Update information. Original WORK ONLY

Introduction

In March 2017, federal agents raided three Caterpillar office buildings in Illinois in an effort to determine whether the heavy equipment manufacturers had shifted corporate profits from the United States to a subsidiary in Switzerland in order to evade domestic taxes (Yu, 2017). The move was also seen as intended to hike the company’s stock price. This work analyzes the audit report by the CPA, and ascertains the legal liability to third parties who relied on the financial statements.

Caterpillar’s Tax and Accounting Fraud

In 2017, federal investigators found that Caterpillar had failed to submit required paperwork tied to exports in recent years. The investigators explained that there are discrepancies between Caterpillar’s regular fillings and what had been submitted by the company to the authorities (Drucker, 2017). The Internal Revenue Authority suggested that the company was trying to depress its tax liability in the United States by an estimated $2 billion by assigning it revenue from the sales of replacement parts to its subsidiary in Switzerland. Since its subsidiary is located in a country with lower federal tax liabilities, the company would be expected to pay less in taxes. Caterpillar rejected the evidence of tax evasion.

This is not the first instance that the company has been investigated for tax evasion. In 2014, the Securities and Exchanges Commission investigated accounting fraud in the company that saw it record its profits from the sale of replacement parts made in the United States in the books of its subsidiary in Switzerland. However, that investigation was closed in 2015 after no critical evidence was collected. The recent investigations are focusing on the company because of suspect tax and accounting fraud presented to the authorities by a professor at Dartmouth’s Tuck School of Business.

Legal Liabilities to Third Parties

Although the investigations of accounting fraud have not been completed, the accusations made towards Caterpillar have provided several insights on the case. The case is closely linked with tax evasion, which has interested the Internal Revenue Authority. Since the United States has one of the highest corporate tax rates of all the developed nations, many multinationals hold their revenues in foreign economies to avoid the hefty taxation rate associated with bringing their funds back to the domestic market. Although this is accepted, it only applies where such revenues are obtained from foreign markets. All of the revenues obtained from operations conducted in the United States have to be declared, and taxed based on the schemes applicable within the nation’s jurisdiction.

As a publicly trading company, there are legal requirements that the company has to meet (Giroux, 2008). In this case, the most significant third parties are the regulators and investors. When the raid was done on Caterpillar offices in 2017, the company’s stock price dropped by 4.2% on the day. It is in the place of the company to offer any information relating to the transfer of its profits to the relevant authorities, and especially the IRS. Since such a transaction would not have a profound impact on investors, the decision would be on the company to reveal any such transactions.

Sanctions under SOX

As a result of the Sarbanes-Oxley Act, the management of companies are individually responsible for the accuracy of financial information provided to all parties. SOX increased the oversight responsibility of the board of directors on matters relating to financial reporting, and guaranteed the independence of auditors hired by companies when reviewing the accuracy of all financial reports (Yu, 2017). If sham transactions to transfer billions of dollars in profit to a subsidiary of the multinational are found to be true, the top management will be liable to respond to the charges made against the company. According to SOX, it is the responsibility of the top management to certify the accuracy of all reported financial information.

The company’s auditors, PricewaterhouseCoopers (PwC) have also been incriminated in the Dr. Robinson’s report that states that the company worked with Caterpillar to set up a strategy to cut on tax liability. The United States implements a corporate income tax rate of 35% on profits earned around the world. However, regulators permit entities to defer the taxes owed on the profits generated until they are brought back to the country. PwC has been incriminated in designing a strategy that would see the company report its domestic earnings as the earnings of a foreign-based subsidiary. SOX requires independent auditors to be liable for the financial information reported. Therefore, PwC would be found liable if the investigations establish the validity of the allegations.

Recommendation

As a result of SOX, the Public Company Accounting Oversight Board (PCAOB) was commissioned to oversee the activities of the auditing profession in the country (Khademian, 2002). The Sarbanes-Oxley Act allowed the PCAOB to impose penalties for fraudulent financial activities. In this case, the ongoing investigations should determine how much the company has evaded in taxes and impose monetary penalties that would see the government receive the avoided amount, and make in less likely for others to use the same strategies.

References

Drucker, J. (2017, March 7). Caterpillar Is Accused in Report to Federal Investigators of Tax

Fraud. Retrieved from The New York Times: https://www.nytimes.com/2017/03/07/business/caterpillar-tax-fraud.html

Giroux, G. (2008). What Went Wrong? Accounting Fraud and Lessons from the Recent

Scandals. Social Research, 74(5), 1205-1209.

Khademian, A. M. (2002). The Securities and Exchange Commission: A Small Regulatory

Agency with a Gargantuan Challenge. Public Administration Review, 62(5), 514-522.

Yu, R. (2017, March 8). Caterpillar shares fall after tax, accounting fraud report. Retrieved from

USA Today: https://www.usatoday.com/story/money/2017/03/08/caterpillar-shares-fall-after-tax-accounting-fraud-report/98892874/