CAYMAN ISLANDS: Top Iraq contractor skirts US taxes offshore

Shell companies in Cayman Islands allow KBR to avoid Medicare, Social Security deductions
Publisher Name: 
The Boston Globe

CAYMAN ISLANDS - Kellogg Brown & Root, the nation's top Iraq war contractor and until last year a subsidiary of Halliburton
Corp., has avoided paying hundreds of millions of dollars in federal
Medicare and Social Security taxes by hiring workers through shell
companies based in this tropical tax haven.

When
Texas pipe-fitter Danny Langford applied for unemployment compensation
after being let go by Service Employers International Inc., he was
rejected, he was told, because he worked for a foreign company.

More
than 21,000 people working for KBR in Iraq - including about 10,500
Americans - are listed as employees of two companies that exist in a
computer file on the fourth floor of a building on a palm-studded
boulevard here in the Caribbean. Neither company has an office or phone
number in the Cayman Islands.

The Defense Department has known
since at least 2004 that KBR was avoiding taxes by declaring its
American workers as employees of Cayman Islands shell companies, and
officials said the move allowed KBR to perform the work more cheaply,
saving Defense dollars.

But the use of the loophole results in a
significantly greater loss of revenue to the government as a whole,
particularly to the Social Security and Medicare trust funds. And the
creation of shell companies in places such as the Cayman Islands to
avoid taxes has long been attacked by members of Congress.

A
Globe survey found that the practice is unusual enough that only one
other ma jor contractor in Iraq said it does something similar.

"Failing
to contribute to Social Security and Medicare thousands of times over
isn't shielding the taxpayers they claim to protect, it's costing our
citizens in the name of short-term corporate greed," said Senator John
F. Kerry, a Massachusetts Democrat on the Senate Finance Committee who
has introduced legislation to close loopholes for companies registering
overseas.

With an estimated $16 billion in contracts, KBR is by
far the largest contractor in Iraq, with eight times the work of its
nearest competitor.

The no-bid contract it received in 2002 to
rebuild Iraq's oil infrastructure and a multibillion-dollar contract to
provide support services to troops have long drawn scrutiny because
Vice President Dick Cheney was Halliburton's chief executive from 1995
until he joined the Republican ticket with President Bush in 2000.

The
largest of the Cayman Islands shell companies - called Service
Employers International Inc., which is now listed as having more than
20,000 workers in Iraq, according to KBR - was created two years before
Cheney became Halliburton's chief executive. But a second Cayman
Islands company called Overseas Administrative Services, which now is
listed as the employer of 1,020 mostly managerial workers in Iraq, was
established two months after Cheney's appointment.

Cheney's office at the White House referred questions to his personal lawyer, who did not return phone calls.

Heather
Browne, a spokeswoman for KBR, acknowledged via e-mail that the two
Cayman Islands companies were set up "in order to allow us to reduce
certain tax obligations of the company and its employees."

Social Security and Medicare taxes amount to 15.3
percent of each employees' salary, split evenly between the worker and
the employer. While KBR's use of the shell companies saves workers
their half of the taxes, it deprives them of future retirement benefits.

In
addition, the practice enables KBR to avoid paying unemployment taxes
in Texas, where the company is registered, amounting to between $20 and
$559 per American employee per year, depending on the company's rate of
turnover.

As a result, workers hired through the Cayman Island
companies cannot receive unemployment assistance should they lose their
jobs.

In interviews with more than a dozen KBR workers registered
through the Cayman Islands companies, most said they did not realize
that they had been employed by a foreign firm until they arrived in
Iraq and were told by their foremen, or until they returned home and
applied for unemployment benefits.

"They never explained it to
us," said Arthur Faust, 57, who got a job loading convoys in Iraq in
2004 after putting his resume on KBRcareers.com and going to orientation with KBR officials in Houston.

But
there is one circumstance in which KBR does claim the workers as its
own: when it comes to receiving the legal immunity extended to
employers working in Iraq.

In one previously unreported case, a
group of Service Employers International workers accused KBR of
knowingly exposing them to cancer-causing chemicals at an Iraqi water
treatment plant. Under the Defense Base Act of 1941, a federal workers
compensation law, employers working with the military have immunity in
most cases from such employee lawsuits.

So when KBR lawyers argued that the workers were KBR employees, lawyers for the men objected; the case remains in arbitration.

"When
it benefits them, KBR takes the position that these men really are
employees," said Michael Doyle, the lawyer for nine American men who
were allegedly exposed to the dangerous chemicals. "You don't get to
take both positions."

Founded by two brothers in Texas in 1919,
the construction firm of Brown & Root quickly became associated
with some of the largest public-works projects of the early 20th
century, from oil platforms to warships to dams that provided
electricity to rural areas.

Its political clout, particularly
with fellow Texan Lyndon Johnson, was legendary, and it became a major
overseas contractor, building roads and ports during the Vietnam war.

Halliburton,
a Houston-based oil conglomerate, acquired Brown & Root in 1962.
And after the Vietnam cease-fire agreement in 1973, it all but stopped
doing overseas military work for two decades.

But in 1991, during
the Gulf War, Halliburton decided to try to revive its military
business. The next year, Brown & Root won a $3.9 million contract
from the Defense Department under Secretary Dick Cheney to develop
contingency plans to support, feed, house, and maintain the US military
in 13 hot spots around the world.

That small contract soon grew into a massive
logistical-support contract under which the company did everything from
building military camps to cooking meals and providing transportation
for troops. Under the contract, the military agreed to reimburse Brown
& Root for all expenses, and to pay a profit of between 1 and 9
percent, depending on performance.

In Somalia, starting in
December 1992, Brown & Root employees helped US soldiers and UN
workers dig wells and collect garbage, among many other tasks. The
company quickly became the largest civilian employer in the country,
with about 2,500 people on its payroll. Its headquarters in Texas had a
"war room," where executives would get daily updates about events in
Mogadishu.

Later the company would play similar roles supporting US troops in Haiti, Rwanda, Bosnia, Uzbekistan, and Afghanistan.

As
its military work increased, Brown & Root sent more American
workers overseas. Americans working and living abroad receive
significant breaks on their income tax, but still must pay Social
Security and Medicare taxes if they work for an American company. The
reasoning is that such workers are likely to return to the United
States and collect benefits, so they and their employers ought to help
pay for them.

But the taxes drive up costs. A former Halliburton
executive who was in a senior position at the company in the early
1990s said construction companies that avoid taxes by setting up
foreign subsidiaries have obvious advantages in bidding for military
contracts.

Payroll taxes can be a significant cost, he said,
speaking on the condition of anonymity. "If you are bidding against
[rival construction firms] Fluor and Bechtel, it might give you a competitive advantage."

Service
Employers International was set up in 1993, as Brown & Root was
ramping up its roster of overseas workers. Two years later, the company
set up Overseas Administrative Services, which serves more senior
workers and provides a pension plan.

The parent company became Kellogg Brown & Root in 1998, when it joined with the oil-pipe manufacturer, M. W. Kellogg.

Around
that time, KBR lost its exclusive contract to provide logistical
support to the US military. But in 2001 it outbid DynCorp to win it
back, by agreeing to a maximum profit of 3 percent of costs.

Then,
in 2002, the firm received a secret contract to draw up plans to
restore Iraq's oil production after the US-led invasion of Iraq. The
Defense Department has said the firm was chosen mainly for its assets
and expertise, not its ability to control costs.

Nonetheless,
KBR's top competitors in Iraq do not appear to have gone to the same
lengths to avoid taxes. Other top Iraq war contractors - including
Bechtel, Parsons, Washington Group International, L-3 Communications, Perini, and Fluor - told the Globe that they pay Social Security and Medicare taxes for their American workers.

"It has been Fluor Corporation's policy to
compensate our employees who are US citizens the same as if they worked
in the geographic United States," said Keith Stephens, Fluor's director
of global media relations. "With the exception of hardship and danger
pay additives for work performed in Iraq, they receive the same
benefits as their US-based colleagues, and Fluor pays or remits all
required US taxes and payroll burdens, including FICA payments and
unemployment insurance."

Only one other top contractor, the
construction and logistics firm IAP Worldwide Services Inc., said it
employs a "limited number" of Americans through an offshore subsidiary.

Officials at DynCorp, the company that KBR outbid for the logistics contract, did not return numerous calls.

KBR
is now widely believed to be the largest private employer of foreigners
in Iraq, and it hires twice as many workers through its Cayman Island
subsidiaries as it does by direct hires. Service Employers
International alone employs more than 20,000 truck drivers,
electricians, accountants, and engineers, roughly half of whom are
American, according to Browne, the KBR spokeswoman.

KBR declined
to release salary information. But workers interviewed by the Globe who
served in a range of jobs said they earned between $48,000 and $85,000
per year. If KBR's American workers averaged even as much as $63,000
per year, they and KBR would have owed more than $100 million per year
in Social Security and Medicare taxes, split evenly between them. Over
the course of the five-year war, their tax bill would have been more
than $500 million.

In 2004, auditors with the Pentagon's Defense
Contract Audit Agency questioned KBR about the two Cayman Island
companies but ultimately made no complaint. The auditors told the Globe
in an email exchange facilitated by Pentagon spokesman Lieutenant
Colonel Brian Maka that any tax savings resulting from the offshore
subsidiaries "are passed on" to the US military.

Browne, the KBR
spokeswoman, said the loss to Social Security could eventually be
offset by the fact that the workers will receive less money when they
retire, since benefits are generally based on how much workers and
their companies have paid into the system.

Medicare, however,
does not reduce benefits for workers who don't contribute, and Browne
acknowledged that KBR has not calculated the impact of its tax
practices on the government as a whole.

She said KBR does not
save money from the practice, since its contracts allow for its labor
expenses to be reimbursed by the US military. But the practice gives
KBR a competitive advantage over other contractors who pay their share
of employment taxes.

And critics of tax loopholes note that the
use of offshore shell companies to avoid payroll taxes places a greater
burden on other taxpayers.

"The argument that by not paying taxes they are
saving the government money is just absurd," said Robert McIntyre,
director of Citizens for Tax Justice, a Washington advocacy group.

To
the people listed as its workers, Service Employers International Inc.
- known to them as SEII - remains something of a mystery.

"Does
anybody know what or where in the Grand Cayman Islands SEII is
located?" a recently returned worker wrote in a complaint about the
company on JobVent.com,
an employment website. He speculated that the office in the Cayman
Islands must be "the size of a jail cell . . . with only a desk and
chair."

In fact, the address on file at the Registry of Companies
in the Cayman Islands leads to a nondescript building in the Grand
Cayman business district that houses Trident Trust, one of the Caymans'
largest offshore registered agents. Trident Trust collects $1,000 a
year to forward mail and serve as KBR's representative on the island.

The
real managers of Service Employers International work out of KBR's
office in Dubai. KBR and Halliburton, which also moved to Dubai,
severed ties last year.

Both KBR and the US military appear to
regard Service Employers International and KBR interchangeably, except
for tax purposes. According to the Defense Contract Auditing Agency,
KBR bills the Service Employers workers as "direct labor costs," and
charges almost the same amount for them as for direct hires.

The
contract that workers sign in Houston before traveling to Iraq commits
workers to abide by KBR's code of ethics and dispute-resolution
mechanisms but states that the agreement is with Service Employers
International.

Some workers said they were told that Service
Employers International was just KBR's payroll company. Others mistook
the name as a reference to the well-known, large union, Service
Employees International.

Henry Bunting, a Houston man who served
as a procurement officer for a KBR project in Iraq in 2003, said he
first found out that he was working for a foreign subsidiary when he
looked closely at his paycheck.

"Their whole mindset was deceit,"
Bunting said. He said that he wrote to KBR several times asking for a
W-2 form so he could file his taxes, but that KBR never responded.

David
Boiles, a truck driver in Iraq from 2004 to 2006, said that he realized
he was working for Service Employers International when he arrived in
Iraq and his foreman told him he was not a KBR employee, despite the
fact that his military-issued identification card said "KBR."

"At first, I didn't believe him," Boiles said.

Danny
Langford, a Texas pipe-fitter who was sent to work in a water treatment
plant in southern Iraq in July 2003, said he, too, initially believed
that he was an employee of KBR.

But when he allegedly got ill from chemicals at the
plant and was terminated that fall, he said, his application for
unemployment compensation was rejected because he worked for a foreign
company.

"Now, I don't know who I was working for," he said in a telephone interview.

For
decades Congress has sought to crack down on corporations that use
offshore subsidiaries to lower their taxes, but most of the debates
have focused on schemes that reduce corporate income taxes, not payroll
taxes. Last year a Senate subcommittee estimated that US corporations
avoid paying $30 and $60 billion annually in income taxes by using
offshore tax havens.

Senators Carl Levin, a Michigan Democrat;
Barack Obama, an Illinois Democrat; and Norm Coleman, a Minnesota
Republican, are trying to pass the Stop Tax Haven Abuse Act, which
would give the US Treasury Department the authority to take special
measures against foreign jurisdictions that impede US tax enforcement.

American
companies that evade payroll taxes face fines or other criminal
penalties. The use of foreign subsidiaries to avoid payroll taxes,
while allowed by the Defense Department, may still be subject to
challenge by the Internal Revenue Service, according to Eric Toder, a
former director of the office of research for the IRS.

Toder said
the IRS could try to take action against a firm if the sole purpose of
setting up an offshore subsidiary was to reduce tax liability. The
practice could become a more costly problem in the future, Toder said,
as an increasing number of American companies register subsidiaries
overseas and bring American employees to work abroad.

"It
obviously looks unseemly where you have a situation where, if you did
it in a straightforward way, they would pay payroll taxes," Toder said.
"If this becomes the norm, and other companies do that as well, it
could further erode the tax base."

Peter Singer, a specialist in
the outsourcing of military functions at the liberal-leaning Brookings
Institution, said the practice will probably attract more scrutiny in
the future, as the military expands its outsourcing and as workplaces
become increasingly global.

"It is fascinating and troubling at
the same time," Singer said. "If you are an executive in a company, you
are thinking: 'Wow. Cash savings and a potential loophole from certain
domestic laws, lawsuits, and taxes. It's win-win.' But if you are a US
taxpayer, it is not a positive synergy."

Globe correspondents Stephanie Vallejo and Matt Negrin contributed to this report.

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