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A bombshell report from Bloomberg Businessweek on the inner workings of an alleged tax evasion scheme inside Caterpillar says the man who alerted authorities could walk away with the biggest paycheck of any U.S. whistleblower to date, and paints a not-so-pretty picture for Cat as a federal investigation into the company continues.
According to the report, Daniel Schlicksup, a once highly-trusted member of Cat’s corporate accounting team, began warning company executives of the illegality of the alleged tax scheme as early as 2007. But, citing Schlicksup’s testimony and affidavits, Bloomberg reports that his superiors and members of the Cat executive team not only ignored Schlicksup’s warnings, but moved him away from the company’s accounting team and allegedly made veiled threats to deter him from going to the media with his allegations.
Federal law enforcement officials raided three Cat facilities in early March as part of an investigation into the company’s tax strategy stemming from a lawsuit filed by Schlicksup against Cat in 2009. The suit alleged the company used what he referred to as a “Swiss structure” and a “Bermuda structure” to avoid paying taxes by moving select profits to offshore shell companies located in Switzerland and Bermuda.
The company has been accused of avoiding more than $2 billion in taxes using the scheme and as a result, the IRS reviewed Cat’s 2007 to 2009 tax returns and levied $1 billion in penalties and increased taxes in early 2015. Among those penalties was a retroactive taxing of profits earned from Caterpillar SARL, a Switzerland-based parts subsidiary.
The lengthy Bloomberg report provides greater detail into the alleged scheme, Schlicksup’s many years of efforts to alert the company’s leadership and portrays Caterpillar executives as at best ignoring the warnings and at worst working to cover up the scheme and silence Schlicksup.
An interesting detail from the report is that Schlicksup could walk away from this mess with a major payday. Since the IRS contends that Cat owes about $2 billion, and because the agency pays whistleblowers between 15 and 30 percent of what it collects, Schlicksup could get a check for up to $600 million.
Schlicksup, who owns several law and finance degrees, joined Cat in 1992 and, according to the Bloomberg report, worked in Brussels, Belgium, and Geneva, Switzerland, between 1996 and 2000 to establish “Cat’s first overseas tax department.” The Geneva office, according to the report, was opened in 1960 as a way to establish a global dealer network. Forty years later, the office would begin overseeing global distribution of replacement parts.
And that’s where, according to Schlicksup, Cat began heading down an illegal path. An excerpt from the Bloomberg report details the genesis of the company’s alleged illegal tax scheme:
For years, Caterpillar accountants credited the Geneva office with 15 percent of the profits on parts sales, while the other 85 percent was allocated as earnings in the U.S. The company paid an effective tax rate of a little less than 30 percent on those U.S. profits. Around the time Schlicksup arrived in Geneva, Caterpillar embarked on a dramatic change in that accounting, led by Robin Beran, a tax manager in Peoria.
With the encouragement of [PricewaterhouseCoopers], where he’d once worked, and the law firm McDermott Will & Emery LLP, Beran reorganized the Geneva operation as Caterpillar Société à Responsabilité Limitée LLC, or CSARL. The move involved more than 70 transactions touching dozens of shell companies in more than a dozen countries, according to Schlicksup’s federal court filings. The objective: to cut the company’s tax bill so Cat could compete better with Komatsu Ltd. and other foreign rivals that enjoyed lower corporate tax rates. In planning documents, PwC said, ‘We are effectively more than doubling the profit on parts.’
For all its complexity, the basics are easy enough to understand: Caterpillar essentially flipped the parts profit allocation so the new Swiss entity would be credited with 85 percent of the income on those sales. The company then paid taxes on those earnings at rates ranging from 4 percent to 6 percent, as negotiated with the Swiss tax authorities.
The report goes on to allege that Cat “wound up effectively keeping two sets of books. The public one attributed the bulk of parts profits to Geneva…” while “an internal ledger known as ‘accountable profits’ tracked the operating income of the divisions and calculated employee bonuses accordingly.”
In other words, Cat’s Morton, Illinois, facility ran the company’s parts operation (and its leadership reaped the rewards) while the overseas offices were credited with the profits.
Seeing all of this, Schlicksup says he warned his supervisors and executive leadership at Cat that “there seemed to be no reason for CSARL to exist other than to lower taxes.” If federal investigators were to find that to be true, Cat’s tax strategy would be in violation of U.S. tax law, which, according to the report, “requires a corporate structure to have clear ‘economic substance.'”
In response to his warnings, Schlicksup says he was moved to Cat’s information technology division albeit with a 7-percent raise. He initially resisted the transfer as “he wasn’t well-versed in IT and thought the shift would make him less valuable to the company, with fewer opportunities for advancement,” according to Bloomberg. But he eventually accepted the new position after being told it was “his only option,” and that same year filed his lawsuit.
He continued to work for the company as the suit was heard and things were understandably tense between Schlicksup and his superiors. Schlicksup said he was essentially trapped at the company. “The message to me was clear,” he said in a testimony, according to the Bloomberg report. “We’re going to hurt you a little, and if you don’t keep quiet, we’re going to hurt you a lot.”
Schlicksup and Cat eventually settled the lawsuit in 2012. Terms were not disclosed.