Islands provide tax haven for U.S. defense contractors; Congress may close loophole

WASHINGTON -- When the Pentagon announced an obscure California company had won a lucrative military contract, no one mentioned any plans for a Caribbean outpost -- a tropical shell the company quickly created that allowed it to duck millions in taxes and deflect U.S. lawsuits.

It's legal, at least for now. Contractors large and small have been heading offshore to shield piles of taxpayer dollars, according to an Associated Press investigation, but irate lawmakers are thundering that they'll put an end to it.

Almost a decade ago, a few months after winning the deal that has totaled more than $2 billion, Combat Support Associates established its subsidiary in the Cayman Islands, a British territory and tax haven.

The subsidiary, CSA Ltd., now employs about 2,000 American citizens in Kuwait, where they support U.S. forces moving in and out of Iraq. Yet as a foreign corporation doing work outside the United States, CSA Ltd. does not pay Social Security and Medicare taxes for these workers. Also, company officials maintain the subsidiary is outside the jurisdiction of U.S. courts, so federal labor rules and anti-discrimination laws don't apply either.

In fact, there's scant evidence that CSA Ltd. exists -- at least physically. There's no listed office address or phone number in the Cayman Islands. Records show the corporation is registered with Close Brothers, an investment house that serves as its shallow footprint in the Caymans.

Close Brothers operates out of a five-story, blue-windowed office building across the street from the docks used by cruise ships visiting this island paradise. There's no sign of CSA Ltd., however. "We can't make any comments in regards to our clients," Close Brothers director Roger Priaulx said by telephone.

Back in the U.S., the House of Representatives passed tax legislation a few weeks ago that would treat foreign subsidiaries of U.S. government contractors as American employers. That means they would have to pay the taxes that finance Social Security and Medicare programs. The Senate is now considering the legislation.

"Companies that avoid this responsibility undermine the country," said John Kerry, D-Mass., chairman of the Senate subcommittee on social security, pensions and family policy. "If everybody avoided their responsibility, where would we be?"

The Joint Committee on Taxation estimates shutting the employment tax loophole would bring in about $846 million in revenue over 10 years. That figure could be higher, lawmakers say, since it's unclear how widespread use of the opening is.

"People are constantly looking for ways to jilt the system," said Rep. Brad Ellsworth, D-Ind., one of the authors of the measure. "Where there's smoke there could be fire, and you go investigate that."

Indeed, the House Oversight and Government Reform Committee has asked 15 Defense and State Department contractors for information about any foreign entities they may have in tax-friendly countries.

The request followed a meeting with representatives from KBR Inc., which had more than $6 billion in government contracts in 2006 alone. According to the committee, KBR has two subsidiaries in the Cayman Islands that are used to reduce the company's tax payments.

The panel is trying to determine how much these contractors earn, how much they pay their U.S. workers holding overseas jobs and how much in taxes goes unpaid.

It can be hard to keep track of company names.

One of the businesses on the committee's list is AECOM Government Services of Fort Worth, Texas. In 1998, AECOM and two other little-known companies -- Research and Analysis Maintenance of El Paso, Texas, and Space Mark Inc. of Alaska -- set up Combat Support Associates as a privately held joint venture.

Then CSA set up CSA Ltd. in the Caymans.

Gary Lewi, a spokesman for Combat Support Associates, said CSA Ltd.'s nearly 2,000 U.S. employees in Kuwait are roughly 30 percent of the company's work force there. The rest are Kuwaitis and third-country nationals, who are usually less expensive to recruit and retain. The company did not respond to additional questions from AP, however, about its business operations and employee compensation.

For a U.S. employee making $55,000 a year -- the salary stated in a recent online ad for one CSA Ltd. job for emergency services -- an employer would pay $4,208 in Social Security and Medicare taxes.

Pinpointing total savings depends on how much workers are paid. If, for example, the American employees of CSA Ltd. make an average of $30,000 a year, the company would owe about $4.6 million in employment taxes.

John Krieger of U.S. PIRG, a federation of public interest groups, said companies with overseas outposts have lower overall expenses and therefore an unfair advantage when competing for work against American businesses that don't.

"It's purely disgraceful for them to pretend to be foreign companies to avoid their very basic responsibilities like Medicare and Social Security," Krieger says. "The whole spirit of open competition has been completely lost."

Groups that represent contractors take an opposite view.

They say tighter controls could make U.S. companies less competitive in the global marketplace. Businesses in Europe and Asia that go after U.S. contracts may be the winners if American companies have fewer ways to keep costs down, said Alan Chvotkin, senior vice president of the Professional Services Council in Arlington, Va.

"Before we rush to a legislative change for a narrow purpose, let's understand the global competitiveness of U.S. firms and their ability to execute contracts outside the United States with this new restriction," Chvotkin says.

Use of the Cayman Islands as a tax shelter is widespread among American businesses, according to the Senate Finance Committee, which estimates that thousands of companies have registered there to dodge taxes. The losers, the committee said, are ordinary Americans who must foot a larger share of the bill to pay for programs that benefit the elderly and the disabled.

Democratic presidential candidate Barack Obama said in March that setting up shell companies "turns the idea of patriotism on its head."

Combat Support Associates was created in 1998 to compete for a contract at Camp Doha in Kuwait. The camp has been a major American outpost since the first Persian Gulf War in the early 1990s. Private sector help has long been needed to run the facility as U.S. troops rotate in and out.

In July 1999, Combat Support Associates was selected for a Camp Doha support contract, a 10-year deal potentially worth $547 million. In March 2003, when U.S. forces invaded Iraq, demand for the company's maintenance and repair services increased dramatically as bases across Kuwait became nerve centers for American troops.

The value of the contract ballooned as well -- reaching well over $2 billion. According to Army Sustainment Command in Rock Island, Ill., $1.9 billion was spent between 1999 and 2007 on the Combat Support Associates contract. An additional $535 million was set aside for the fiscal year that ends Sept. 30.

Court records from a whistleblower case in Florida and workplace discrimination lawsuits filed against the company in Texas and Maryland show how the company fashioned its corporate architecture.

CSA Ltd. was registered in September 1999. Its purpose was to handle the unclassified work in Kuwait. That accounts for close to 90 percent of the contract. From its offices in Orange, Calif., Combat Support Associates would perform the remaining 10 percent, which includes the classified duties requiring employees with security clearances.

So while Combat Support Associates won the Kuwait contract, it delegated responsibility for the most of the work to an entity organized under the business-friendly laws of the Caymans. According to company managers, CSA Ltd. has its own human resources department, makes its own hiring decisions and even maintains its own banking accounts and issues its own paychecks.

That separation between the two formed the basis for a defense against a former CSA Ltd. employee named John G. Watson who sued the company in 2003. Watson claimed he'd been denied a promotion because he was black, a violation of the Civil Rights Act.

Lawyers for the company denied Watson's allegations. They also said CSA Ltd. was a foreign company and not subject to U.S. law. The case should be dismissed, they argued.

A federal judge in Maryland refused to do so. In a May 2005 ruling, Judge Richard Bennett concluded the "two companies' operations were so intertwined as to be virtually indistinguishable." The case was settled out of court. Watson's attorney, Dennis Chong, says the terms of the settlement remain confidential.

John Gadd, a lawyer in Clearwater, Fla., had less success representing a former CSA Ltd. business manager who charged the company had retaliated against her after she objected to its accounting methods.

Gadd's client, Debbie Einmo, a Winter Haven, Fla., resident, said she learned of her company job from an advertisement on the Houston Chronicle newspaper's Web site. Because she was recruited in Florida, the case should be tried there, she and Gadd argued.

Attorneys for CSA Ltd. denied Einmo's charges. And they also argued the company had no offices in Florida so there was no basis for trying the case there. Last August, a federal magistrate in Tampa agreed. The case was eventually dismissed.

"I didn't fully appreciate or anticipate that they were trying to entirely circumvent U.S. law," Gadd says. "It didn't seem legitimate. The idea of a corporation is not to create a fiction that is untouchable."

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Associated Press researcher Jennifer Farrar contributed to this report from New York.

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On the Net:

Combat Support Associates: www.csakuwait.com