You think you were mad when we locked you out of the site for a few hours this morning? Wait until you read this.
First, get caught up on the whole Caterpillar sitch from Bloomberg View:
The idea behind the ban on information-technology consulting was to promote auditor independence — which is the legal fiction that an accounting firm should stay at arm's length from its audit clients, even though that's impossible because the clients pay the auditor's fees.
Yet Congress and the accounting firms' regulators continue to let audit firms do tax-consulting work for audit clients. Why is that? The short answer is that the accounting profession has very good lobbyists, and tax consulting is a lucrative business. Aside from that, there isn't a good reason.
Today the Senate Permanent Subcommittee on Investigations is holding a hearing that spotlights an offshore tax strategy that Caterpillar Inc. bought more than a decade ago from its auditor, PricewaterhouseCoopers LLP. The shelter, which involved shifting profits to Switzerland from the U.S., saved Caterpillar more than $2.4 billion, according to the panel's chairman, Carl Levin. Pricewaterhouse charged Caterpillar more than $55 million for its services. Nice trade, as they say on Wall Street.
However you might feel about the Big 4 a la carte menu, and however little you know about how all this works, there is no way you can read the following and not get at least a little irritated.
This is directly from the Senate Permanent Subcommittee on Investigations majority staff report [PDF]:
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 3 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.
Wow, that sounds great. Well, if you're Caterpillar. But then you get to this part, where PwC is practically laughing all the way to the bank and not even ashamed of it:
In November 2008, an email exchange between two PWC transfer pricing experts assigned to Caterpillar discussed the possible problems with CSARL. Steven Williams, a PWC Managing Director, wrote:
“[J]ust curious—say they [Caterpillar] decide most PMs [Product Managers] stay in U.S. How do we retain CSARL parts profits if those ‘US entrepreneurs’ claim both machine AND parts profit?”
Thomas Quinn, a PWC tax partner who helped design the CSARL transaction, replied:
“PMs in US will put some pressure on the parts profit model. These guys are really bought into the PM is king concept. We are going to have to create a story that will put some distance between them [product managers] and parts (eg. all the parts that are non- current) to retain the benefit. Get ready to do some dancing.”
Mr. Williams responded:
“What the heck. We’ll all be retired when this audit comes up on audit. [Edward] Bodnam and [C]hris Dunn will have to solve it. Baby boomers have their fun, and leave it to the kids to pay for it.”
GUYS. This is not even an April Fool's joke.
We'll dig into the report further but just wanted to share that bit with you in the meantime. Feel free to express your rage in the comments.