Top Iraq Contractor Skirts US Taxes Offshore Shell companies in Cayman Islands allow KBR to avoid Medicare, Social Security deductions

by Farah Stockman

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.0306 02

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.

© 2008 The Boston Globe