014 "In the Matter of Caterpillar Inc.," Caterpillar Expert Witness Report, John P. Steines, Jr., Professor of Law, New York University, at PSI-Caterpillar-17-000003 - 023, at 003. CSARL acquired its current name in 1999, in connection with the implementation of the PWC tax strategy.

²⁷⁹ 2/16/2010 "Caterpillar Inc. CSARL Permanent File Chronological History: 1999-2010," PwC_PSI_CAT _00003406 - 463, at 406. "SARL" stands for Société à responsabilité limitée, a type of private limited liability corporate entity that exists in Switzerland, France, and a few other countries. A SARL is a company whose liability is limited to the contributions of its members. It is comparable to a limited liability partnership in the United States. See also 3/7/2014 "In the Matter of Caterpillar Inc.," Caterpillar Expert Witness Report, John P. Steines, Jr., Professor of Law, New York University, at PSI-Caterpillar-17-000003 - 023.

²⁸⁰ 2/16/2010 "Caterpillar Inc. CSARL Permanent File Chronological History: 1999-2010," PwC_PSI_ CAT_00003406 - 463, at 406 (CSARL is treated as a partnership for U.S. tax purposes and is owned directly or indirectly (through disregarded entities) by controlled foreign corporations that are directly or indirectly owned by Caterpillar). See also 3/7/2014 "In the Matter of Caterpillar Inc.," Caterpillar Expert Witness Report, John P. Steines, Jr., Professor of Law, New York University, at PSI-Caterpillar-17-000003 - 023.

²⁸¹ See 2/16/2010 "Caterpillar Inc. CSARL Permanent File Chronological History: 1999-2010," PwC_ PSI_CAT_00003406 - 463, at 407 and 411.

²⁸² Id. at 411.

²⁸³ 8/14/2013 Caterpillar response to Subcommittee Questionnaire, CAT-000001 - 065, at 011 - 038.

²⁸⁴ Id.

²⁸⁵ See 11/13/2006 PWC national office memorandum from Kevin Mitchell to Sharad Jain, "Caterpillar Inc.," PSI-TWLF-21-000001 - 265, at 229.

²⁸⁶ Id. See also See 3/7/2014 "In the Matter of Caterpillar Inc.," Caterpillar Expert Witness Report, John P. Steines, Jr., Professor of Law, New York University, at PSI-Caterpillar-17-000003 - 023, at 005-06.

²⁸⁷ See, e.g., See 3/7/2014 "In the Matter of Caterpillar Inc.," Caterpillar Expert Witness Report, John P. Steines, Jr., Professor of Law, New York University, at PSI-Caterpillar-17-000003 - 023, at 006 ("The restructuring simply removed Caterpillar from the outbound PFRP supply chain. As a result, Caterpillar earned no profits (other than royalties and fees paid by CSARL described below) from outbound PFRP sales, and CSARL's profits were no longer taxable under Subpart F because there was no longer a related party (Caterpillar under the old structure) in the supply chain, which Section 954(d) requires as a condition of foreign base company sales income.").

²⁸⁸ See also 12/1998, Caterpillar Inc., Global Tax Optimization, Risk Adjusted Benefit Analysis, Working Papers -- Draft 1," PWC-PSI-CAT-00001336 - 671, at 411.

²⁸⁹ Id. at 412.

²⁹⁰ See 11/13/2006 PWC national office memorandum from Kevin Mitchell to Sharad Jain, "Caterpillar Inc.," PSI-TWLF-21-000001 - 265, at 229. See also 3/7/2014 "In the Matter of Caterpillar Inc.," Caterpillar Expert Witness Report, John P. Steines, Jr., Professor of Law, New York University, at PSI-Caterpillar-17-000003 - 023, at 004.

²⁹¹ 11/30/2000 "European Manufacturing Initiative Caterpillar SARL," PwC_PSI_CAT_00016468 - 511, at 502.

²⁹² See 8/22/2008 "Delivering Vision 2020 Value Transformation: An After-Tax View," PwC_PSI_CAT_00058419 - 472, at 429.

²⁹³ In the mid-2000's, CSARL's marketing companies became a cost center and profits became reallocated to the product groups. Subcommittee interview of Jananne Copeland, Caterpillar (10/30/2013).

²⁹⁴ See, e.g., 1/1/2001 Second Amended and Restated License Agreement, CAT-000306 - 699, at 373. See also 9/23/2013 letter from Caterpillar to Subcommittee, PSI-Caterpillar-04-000001 - 009 at 004.

²⁹⁵ 1/16/2003 Caterpillar's legal counsel memorandum "History of Significant Changes in International Operations (Not Inclusive of Financing Arrangements) 1997 - 2002," PSI-TWLF-02-000423 - 436, at 423.

²⁹⁶ Id.

²⁹⁷ Id.

²⁹⁸ Id. at 427. See also 9/1/1999 Purchasing Agency Agreement (unexecuted copy), PwC_PSI_CAT_00053632 - 641; "Reallocated Parts Purchasing Agreement, December 1, 1999," CAT-000306 - 699, at 535-542.

²⁹⁹ 1/16/2003 Caterpillar's legal counsel memorandum "History of Significant Changes in International Operations (Not Inclusive of Financing Arrangements) 1997 - 2002," PSI-TWLF-02-000423 - 436, at 427.

³⁰⁰ 1/16/2003 Caterpillar's legal counsel memorandum "History of Significant Changes in International Operations (Not Inclusive of Financing Arrangements) 1997 - 2002," PSI-TWLF-02-000423 - 436, at 423-24. See also, e.g., 9/1/1999 Fifth Amended and Restated Services Agreement, CAT-000653 - 663.

³⁰¹ 12/3/2013 Caterpillar Response to Subcommittee Questionnaire, CAT-000270 - 298, at 295 - 296. A September 1999 services agreement stated the services "shall include, but not be limited to: 1. Creation, translation, and dissemination of services manuals, service literature, and other materials for replacement parts; 2. Inventory availability management; 3. Providing parts customer service to dealers (i.e., dealer order inquiries, dealer order expediting); 4. Providing parts pricing determinations; 5. Processing of dealer parts returns; 6. Human resources assistance; 7. Maintenance and support with respect to information systems; 8. Marketing consulting (i.e., creation and support of dealer marketing programs); 9. Strategic planning; and 10. Accounting services." In addition with respect to CSARL inventory in U.S. warehouses: "11. Manage and monitor inventory levels worldwide and perform expediting services; 12. Arrange for transportation of CAT SARL goods; 13. General warehousing services and facilitites for such; and 14. Inventory management services at U.S. warehouses." 9/1/1999 Fifth Amended and Restated Services Agreement, CAT-000653 - 663, at 661. PWC's initial planning document indicated that a payment would be made to Caterpillar Inc. in the United States for parts procurement and for management of the parts system. 12/1998, Caterpillar Inc., Global Tax Optimization, Risk Adjusted Benefit Analysis, Working Papers -- Draft 1," PwC-PSI-CAT-00001336 - 671, at 408.

³⁰² See, e.g., 9/1/1999 Fifth Amended and Restated Services Agreement, CAT-000653 - 663, at 663. Subcommittee interview of Thomas Quinn, PWC (10/2/2013).

³⁰³ 1/16/2003 Caterpillar's legal counsel memorandum "History of Significant Changes in International Operations (Not Inclusive of Financing Arrangements) 1997 - 2002," PSI-TWLF-02-000423 - 436.

³⁰⁴ See 11/13/2006 PWC national office memorandum from Kevin Mitchell to Sharad Jain, "Caterpillar Inc.," PSI-TWLF-21-000001 - 265, at 193.

³⁰⁵ See 1/16/2003 Caterpillar's legal counsel memorandum "History of Significant Changes in International Operations (Not Inclusive of Financing Arrangements) 1997 - 2002," PSI-TWLF-02-000423 - 436.

³⁰⁶ See, e.g., 1/1/2011 License Agreement, CAT-000306 - 699. The licensing agreement specified a 4% bundled royalty payment, based upon a "weighted average" of 15% parts royalty and 3% machine royalty. See, e.g., 3/2005 "Caterpillar Inc. Summary Meeting Notes, Revised Draft," from March 7-9, 2005 meeting in Geneva, PwC_PSI_CAT_00150466 - 488, at 470.

³⁰⁷ Subcommittee interview of Thomas Quinn, PWC (12/17/2013); 1/16/2003 Caterpillar's legal counsel memorandum "History of Significant Changes in International Operations (Not Inclusive of Financing Arrangements) 1997 - 2002," PSI-TWLF-02-000423 - 436, at 423-24; 3/2005 "Caterpillar Inc. Summary Meeting Notes, Revised Draft," from March 7-9, 2005 meeting in Geneva, PwC_PSI_CAT_00150466 - 488, at 470; See 3/7/2014 "In the Matter of Caterpillar Inc.," Caterpillar Expert Witness Report, John P. Steines, Jr., Professor of Law, New York University, at PSI-Caterpillar-17-000003 - 023, at 005.

³⁰⁸ These percentages are based on financial figures provided by Caterpillar to the Subcommittee. Typically, CSARL aggregates the profits from non-U.S. sales of Caterpillar parts and machines and provides Caterpillar Inc. with one bundled royalty amount for use of all Caterpillar licensed property. Since the Swiss tax strategy focused solely on Caterpillar's purchased finished replacement parts (PFRP) business, however, the Subcommittee requested data on just the portion of CSARL's profits and royalty payments related to non-U.S. PFRP sales. Caterpillar provided the Subcommittee with an estimate of CSARL's total PFRP profits before tax over an eight-year period. For that eight-year period, according to Caterpillar, CSARL's non-U.S. PFRP profits before tax totaled $8,075,907,000. See 12/3/2013 Caterpillar response to Subcommittee questionnaire, CAT-000270 at 277. Caterpillar also provided the Subcommittee with an estimate of CSARL's annual royalty payments to Caterpillar Inc. associated with the non-U.S. replacement parts business. For that same period of time, according to Caterpillar, CSARL's royalty payments to Caterpillar Inc. totaled $1,098,149,000. See 12/3/2013 Caterpillar Response to Subcommittee Questionnaire, CAT-000270 - 298, at 301. That royalty amount includes payments made by CSARL for both PRFP parts manufactured by independent third parties and parts manufactured by Caterpillar. Using the figures provided by Caterpillar, the royalty, or license fee, paid by CSARL to Caterpillar Inc. for profits related to parts averaged 13.6% of CSARL's PFRP profits over the eight-year time period. Over that same time period, CSARL retained the remaining 86.4% of the PFRP profits. CSARL also paid Caterpillar Inc. service fees during that eight-year time period for services provided by Caterpillar Inc. related to the replacement parts business in an amount equal to Caterpillar's costs plus 5%. For the 8 year period, using data provided by Caterpillar on the total amount of service fees paid by CSARL to Caterpillar Inc., the Subcommittee estimated that the 5% markup related to those fees totaled about $75 million, which, if accurate, would alter the 13.6% and 86.4% profit split by only about 1 percentage point.

³⁰⁹ 7/2/2002 "Caterpillar, CSARL Technology Ownership," PwC_PSI_CAT_00024791 - 808, at 799. Caterpillar explained to the Subcommittee that the transfer pricing method it used yield a range of potentially acceptable royalty rates, and the 4% rate was heading toward the bottom of the acceptable range, hence the "pressure" to increase the rate. Subcommittee interview of Steven Williams, PWC (2/19/2014).

³¹⁰ Subcommittee interview of Steven Williams, PWC (2/19/2014). See also 1/25/2006 email from Christopher Dunn, PWC, to Steven Williams, PWC, "CSARL royalty rate," PwC_PSI_CAT_00132905 - 909.

³¹¹ 1/23/2006 email from Steven Williams, PWC, to Mark Dalbey, PWC, "CSARL royalty rate," PwC_PSI_CAT_00018341.

³¹² 10/27/2008 email from Rodney Perkins, Caterpillar, to Edward Bodnam, PWC, "Alignment VPs and PMs by Subject Facilities," PwC_PSI_CAT_00059123 - 127, at 125.

³¹³ Subcommittee interview of Rodney Perkins, Caterpillar (1/15/2014). James Bowers, the PWC tax partner who reviewed Caterpillar's tax issues, including with respect to CSARL, also expressed discomfort about the royalty level, explaining that it was always difficult to evaluate. Subcommittee interview of James Bowers, PWC (1/23/2014). See also other documents raising concerns about the CSARL royalty rate, 1/25/2006 email from Christopher Dunn, PWC, to Steven Williams, PWC, "CSARL royalty rate," PWC_PSI_CAT_00132905 - 909; 11/14/2005 draft "Caterpillar SARL 2006 - 2010 Royalty Rate: Options and Implications," PwC_PSI_CAT_00133088 - 115; 12/6/2005 "Caterpillar SARL 2006 - 2010 Royalty Rate: Executive Summary," PwC_PSI_CAT_00133120 - 126.

³¹⁴ 12/3/2013 Caterpillar Response to Subcommittee Questionnaire, CAT-000270 - 298, at 277; 1/14/2014 Caterpillar Response to Subcommittee Questionnaire, CAT-000299 - 303, at 301.

³¹⁵ 3/7/2014 "In the Matter of Caterpillar Inc.," Caterpillar Expert Witness Report, John P. Steines, Jr., Professor of Law, New York University, at PSI-Caterpillar-17-000003 - 023, at 005.

³¹⁶ Id.

³¹⁷ 6/8/2006 email from Robin Beran, Caterpillar, to James Bowers, PWC, "Fw: FYI -- 2006 Corporate Tax Audit Committee Presentation," PwC_PSI_CAT_00004799 - 827, at 823; Deposition of Robin Beran in Schlicksup v. Caterpillar, PSI-TWLF-12- 000064.

³¹⁸ Subcommittee interview of Thomas Quinn, PWC (12/17/2013).

³¹⁹ See Background chapter, Export Exception.

³²⁰ See Subcommittee interviews of Thomas Quinn, PWC (10/2/2013 and 12/17/2013) (indicating that when a PWC representative suggested segregating the two sets of replacement parts, he was "laughed out of the room").

³²¹ Subcommittee interview of Thomas Quinn, PWC (10/2/2013); 9/8/2009 "Caterpillar Inc. CSARL Briefing," PWC-PSI-CAT-00069730 - 772, at 00069759 - 61; Deposition of Robin Beran in Schlicksup v. Caterpillar, PSI-TWLF-12-000064 - 065, at 57-58.

³²² Subcommittee interview of Thomas Quinn, PWC (10/2/2013); 3/7/2014 "In the Matter of Caterpillar Inc.," Caterpillar Expert Witness Report, John P. Steines, Jr., Professor of Law, New York University, at PSI-Caterpillar-17-000003 - 023, at 005.

³²³ Subcommittee interview of Rodney Perkins, Caterpillar (1/15/2014). PWC's tax consultant and partner, Thomas Quinn, referred to the interchangeable use of each other's parts as an "accommodation," rather than a "borrow." He advised that entities did not borrow back and forth, since that type of borrowing would create a problem. Instead, he described the activity as follows: if one of the parties ran out of its allocation in a bin, it would take parts allocated to the other party, but would replace those parts at later date from future deliveries. Subcommittee interview of Thomas Quinn, PWC (12/17/2013). See also 3/7/2014 "In the Matter of Caterpillar Inc.," Caterpillar Expert Witness Report, John P. Steines, Jr., Professor of Law, New York University, at PSI -Caterpillar-17-000003 - 023, at 5.

³²⁴ Deposition of Robin Beran in Schlicksup v. Caterpillar, PSI-TWLF-12-000065, at 58.

³²⁵ 3/13/2014 letter from Caterpillar's legal counsel to Permanent Subcommittee on Investigations, PSI-Caterpillar-18-000001 - 003, at 003.

³²⁶ Id.

³²⁷ Deposition of Jananne Copeland in Schlicksup v. Caterpillar, PSI-TWLF-15-000007, at 52-53.

³²⁸ 6/11/2005 memorandum from PWC Swiss Tax Team, "Morton," PwC_PSI_CAT_00206146 - 149.

³²⁹ Undated PWC report, "Caterpillar CTOP Summary of Ideas," PwC_PSI_CAT_00004566 - 631, at 618. See also 9/1998 PWC report, "Caterpillar Inc. Global Tax Optimization Case for Action," PwC_PSI_CAT_00004632, at 674.

³³⁰ Undated PWC report, "Caterpillar Inc. Operational Feasibility Analysis High Level Target Designs: Migration/Deferral," PwC-PSI-CAT-00004548 - 565, at 551. 7/14/1998 email from Steven Williams, PWC, to Thomas Quinn, PWC, and others, PwC_PSI_CAT_00204970 - 974.

³³¹ Caterpillar presentation, "Product Management Alignment," (1/9/2009), PwC-PSI-CAT-00224682 - 686, at 685.

³³² Subcommittee interviews of Robin Beran, Caterpillar (10/18/2013), Rodney Perkins, Caterpillar (1/15/2014), and Steven Williams, PWC (2/19/2014) (each acknowledging they analyzed the CSARL transaction under a transfer pricing analysis and indicating that it was not necessary to move personnel); James Bowers, PWC (1/23/2014). All documents discussing moving product managers to CSARL related to CSARL's entering into tolling agreements with Caterpillar's manufacturing facilities in Belgium and France; none related to parts. See, e.g., 6/1/1999 minutes of GloVE Steering Committee meeting, PwC_PSI_CAT_00168292 - 296, at 295 (proposal to move product managers to Geneva related to implementation of manufacturing tolling agreements).

³³³ William Springer, Caterpillar (11/7/2013). See also Deposition of William Springer in Schlicksup v. Caterpillar, at PSI-TWLF-18-000003, at 13.

³³⁴ Subcommittee interview of Sally Stiles, Caterpillar, Director of Global Tax and Trade Operations (9/4/2013).

³³⁵ 11/13/2006 PWC national office memorandum from Kevin Mitchell to Sharad Jain "Caterpillar Inc.," PSI-TWLF-21-000001 - 265, at 229. See also Subcommittee interview of Robin Beran (10/18/2013).

³³⁶ Deposition of Robin Beran in Schlicksup v. Caterpillar, at PSI-TWLF-10-000008, at 178.

³³⁷ Deposition of Edward Rapp in Schlicksup v. Caterpillar, at PSI-TWLF-19-000019, at 074.

³³⁸ Subcommittee interview of Jananne Copeland, Caterpillar (10/30/2013).

³³⁹ Deposition of Jananne Copeland in Schlicksup v. Caterpillar, PSI-TWLF-15-000018, at 39.

³⁴⁰ Subcommittee interviews of Robin Beran, Caterpillar (10/18/2013) and Rodney Perkins, Caterpillar (1/15/2014). See also servicing agreements.

³⁴¹ 3/7/2014 "In the Matter of Caterpillar Inc.," Caterpillar Expert Witness Report, John P. Steines, Jr., Professor of Law, New York University, at PSI-Caterpillar-17-000003 - 023, at 007. See also 12/3/2013 Caterpillar response to Subcommittee Questionnaire, CAT-000270 - 298, at 296.

³⁴² 4/13/2010 Caterpillar report Global Tax & Trade Update, PwC_PSI_CAT_00205974 - 990, at 984.

³⁴³ 1/22/2008 Caterpillar presentation for meeting with Edward Rapp, Caterpillar Global Finance & Strategic Support, PSI-TWLF-19-000001 - 215, at 094. The additional tax costs would presumably be due to the growth of Caterpillar's pool of offshore earnings outpacing the amount of previously taxed income the company had on hand and available for repatriation to the United States without additional tax. Id.

³⁴⁴ 7/2/2002 PWC presentation, "CSARL Technology Ownership," PwC_PSI_CAT_00024791 - 808, at 797.

³⁴⁵ 2/28/2005 email from Robin Beran, Caterpillar, to David Burritt, Caterpillar, "Authorization to proceed with planning and ABP [sic] cost adjustment," PSI-TWLF-12-000008, at 315. The "significant additional tax costs" refers to the company's having to pay the U.S. corporate tax rate of up to 35% if the funds were to be repatriated to the United States.

³⁴⁶ Id.

³⁴⁷ 7/14/2006 memorandum from Robin Beran, Caterpillar, to David Burritt, Caterpillar, PSI-TWLF-16-000004, at 262-263.

³⁴⁸ 4/13/2010 Caterpillar Inc. presentation to Audit Committee, "Global Tax & Trade Update," PwC_PSI_CAT_00205974 - 990, at 984.

³⁴⁹ Id.

³⁵⁰ Id.

³⁵¹ 12/31/2011 PWC Audit Memo, "Review intercompany transaction including company reorganizations and significant agreements," PwC-PSI-CAT-00194435 - 436.

³⁵² See March 2014 "Foreign Indefinitely Reinvested Earnings: Balances Held by the Russell 1000; A Six-Year Snapshot," Audit Analytics, at 4.

³⁵³ Subcommittee interview of James Bowers, PWC (1/23/2014). See also 6/2004 "Presentation to Caterpillar Inc. Audit Committee," CAT -001899 - 939, at 912; 4/10/2007 "FIN 48 Adoption and Corporate Tax Update," at CAT-002037 and 040; 4/13/2010 Caterpillar Inc. presentation to Audit Committee, "Global Tax & Trade Update," PwC_PSI_CAT_00205974 - 990, at 982.

³⁵⁴ Subcommittee interview of James Bowers, PWC (1/23/2014).

³⁵⁵ 4/10/2007 "FIN 48 Adoption and Corporate Tax Update," at CAT-002041. FIN 48 stands for FASB Interpretation No. 48.

³⁵⁶ Caterpillar report, "Caterpillar Inc., Global Finance -- Tax Risk Management, World Class Global Finance Operations to Support Vision 2020," PSI-TWLF-4-000091 - 097, at 093.

³⁵⁷ 8/19/2005 email from David Burritt, Caterpillar, to Daniel Schlicksup, Caterpillar,"Re: Gene Fife -- 210 of 250 companies remove CFO when there is material weakness," PSI-TWLF-04-000131 ("This is exactly why we must step up the rigor on tax processes").

³⁵⁸ 2/21/2005 email from Deborah Schrader, Caterpillar, to Elaine Atchley, Caterpillar,"General Mailing -- Personnel Announcement," PSI-TWLF-04-000004.

³⁵⁹ For more about the Corporate Executive Board, see its website, http://www.executiveboard.com/exbd/about/index.page?.

³⁶⁰ Subcommittee interview of David Burritt, Caterpillar, former CFO (12/4/2013). See also 2/10/2006 email from David Burritt, Caterpillar, to Daniel Schlicksup, Caterpillar, "Re: Fw: Meeting re Tax Guardrails," PSI-TWLF-04-0038. See also 9/23/2005 email from David Burrett, Caterpillar, to Douglas Oberhelman, Caterpillar, and others, "FYI Only -- Meeting with Gene Fife on Sept 26," PSI-TWLF-04-000039.

³⁶¹ See "Caterpillar Inc., Global Finance-Tax Risk Management, World Class Global Finance Operations to Support Vision 2020, PSI-TWLF-16-000188 - 194, at 190.

³⁶² See 3/21/2006 TRGRs presentation with ratings chart, prepared by Caterpillar, PSI-TWLF-11-000225.

³⁶³ Id.

³⁶⁴ "Caterpillar Inc., Global Finance-Tax Risk Management, World Class Global Finance Operations to Support Vision 2020," at slide 6, PSI-TWLF-16-000188 - 194, at 193.

³⁶⁵ Rodney Perkins Deposition in Schlicksup v. Caterpillar, PSI-TWLF-10-000004, at 117.

³⁶⁶ 9/23/2005 email from David Burritt, Caterpillar CFO, to Douglas Oberhelman, Caterpillar Group President for Finance, "Meeting with Gene Fife on Sept 26," PSI-TWLF-04-000039.

³⁶⁷ 9/26/2005, Presentation re Global Tax Management, PSI-TWLF-04-000040-073, at 040 and 066. Subcommittee interview of Daniel Schlicksup (8/29/2013 - 8/30/2013).

³⁶⁸ See 10/28/2005 email from Robin Beran, Caterpillar, to Daniel Schlicksup, "Dec. audit commmtg," PSI-TWLF-04-000341 - 344 ("Gene was very excited about this when we met with him, indicated that he wants this [TRGRs] to be part of every audit committee meeting and obviously wanted it on the Dec agenda (Doug [Oberhelman] even mentioned that to us). I would ask, when was the last time Gene acted in this manner about a tax issue?").

³⁶⁹ 12/13/2005 Presentation re Global Tax Management, slides 1 and 27, PSI-TWLF-16-000167 - 180, at 167 and 180; Subcommittee interview of Daniel Schlicksup (8/29/2013 - 8/30/2013).

³⁷⁰ 1/3/2006 email from Rodney Perkins to Daniel Schlicksup, Jananne Copeland, and others, "Need asap please . . . creating Tax Ri[s]k Guard Rails," PSI-TWLF-04-000345-346; 2/7/2006 email from Dan Schlicksup to David Burritt, "Tax Risk Guard Rails-audex," PSI-TWLF-04-000978 ("David, I have a solid draft to the guard rails done. . . . I feel comfortable that if Gene [Fife] demanded to see something today and you came and got me, I could present the draft and get the Aud Comm comfortable that we are meeting our commitments."); 2/9/2006 email from Brad Halverson, CAT controller, to Daniel Schlicksup, "Tax Risk Guardrails, PSI-TWLF-04-000356-357; 2/10/2006 email from David Burrito to Daniel Schlicksup, "Meeting re Tax Guard Rails," PSI-TWLF-04-000358-359 ("Meeting with Brad Halverson and Robin Beran week of Mar 13 - 2 hours (BradH, RobinB, DanS, Janie Copeland) Meeting week of Feb 20 off-site, all day at Ivy Club (Rod, Sally, Gary, JamesC, Al, Robin, JohnC, DanS JanieC and Terri Pierpont) Meeting week of Feb 27 off-site, all day at Ivy Club (Rod, Sally, Gary, JamesC, Al, Robin, JohnC, DanS, JanieC and Terri Pierpont)." 02/27/2006 email from Daniel Schlicksup to David Burritt, "A/C meeting," PSI-TWLF-04-000089 ("We had a two offsite last week to finalize the guard rails. We have two more days next week to plot the tax positions on the guard rails.").

³⁷¹ Subcommittee interview of Rodney Perkins, Caterpillar (1/15/2014) and Robin Beran, Caterpillar (10/18/2013). Mr. Beran told the Subcommittee that CFO David Burritt formed the idea for the Tax Council.

³⁷² See, e.g., Subcommittee interview of Rodney Perkins, Caterpillar (1/15/2014). Mr. Perkins described two meetings on the tax risk guardrails project, each of which was "offsite" and about 1-2 days in length. He told the Subcommittee one additional meeting took place about a year after the initial meetings. Mr. Perkins said the meetings were very thorough, and everyone weighed in. He indicated that there was a sense in the meetings to move on as quickly as possible, but that the participants put in a good faith effort during the meetings. See also Sally Stiles Deposition in Schlicksup v. Caterpillar, PSI-TWLF-11-000008, at 65; Deposition of Rodney Perkins in Schlicksup v. Caterpillar, PSI-TWLF-10-000004, at 115; deposition of Robin Beran in Schlicksup v. Caterpillar, at PSI-TWLF-12-000008, at 32.

³⁷³ 3/21/2006 Tax Risk Guard Rails presentation, PSI-TWLF-11-000224 - 227.

³⁷⁴ 3/21/2006 TRGRs presentation, prepared by Caterpillar, ratings chart at PSI-TWLF-11-000225.

³⁷⁵ Id. Of the 15 tax positions it reviewed, the Tax Council rated the bundled royalty rate and the virtual inventory system as the third and sixth highest risk tax positions.

³⁷⁶ See, e.g., 1/11/2006 email from David Burritt to Daniel Schlicksup, "the Audit Committee & Tax Risk Guard Rails," PSI-TWLF-04-000076 ("Please plan to include in Feb advance material"); 2/9/2006 email from David Burritt to Dan Schlicksup, "Tax Risk Guard Rails," PSI-TWLF-04-000080 ("We need to move this forward . . . . The issue was not raised but I think we missed a due date. Let's make sure this gets included in the April material in 'final' form."); and 5/12/2006 email from David Burritt to Robin Beran "Audit Committee-June," PSI-TWLF-16-000217 ("I will call Ali but our instruction from Gene [Fife, Audit Committee Chairman] was on [tax risk] guard rails"); 5/12/2006 email from David Burritt to Robin Beran "Audit Committee- June" (responding to a question from Mr. Burritt about whether they were ready to present to the Audit Committee, Mr. Beran wrote: "We were done with them [the TRGRs] about 5 weeks ago.").

³⁷⁷ 6/13/2006 Audit Committee Presentation, "Income Tax Update," CAT 001949 - 1965; 6/13/2006 "Agenda Audit Committee," PSI-TWLF-16-000214 ("this presentation will provide an update on World Class Tax initiatives supporting our Global Finance Transformation, including "tax guard rails.") Robin Beran testified that the "Income Tax Update" presentation noted above looked like part of the presentation given to the Audit Committee in June, but he was unsure whether he gave the presentation. Deposition of Robin Beran in Schlicksup v. Caterpillar, PSI-TWLF-12-000008, at 114. The Subcommittee obtained from PWC a similar copy of a 6/13/2006 Audit Committee presentation, which was an attachment to an email between Robin Beran, Caterpillar, and James Bowers, PWC tax partner, which included an email that indicated the presentation was sent to Caterpillar senior executives Douglas Oberhelman and David Burritt. 6/8/2006 email from Robin Beran to James Bowers, "Fw: FYI - 2006 Corporate Tax Audit Committee Presentation," PwC_PSI_CAT_00004799 - 827. The attachment to this email set out plotted tax positions identifying risk for various positions including CSARL's Bundled Royalty rate and the Virtual Inventory. Id. at 827. It does not appear that these positions were presented to the Audit Committee at the June 2006 meeting. Neither Robin Beran nor the Audit Committee Chairman, Eugene Fife, recalled any details about the TRGRs presentation to the Audit Committee. Subcommittee interviews of Robin Beran, Caterpillar (10/18/2013) and Eugene Fife, Caterpillar (11/13/2013). In fact, Mr. Fife had no recollection of the phrase "Tax Risk Guard Rails." Former CFO David Burritt remembers the concept of TRGRs being discussed with the Audit Committee, but he does not recall whether the actual TRGRs were presented. Subcommittee interview of David Burritt, Caterpillar (12/4/2013).

³⁷⁸ Subcommittee interview of James Bowers, PWC tax partner (1/23/2014). He advised that the ratings were presented to the Audit Committee in April 2008.

³⁷⁹ Id.

³⁸⁰ Id.

³⁸¹ 8/11/2006 emails between Dan Schlicksup and David Burritt, "Tax Risk Guard Rails," PSI-TWLF-04-000126 - 128, at 127.

³⁸² Id. at 126.

³⁸³ 7/28/2006 email from Robin Beran to Dan Schlicksup, PSI-TWLF-04-000368.

³⁸⁴ Subcommittee interview of David Burritt, former Caterpillar CFO (12/4/2013); "Caterpillar Inc. Report to Audit Committee," PSI-TWLF-16-000114 - 124, at 121. The report was provided as part of Caterpillar's "World Class Tax Update" that it had "implemented the Tax Risk Guard Rails to reduce Risk and Complexity."

³⁸⁵ 3/21/2006 Tax Risk Guardrails, PSI-TWLF-04-000382; 10/15/2007 Tax Risk Guardrails, PSI-TWLF-04-000383; 3/18/2008 Tax Risk Guardrails, PSI-TWLF-04-000384 and 2/8/2006, Tax Risk Guardrails Criteria (draft), PSI-TWLF-04-000381.

³⁸⁶ 4/8/2008 Caterpillar "Global Tax Update," CAT-002087 - 112; 5/13/2008 email from James Bowers, PWC audit partner, to Sharad Jain, "Tax Presentation," PWC_PSI_CAT_00036773. Mr. Bowers advised the Subcommittee that the attachment to the email was presented to the Audit Committee. Subcommittee interview of James Bowers, PWC (1/23/2014).

³⁸⁷ Id. The presentation showed that Caterpillar's tax risk management processes were "robust," 4/8/2008 Caterpillar "Global Tax Update," CAT-002087 - 112, at 094.

³⁸⁸ 4/8/2008 Caterpillar "Global Tax Update," CAT-002087 - 112. See also 5/13/2008 email from James Bowers, PWC, to Sharad Jain "Tax Presentation" PwC_PSI_CAT_00036773.

³⁸⁹ 4/8/2008 Caterpillar "Global Tax Update," CAT-002087 - 112; 5/13/2008 email from James Bowers, PWC, to Sharad Jain, "Tax Presentation," PwC_PSI_CAT_00036773.

³⁹⁰ Id.

³⁹¹ 5/13/2008 email from James Bowers, PWC, to Sharad Jain "Tax Presentation" PwC_PSI_CAT_00036774 - 791, at 785.

³⁹² Subcommittee interview of Eugene Fife, Caterpillar Audit Committee Chair (11/13/2013).

³⁹³ Deposition of Robin Beran in Schlicksup v. Caterpillar, PSI-TWLF-12-000008, at 23.

³⁹⁴ Subcommittee interview of Robin Beran, Caterpillar (10/18/2013).

³⁹⁵ Subcommittee interview of Rodney Perkins, Caterpillar (1/15/2014). Mr. Perkins also advised the Subcommittee that he was more concerned with the adequacy of the amount of the licensing fees paid by CSARL, than the lack of a business purpose or economic substance in the CSARL transaction.

³⁹⁶ Subcommittee interview of David Burritt, former Caterpillar CFO (12/4/2013).

³⁹⁷ Robin Beran told the Subcommittee that he shared the anonymous letter with the IRS auditors stationed at the company. Subcommittee interview of Robin Beran, Caterpillar Tax Director (10/18/2013).

³⁹⁸ 5/6/2004 memorandum from Robin Beran, Caterpillar, to Douglas Oberhelman, Caterpillar, "Tax Concerns Raised by an Unnamed Source," PSI-TWLF-02-0001393 - 396, at 395.

³⁹⁹ Id.

⁴⁰⁰ Id. at 393.

⁴⁰¹ Id. at 394.

⁴⁰² 1/19/2007 email from Daniel Schlicksup, Caterpillar Global Tax Strategy Manager, to Robin Beran, Caterpillar, PSI-TWLF-02-000349 - 352, at 349.

⁴⁰³ Id. Mr. Schlicksup sent another email to Mr. Beran about the lack of economic substance in the CSARL transaction in March 2008. Mr. Beran responded: "I didn't get to mention it you . . . but it [is] covered extensively in 4 memos" prepared by outside counsel. 3/24/2008 email from Robin Beran, Caterpillar, to Daniel Schlicksup, Caterpillar, PSI-TWLF-02-000469.

⁴⁰⁴ 7/19/2007 email from Daniel Schlicksup, Caterpillar, to Debra Kuper, Caterpillar Senior Corporate Counsel, "FYI, I assume you want this information as it comes up," PSI-TWLF-02-000368; 8/14/2007 email from Daniel Schlicksup, Caterpillar, to James Buda, Caterpillar, "Tomorrow's Meeting," PSI-TWLF-02-000369 - 379.

⁴⁰⁵ 9/07/2007 email from Daniel Schlicksup, Caterpillar, to Nancy Snowden, Caterpillar Director of Business Resources, "OBP Complaint -- Accounting Practices-No. 2," PSI-TWLF-02-000387 - 392, at 387.

⁴⁰⁶ 4/1/2008 email from Daniel Schlicksup, Caterpillar, to Robin Beran, Caterpillar, "Pls review again before we send in AM," PSI-TWLF-07-000022.

⁴⁰⁷ 5/1/2008 memorandum from Daniel Schlicksup, Caterpillar, to the Caterpillar Executive Office (Douglas Oberhelman, Group President; and Edward Rapp, Group President), PSI-TWLF-02-001208 - 222.

⁴⁰⁸ Mr. Schlicksup was later demoted from his position in the Caterpillar tax department and filed a lawsuit against his employer charging retaliation under the Sarbanes-Oxley Act. Schlicksup v. Caterpillar, Case No. 09-1208 (C.D. Illinois, Peoria Division 2009). In 2012, the lawsuit was settled for an undisclosed amount and dismissed. One Caterpillar representative expressed the view that Mr. Schlicksup may have decided to file the lawsuit earlier and wrote emails while at the company to help his case.

⁴⁰⁹ Deposition of Rodney Perkins in Schlicksup v. Caterpillar, PSI-TWLF-10-000004, at 111. When the Subcommittee asked Mr. Perkins about his deposition testimony, he claimed that what he meant was that there was no advantage in a lower effective tax rate for the business units. This explanation didn't appear credible in the context of the questions and answers given during his deposition cited above.

⁴¹⁰ Deposition of Sally Stiles in Schlicksup v. Caterpillar , PSI-TWLF-11-000008, at 106-07; Subcommittee interview of Robin Beran, Caterpillar (10/18/2013).

⁴¹¹ Caterpillar presentation from Robin Beran, Caterpillar, to Edward Rapp, Caterpillar, Global Tax & Trade, PSI_TWLF_19_00090 - 097, at 093.

⁴¹² See 7/15/2011 "Guidance for Examiners and Managers on the Codified Economic Substance Doctrine and Related Penalties," prepared by the IRS, http://www.irs.gov/Businesses/Guidance-for-Examiners-and-Managers-on-the-Codified-Economic-Substance-Doctrine-and-Related-Penalties.

⁴¹³ Subcommittee interviews of Rodney Perkins, Caterpillar (1/15/14) and Jananne Copeland, Caterpillar (10/30/2013); Deposition of Jananne Copeland Schlicksup v. Caterpillar, PSI-TWLF-15-000007, at 39.

⁴¹⁴ Caterpillar Inc. Annual Report (Form-10K), at 8 (2/19/2013).

⁴¹⁵ 2/16/2010 "Caterpillar Inc., CSARL Permanent File, Chronological History: 1999-2010," PwC_PSI_CAT_00003406 - 463, at 409-410.

⁴¹⁶ Id.

⁴¹⁷ 12/3/2013 Caterpillar response to Subcommittee Questionnaire, CAT-000270 - 298, at 297.

⁴¹⁸ For more information about the proposed regulation, see background chapter of this report, Foreign Base Company Sales Income -- Manufacturing Exception.

⁴¹⁹ See Treas. Reg. § 1.954-3(a)(4)(iii).

⁴²⁰ 11/4/2008 emails between Steven Williams, PWC Managing Director, Global Transfer Pricing, and Thomas Quinn, PWC International Tax Service Partner, PwC_PSI_CAT_00033157 - 159.

⁴²¹ Id.

⁴²² See 11/6/2008 emails between Steven Williams, PWC, and Thomas Quinn, PWC, PwC_PSI_CAT_00033229 - 00033234.

⁴²³ 11/11/2008 email from Rodney Perkins, Caterpillar, to Thomas Quinn, PWC, "Exec Office Slides-Business Alignment," PwC_PSI_CAT_00033241; 11/11/2008 presentation, Caterpillar Inc., "2009 Business Alignment Update Briefing," PwC_PSI_CAT_00033242 - 252.

⁴²⁴ Id. at 245.

⁴²⁵ Id.

⁴²⁶ Id. at 247 and 350. See also 11/6/2008 email from Steven Williams, PWC, to Thomas Quinn, PWC, PwC_PSI _CAT_00033229 ("need five guys outside US to maintain CSARL benefits (250 in parts, 50+ in machines in normal years)").

⁴²⁷ 11/11/2008 email from Rodney Perkins, PWC, to Thomas Quinn, PWC, "Exec Office Slides-Business Alignment," PwC_PSI_CAT_00033241; 11/11/2008 presentation, Caterpillar Inc., "2009 Business Alignment Update Briefing," PwC_PSI_CAT_00033242 - 252.

⁴²⁸ 1/9/2009 email from Michael Murphy, PWC, to Steven Williams, PWC, "CAT Slides," PwC_PSI_CAT_00224682; 2009 presentation, Caterpillar Inc., "Product Management Alignment," PwC_PSI_CAT_00224683 - 686, at 685.

⁴²⁹ 12/05/2008 email from Rodney Perkins, PWC, to Thomas Quinn, PWC, "Business Alignment-Product Manager Conference Calls-Global Tax Observations," PwC_PSI_CAT_00060748 - 749.

⁴³⁰ Id.

⁴³¹ PWC presentation, "Caterpillar Inc. CSARL 2009 activities Report to Audit Team January 2010," PwC_PSI_CAT_0003830 - 0003875, at 833 [emphasis in original]. See also 12/3/2013 Caterpillar response to Subcommittee Questionnaire, CAT-000270 - 298, at 281-293.

⁴³² 12/3/2013 Caterpillar response to Subcommittee Questionnaire, CAT-000270 - 298, at 286; PWC presentation, "Caterpillar Inc. CSARL 2009 activities Report to Audit Team January 2010," PwC_PSI_CAT_0003830 - 875, at 848.

⁴³³ 12/3/2013 Caterpillar response to Subcommittee Questionnaire, CAT-000270 - 298, at 286.

⁴³⁴ 5/17/2010 email from Michael Murphy, PWC Manager Autonomy and Technology, to Steven Williams, PWC, "WW Parts Manager," PwC_PSI_CAT_00213059 - 064, at 063.

⁴³⁵ PWC presentation, "Caterpillar Inc. CSARL 2009 Activities Report to Audit Team January 2010," PWC_PSI_CAT_0003830 - 875, at 847.

⁴³⁶ Id. at 848.

⁴³⁷ 3/15/2010 "Caterpillar Inc. Worldwide Parts Management Final Closing Book, Draft Version as of March 15, 2010," PwC_PSI_CAT_00003876 - 168, at 882.

⁴³⁸ Id. at 888-891 and 906-912.

⁴³⁹ Subcommittee interview of David Picard, Caterpillar (3/4/2014).

⁴⁴⁰ Caterpillar's legal counsel sent the Subcommittee a letter identifying four key parts personnel who were transferred to CSARL in connection with the restructuring of the Swiss entity, COSA: "[T]here has been substantial movement of personnel with significant responsibilities within, and to, Switzerland including: (i) the promotion of a Vice-President as a new Group President responsible for all of EAME operations, (ii) the movement of several Product Managers to Switzerland, and (iii) the appointment of a Parts Purchasing Manager in Switzerland. Further, the Worldwide Parts Manager was later located in Switzerland together with a newly appointed Vice-President in Singapore." 9/23/2013 Caterpillar letter to the Subcommittee, PSI-Caterpillar-04-000001 - 009, at 004. In a subsequent letter, Caterpillar's legal counsel provided additional detail about the positions shifted to CSARL after its creation, and included a list of more than three dozen positions, many of which had already been located in Switzerland. The list was composed primarily of positions at the manager level. 12/3/2013 Caterpillar response to Subcommittee Questionnaire, CAT-000270 - 298, at 281-93. The listed positions appear to have been primarily regional in focus, often associated with CSARL's tolling agreements with Caterpillar's Belgian and French manufacturing facilities, and seemed to bear little direct connection with or responsibility for the company's global parts business. For example, Gerard Vittecoq, who was a managing director in Caterpillar Belgium S.A., responsible for the Belgium manufacturing facilities, moved to CSARL and became the Vice President of EAME. His new responsibilities included "joint responsibility with the newly created Product Development Division for EAME, excluding Marketing." He also had responsibility for enterprise profitability for manufacturing facilities within EAME. His responsibilities appear to have been limited to the machines manufactured in EAME, and included only a minimal role at best in connection with the global PFRP parts business or third party parts suppliers. Another example offered in the letter was the promotion of Edward Rapp, who became Vice President for EAME Marketing. Mr. Rapp, who served in Geneva between 1995 and 2004, received this promotion without changing his location. Mr. Rapp, who presumably had day-to-day contacts with EAME dealers, testified at a deposition in 2011, that while in Geneva he was familiar with CSARL's predecessor, COSA, but had not heard of CSARL. Deposition of Edward Rapp in Schlicksup v. Caterpillar, PSI-TWLF-19-000001, at 74.

⁴⁴¹ 3/27/2014 Information provided by Caterpillar to the Subcommittee, PSI-Caterpillar-21-000001 - 002.

⁴⁴² 3/7/2014 "In the Matter of Caterpillar Inc.," Caterpillar Expert Witness Report by John P. Steines, Jr., Professor of Law, New York University, PSI-Caterpillar-17-000003 - 023, at 017 - 018.

⁴⁴³ Subcommittee interviews of Robin Beran, Caterpillar (10/18/2013) and Rodney Perkins, Caterpillar (1/15/2014). Those issues are addressed below.

⁴⁴⁴ See Treas. Reg § 1.482-1(b).

⁴⁴⁵ See Treas. Reg § 1.482-1(b) Arm's length standard ("In determining the true taxable income of a controlled taxpayer, the standard to be applied in every case is that of a taxpayer dealing at arm's length with an uncontrolled taxpayer. A controlled transaction meets the arm's length standard if the results of the transaction are consistent with the results that would have been realized if uncontrolled taxpayers had engaged in the same transaction under the same circumstances (arm's length result). However, because identical transactions can rarely be located, whether a transaction produces an arm's length result generally will be determined by reference to the results of comparable transactions under comparable circumstances.").

⁴⁴⁶ Caterpillar's 1995 transfer pricing documentation described the portion of parts profits allocated to Caterpillar's Swiss marketing affiliate as 4% of the cumulative 30% return on part sales earned by Caterpillar. 12/19/1996 "Caterpillar Inc. Evaluation of Arm's Length Pricing for Intercompany Transactions Year Ended December 31, 1995," PwC_CAT_PSI_00008881 - 104, at 959. See also 11/14/2005 "Caterpillar SARL 2006-2012 Royalty Rate: Options and Implications," PwC_PSI_CAT_00133127 - 180, at 164; 3/7/2014 "In the Matter of Caterpillar Inc.," Caterpillar Expert Witness Report by John P. Steines, Jr., Professor of Law, New York University, at PSI-Caterpillar-17-000003 - 023, at 007; Subcommittee interview of Thomas Quinn, PWC (12/17/2013).

⁴⁴⁷ See 3/7/2014 "In the Matter of Caterpillar Inc.," Caterpillar Expert Witness Report by John P. Steines, Jr., Professor of Law, New York University, at PSI-Caterpillar-17-000003 - 023, at 006.

⁴⁴⁸ See id. at 003 - 004.

⁴⁴⁹ 12/3/2013 Caterpillar response to Subcommittee Questionnaire, CAT-000270 - 298, at 277.

⁴⁵⁰ 11/14/2005 "Caterpillar SARL 2006-2012 Royalty Rate: Options and Implications," PwC_PSI_CAT_00133127 - 180; 9/23/2013 Caterpillar Letter to Subcommittee, PSI-Caterpillar-000002 - 009, at 004 (CSARL license permitted it "to make, purchase, use, offer for sale, sell, and/or import" PFRPs in exchange for paying an "arm's length" annual royalty).

⁴⁵¹ 9/23/2013 Caterpillar Letter to the Subcommittee, PSI-Caterpillar 000001 - 009, at 003.

⁴⁵² Id. at 007.

⁴⁵³Ciba-Geigy Corp. v. Comm'r, 85 T.C. 172, 229 (1985).

⁴⁵⁴ See, e.g., Eli Lilly & Co. v. Commissioner, 84 T.C. 996 (1985), rev'd in part and aff'd in part, 856 F.2d 855 (7th Cir. 1988) (approving 55/45 profit split); G.D. Searle & Co. v. Commissioner, 88 T.C. 252 (1987) (approving 44/66 profit split); Bausch & Lomb, Inc. v. Commissioner, 92 T.C. 525, 584 (1989), aff'd, 933 F.2d 1084, 1089 (2d Cir. 1991) (approving 50/50 profit split).

⁴⁵⁵ When Caterpillar's PWC tax consultants were asked if true unrelated parties would ever give away income in this manner, they deflected the question, responding that the transaction merely needed to be justified under current transfer pricing rules. Subcommittee interviews of Thomas Quinn, PWC (12/17/2013) and Steven Williams, PWC (2/19/2014).

⁴⁵⁶Lucas v. Earl, 281 U.S. 111 (1930). In Lucas, a man attempted to lower his tax payments by assigning the legal right to his work income, through contract, to his wife. The court determined that the husband had performed the work accruing the right to the income, with no role played by his wife, and that his income could not be assigned to her. The court wrote:

⁴⁵⁷ See 10/5/1999 "Caterpillar Inc. Global Value Enhancement Project Draft", PwC_PSI_CAT_00004483 - 530, at 508.

⁴⁵⁸ 11/14/2005 "Caterpillar SARL 2006-2012 Royalty Rate: Options and Implications," PwC_PSI_CAT_00133127 - 180, at 148.

⁴⁵⁹ 2/16/2010 "Caterpillar Inc. CSARL Permanent File Chronological History: 1999-2010," PwC_PSI_CAT_00003406 - 463, at 406.

⁴⁶⁰ See 10/5/1999 "Caterpillar Inc. Global Value Enhancement Project Draft," PwC_PSI_CAT_00004483-530, at 498.

⁴⁶¹ 8/30/2013 Caterpillar response to Subcommittee Questionnaire, CAT-000066 - 108, at 076.

⁴⁶² Caterpillar Inc. Annual Report (Form-10K), at A-17 and A-18 (1997).

⁴⁶³ In 2012, 54% of Caterpillar machines and nearly 70% of Caterpillar replacement parts sold abroad were manufactured in the United States. 1/14/2014 Caterpillar Response to Subcommittee Questionnaire, CAT-000299 - 303, at 302.

⁴⁶⁴ 11/26/2013 letter from Caterpillar to Subcommittee, CAT-000267 - 269, at 268. Since Caterpillar has no parts warehouses in Switzerland, CSARL's remaining parts are stored in warehouses and distribution centers located in a variety of other countries around the world.

⁴⁶⁵ See 3/7/2014 "In the Matter of Caterpillar Inc.," Caterpillar Expert Witness Report by John P. Steines, Jr., Professor of Law, New York University, at PSI-Caterpillar-17-000003 - 023, at 007; Subcommittee Interview of Thomas Quinn, PWC (10/2/2013).

⁴⁶⁶ See 3/7/2014 "In the Matter of Caterpillar Inc.," Caterpillar Expert Witness Report by John P. Steines, Jr., Professor of Law, New York University, at PSI-Caterpillar-17-000003 - 023, at 007.

⁴⁶⁷ See IRC § 956(c)(2)(B).

⁴⁶⁸ See, e.g., Commissioner v. Culbertson, 337 U.S. 280 (1949).

⁴⁶⁹ See Subcommittee interview of Thomas Quinn, PWC (12/17/2013).

⁴⁷⁰ 3/13/2014 letter from Caterpillar's legal counsel to Permanent Subcommittee on Investigations, PSI-Caterpillar-18-000001 - 003, at 003.

⁴⁷¹ See, e.g., Commissioner v. Culbertson, 337 U.S. 280 (1949) (stating that the relevant inquiry is to determine whether the parties in good faith and acting with a business purpose intended to join together in the conduct of a joint enterprise for profit). The Tax Court has also set forth a list of factors that courts have used to evaluate this factual inquiry. See Luna v. Commissioner, 42 T.C. 1067 (1964).

⁴⁷² See Article 7(2) of the Swiss-U.S. Bilateral Income Tax Treaty (1996).

⁴⁷³ 9/8/2009 "CSARL Briefing," prepared by PWC, PWC_PSI_CAT_00093950 - 992, at 981.

⁴⁷⁴ See 12/3/2013 Caterpillar response to Subcommittee Questionnaire, CAT-000270 - 298, at 277; 1/14/2014 Caterpillar response to Subcommittee Questionnaire, CAT-000299 - 303, at 301.

⁴⁷⁵ 4/18/1996 "Caterpillar Inc. Evaluation of Arm's Length Pricing for Intercompany Transactions Year Ended December 31, 1994," PwC_CAT_PSI_00008634 - 880, at 673.

⁴⁷⁶ See undated, unattributed handwritten PWC notes, PwC_PSI_CAT_00011180 - 183, at 181; 3/7/2014 "In the Matter of Caterpillar Inc.," Caterpillar Expert Witness Report by John P. Steines, Jr., Professor of Law, New York University, at PSI-Caterpillar-17-000003 - 023, at 007.

⁴⁷⁷ 12/1998, Caterpillar Inc., Global Tax Optimization, Risk Adjusted Benefit Analysis, Working Papers - Draft 1," PWC-PSI-CAT-00001336 - 671, at 412.

⁴⁷⁸ Id. Caterpillar's tax consultant also told the Subcommittee that PWC realized it took a risk in changing the intercompany transfer pricing method and documentation for the company. Subcommittee interview of Thomas Quinn, PWC (12/17/2013). See also 12/1998, Caterpillar Inc., Global Tax Optimization, Risk Adjusted Benefit Analysis, Working Papers - Draft 1," PWC-PSI-CAT-00001336 - 671, at 411 (identifying as a "Risk" the "change from current intercompany pricing method and documentation").

⁴⁷⁹ Subcommittee interview of Steven Williams, PWC (2/19/2014).

⁴⁸⁰ Subcommittee interview of Thomas Quinn, PWC (10/2/2013; 12/17/2013); 9/1998 PWC report, "Caterpillar Inc. Global Tax Optimization Case for Action," PwC_PSI_CAT_00004632, at 675-76; 12/1998 Caterpillar Inc., Global Tax Optimization Risk Adjusted Benefit Analysis, Working Papers -- Draft 1" prepared by PWC, PwC_PSI_CAT_00001411, at 412.

⁴⁸¹ 12/19/1996 Caterpillar Inc. Evaluation of Arm's Length Pricing for Intercompany Transactions, Year Ended December 31, 1995, Prepared by Price Waterhouse LLP, Final Report, PwC_CAT_PSI_00008881 - 971, at 930 - 971.

⁴⁸² Id. at 929.

⁴⁸³ Id. at 931.

⁴⁸⁴ 9/17/2001 "Caterpillar Fiscal Year 2000 Transfer Pricing Documentation Report," PwC_CAT_PSI_00004975 - 162, at 029 - 030. This same language was repeated in Caterpillar's report the following year. 9/16/2002 Caterpillar U.S. Transfer Pricing Documentation Report Year Ended December 31, 2001, PwC_CAT_PSI_00005163 - 305, at 212-213.

⁴⁸⁵ 9/17/2001 "Caterpillar Fiscal Year 2000 Transfer Pricing Documentation Report," PwC_CAT_PSI_00004975 - 162, at 032.

⁴⁸⁶ 11/6/1998 PWC memorandum from John Hatch to Charles Larson and Steven Williams, "Subject: CAT and COSA," PwC_PSI_CAT_00169827 - 838, at 827.

⁴⁸⁷ Id. at 832.

⁴⁸⁸ Id. at 828. "The analysis should make clear the difficulties faced in trying to quantify a share of profits from parts sales attributed to the field population." Id. at 830.

⁴⁸⁹ Id. at 828.

⁴⁹⁰ Id. at 836.

⁴⁹¹ Id. at 834.

⁴⁹² Id. at 836.

⁴⁹³ 4/18/1996 "Caterpillar Inc. Evaluation of Arm's Length Pricing for Intercompany Transactions Year Ended December 31, 1994," PwC_CAT_PSI_00008634 - 880, at 685.

⁴⁹⁴ See, e.g.,12/3/2013 Caterpillar response to Subcommittee Questionnaire, CAT-000270 - 298, at 295.

⁴⁹⁵ Caterpillar Inc., Economic Analysis of Intangible Assets Transferred by Caterpillar Americas Co. to Caterpillar Americas Sarl Prepared by Price Waterhouse Coopers, PwC_PSI_CAT_00142353 -- 00142367, at 357.

⁴⁹⁶ Id.

⁴⁹⁷ Id.

⁴⁹⁸ Id.

⁴⁹⁹ 11/26/2001 Caterpillar Inc., "Economic Analysis of Intangible Assets Transferred by Caterpillar Americas Co. to Caterpillar Americas Sarl Prepared by Price Waterhouse Coopers," PwC_PSI_CAT_00142353 - 389, at 357.

⁵⁰⁰ Id. at 367.

⁵⁰¹ Id. at 356.

⁵⁰² Id.

⁵⁰³ 7/9/2007 email from Steven Williams, PWC, to Christopher Dunn, PWC, PwC_PSI_CAT_00122483 - 484.

⁵⁰⁴ 3/2005 "Caterpillar Inc. Summary Meeting Notes, Revised Draft," from March 7-9, 2005 meeting in Geneva, PwC_PSI_CAT_00150466 - 488, at 469.

⁵⁰⁵ Subcommittee interview of David Burritt, former Caterpillar CFO (12/4/2013).

⁵⁰⁶ See 3/7/2014 "In the Matter of Caterpillar Inc.," Caterpillar Expert Witness Report by John P. Steines, Jr., Professor of Law, New York University, at PSI-Caterpillar-17-000003 - 023, at 007 (describing the 4% share as "a relatively small gross profit").

⁵⁰⁷ 12/19/1996 "Caterpillar Inc. Evaluation of Arm's Length Pricing for Intercompany Transactions Year Ended December 31, 1995," PwC_CAT_PSI_00008881 - 104, at 959.

⁵⁰⁸ 8/22/2008 "Delivering Vision 2020 Value Transformation: An After-Tax View," PwC_PSI_CAT_00058419 - 472, at 446 - 47. According to PWC, prior to Mr. Fites' setting the across-the-board share of accountable profits for Caterpillar marketing companies in 1992, Caterpillar had split the non-U.S. residual parts profits with the marketing companies on a 50/50 legal entity basis. The U.S. share of the sales profits were reported as U.S. taxable income on Caterpillar's U.S. tax return, while the marketing companies' share was also reported on Caterpillar's tax return as Subpart F income. Subcommittee interview of Steven Williams, PWC (2/19/2014).

⁵⁰⁹ See undated, unattributed handwritten PWC notes, PwC_PSI_CAT_00011180 - 183, at 181 ("don't want to change accountabilities. People won't like"); "Caterpillar Inc. Operational Feasibility Analysis High Level Target Designs: Migration/Deferral," prepared by PWC, PWC_PSI_CAT_00004548 - 565, at 552 ("Preliminary Operational Issues: . . . (3) Reconciliation of divergence between legal entity and accountable profit.").

⁵¹⁰ See also 12/1998, Caterpillar Inc., Global Tax Optimization, Risk Adjusted Benefit Analysis, Working Papers -- Draft 1," PWC-PSI-CAT-00001336 - 671, at 415, at 411-413 [emphasis omitted from original].

⁵¹¹ Id. at 413. See also 9/2006 "Caterpillar European Business Model Review, PwC_PSI_CAT_00028030 - 095, at ("Accountable (vs legal entity) concepts are often referred to. However the key personnel who would be involved in a tax audit are well educated regarding legal entity. The risk of people in the business without an understanding of the differences between the two should be closely managed.").

⁵¹² Subcommittee interview of Janie Copeland, Caterpillar (10/30/2013). Ms. Copeland told the Subcommittee that it was understood that CSARL and its related transaction would impact the legal entity reported profits, but the CSARL changes were required to have a "zero impact" on the accountable for the business units. See also 1/16/2003 CNAMSARL Accounting Guidebook, PSI-TWLF-10-000173.

⁵¹³ Subcommittee interview of Jananne Copeland, Caterpillar (10/30/2013). Ms. Copeland told the Subcommittee that in the mid-2000s, the accountable profits system changed. The marketing groups no longer were allocated accountable profits, but instead were to be treated cost centers; any profits were instead reallocated to the product groups.

⁵¹⁴ See 9/23/2013 letter from Caterpillar to the Subcommittee, PSI-Caterpillar-04-000001 - 009.

⁵¹⁵ Id. at 004.

⁵¹⁶ Id.

⁵¹⁷ Subcommittee interview of Thomas Quinn, PWC (12/17/2013).