INCOME TAXES
We generated profits of $6.3 million and losses of $151.6 million and $578.2 million from continuing operations before income taxes in the U.S. and a loss of $202.3 million, profits of $1.1 billion and a loss of $893.0 million from continuing operations before income taxes in non-U.S. jurisdictions for the years ended December 31, 2017, 2016 and 2015, respectively.
The following table summarizes components of our provision for income taxes from continuing operations for each of the years in the three-year period ended December 31, 2017 (in millions):
|
| | | | | | | | | | | |
| 2017 | | 2016 | | 2015 |
Current income tax (benefit) expense: | |
| | |
| | |
|
U.S. | $ | (2.2 | ) | | $ | (6.6 | ) | | $ | 18.7 |
|
Non-U.S. | 56.4 |
| | 86.4 |
| | 125.4 |
|
| 54.2 |
| | 79.8 |
| | 144.1 |
|
Deferred income tax expense (benefit): | |
| | |
| | |
|
U.S. | 36.0 |
| | 15.9 |
| | (180.4 | ) |
Non-U.S. | 19.0 |
| | 12.8 |
| | 22.4 |
|
| 55.0 |
| | 28.7 |
| | (158.0 | ) |
Total income tax expense (benefit) | $ | 109.2 |
| | $ | 108.5 |
| | $ | (13.9 | ) |
U.S. Tax Reform
U.S. tax reform was enacted on December 22, 2017 and introduced significant changes to U.S. income tax law, including a reduction in the statutory income tax rate from 35% to 21% effective January 1, 2018, a base erosion anti-abuse tax that effectively imposes a minimum tax on certain payments to non-U.S. affiliates and new and revised rules relating to the current taxation of certain income of foreign subsidiaries. We recognized a net tax expense of $16.5 million during the fourth quarter of 2017 in connection with enactment of U.S. tax reform, consisting of a $38.5 million tax expense associated with the one-time transition tax on deemed repatriation of the deferred foreign income of our U.S. subsidiaries, a $17.3 million tax expense associated with revisions to rules over the taxation of income of foreign subsidiaries, a $20.0 million tax benefit resulting from the re-measurement of our deferred tax assets and liabilities as of December 31, 2017 to reflect the reduced tax rate and a $19.3 million tax benefit resulting from adjustments to the valuation allowance on deferred tax assets.
Due to the timing of the enactment of U.S. tax reform and the complexity involved in applying its provisions, we have made reasonable estimates of its effects and recorded such amounts in our consolidated financial statements as of December 31, 2017 on a provisional basis. As we continue to analyze applicable information and data, and interpret any additional guidance issued by the U.S. Treasury Department, the Internal Revenue Service and others, we may make adjustments to the provisional amounts throughout the one-year measurement period as provided by Staff Accounting Bulletin No. 118. Our accounting for the enactment of U.S. tax reform will be completed during 2018 and any adjustments we recognize could be material. The ongoing impact of U.S. tax reform may result in an increase in our consolidated effective income tax rate in future periods.
Deferred Taxes
The following table summarizes significant components of deferred income tax assets (liabilities) as of December 31, 2017 and 2016 (in millions):
|
| | | | | | | | |
| | 2017 | | 2016 |
Deferred tax assets: | | | | |
|
Net operating loss carryforwards | | $ | 187.1 |
| | $ | 197.9 |
|
Foreign tax credits | | 132.3 |
| | 91.7 |
|
Premiums on long-term debt | | 36.1 |
| | 72.7 |
|
Deferred revenue | | 26.0 |
| | 55.7 |
|
Employee benefits, including share-based compensation | | 20.7 |
| | 30.6 |
|
Other | | 12.8 |
| | 17.2 |
|
Total deferred tax assets | | 415.0 |
| | 465.8 |
|
Valuation allowance | | (278.8 | ) | | (238.8 | ) |
Net deferred tax assets | | 136.2 |
| | 227.0 |
|
Deferred tax liabilities: | | |
| | |
|
Property and equipment | | (51.5 | ) | | (103.3 | ) |
Deferred U.S. tax on foreign income | | (24.8 | ) | | (15.2 | ) |
Deferred transition tax | | (13.7 | ) | | — |
|
Deferred costs | | (9.1 | ) | | (11.4 | ) |
Intercompany transfers of property | | — |
| | (18.9 | ) |
Other | | (8.7 | ) | | (8.4 | ) |
Total deferred tax liabilities | | (107.8 | ) | | (157.2 | ) |
Net deferred tax asset | | $ | 28.4 |
| | $ | 69.8 |
|
The realization of substantially all of our deferred tax assets is dependent on generating sufficient taxable income during future periods in various jurisdictions in which we operate. Realization of certain of our deferred tax assets is not assured. We recognize a valuation allowance for deferred tax assets when it is more-likely-than-not that the benefit from the deferred tax asset will not be realized. The amount of deferred tax assets considered realizable could increase or decrease in the near term if our estimates of future taxable income change.
As of December 31, 2017, we had deferred tax assets of $132.3 million for U.S. foreign tax credits (“FTC”) and $187.1 million related to $844.1 million of net operating loss (“NOL”) carryforwards, which can be used to reduce our income taxes payable in future years. The FTCs expire between 2022 and 2038. NOL carryforwards, which were generated in various jurisdictions worldwide, include $429.2 million that do not expire and $414.9 million that will expire, if not utilized, beginning in 2018 through 2037. Due to the uncertainty of realization, we have a $250.3 million valuation allowance on FTC and NOL carryforwards.
Effective Tax Rate
Ensco plc, our parent company, is domiciled and resident in the U.K. Our subsidiaries conduct operations and earn income in numerous countries and are subject to the laws of taxing jurisdictions within those countries. The income of our non-U.K. subsidiaries is generally not subject to U.K. taxation. Income tax rates imposed in the tax jurisdictions in which our subsidiaries conduct operations vary, as does the tax base to which the rates are applied. In some cases, tax rates may be applicable to gross revenues, statutory or negotiated deemed profits or other bases utilized under local tax laws, rather than to net income.
Our drilling rigs frequently move from one taxing jurisdiction to another to perform contract drilling services. In some instances, the movement of drilling rigs among taxing jurisdictions will involve the transfer of ownership of the drilling rigs among our subsidiaries. As a result of frequent changes in the taxing jurisdictions in which our drilling rigs are operated and/or owned, changes in profitability levels and changes in tax laws, our annual effective income tax rate may vary substantially from one reporting period to another. In periods of declining profitability, our income tax expense may not decline proportionally with income, which could result in higher effective income tax rates. Further, we may continue to incur income tax expense in periods in which we operate at a loss.
Our consolidated effective income tax rate on continuing operations for each of the years in the three-year period ended December 31, 2017, differs from the U.K. statutory income tax rate as follows:
|
| | | | | | | | |
| 2017 | | 2016 | | 2015 |
U.K. statutory income tax rate | 19.2 | % | | 20.0 | % | | 20.2 | % |
Non-U.K. taxes | (40.4 | ) | | (7.9 | ) | | (12.3 | ) |
Valuation allowance | (18.0 | ) | | 2.6 |
| | (1.5 | ) |
Goodwill and asset impairments | (17.1 | ) | | — |
| | (4.0 | ) |
Bargain purchase gain | 13.8 |
| | — |
| | — |
|
U.S. tax reform | (8.4 | ) | | — |
| | — |
|
Debt repurchases | (2.8 | ) | | (4.1 | ) | | — |
|
Other | (2.0 | ) | | .3 |
| | (1.5 | ) |
Effective income tax rate | (55.7 | )% | | 10.9 | % | | .9 | % |
Our 2017 consolidated effective income tax rate includes $32.2 million associated with the impact of various discrete tax items, including $16.5 million of tax expense associated with U.S. tax reform and $15.7 million of tax expense associated with the exchange offers and debt repurchases, rig sales, a restructuring transaction, settlement of a previously disclosed legal contingency, the effective settlement of a liability for unrecognized tax benefits associated with a tax position taken in prior years and other resolutions of prior year tax matters.
Our 2016 consolidated effective income tax rate includes the impact of various discrete tax items, including a $16.9 million tax expense resulting from net gains on the repurchase of various debt during the year, the recognition of an $8.4 million net tax benefit relating to the sale of various rigs, a $5.5 million tax benefit resulting from a net reduction in the valuation allowance on U.S. foreign tax credits and a net $5.3 million tax benefit associated with liabilities for unrecognized tax benefits and other adjustments relating to prior years.
Our consolidated effective income tax rate for 2015 includes the impact of various discrete tax items, primarily related to a $192.5 million tax benefit associated with rig impairments and an $11.0 million tax benefit resulting from the reduction of a valuation allowance on U.S. foreign tax credits.
Excluding the impact of the aforementioned discrete tax items, our consolidated effective income tax rates for the years ended December 31, 2017, 2016 and 2015 were (96.0)%, 20.3% and 16.0%, respectively. The changes in our consolidated effective income tax rate, excluding discrete tax items, during the three-year period result primarily from changes in the relative components of our earnings from the various taxing jurisdictions in which our drilling rigs are operated and/or owned and differences in tax rates in such taxing jurisdictions.
Unrecognized Tax Benefits
Our tax positions are evaluated for recognition using a more-likely-than-not threshold, and those tax positions requiring recognition are measured as the largest amount of tax benefit that is greater than 50% likely of being realized upon effective settlement with a taxing authority that has full knowledge of all relevant information. As of December 31, 2017, we had $147.6 million of unrecognized tax benefits, of which $139.4 million was included in other liabilities on our consolidated balance sheet and the remaining $8.2 million, which is associated with a tax position taken in tax years with NOL carryforwards, was presented as a reduction of deferred tax assets. As of December 31, 2016, we had $122.0 million of unrecognized tax benefits, of which $116.3 million was included in other liabilities on our consolidated balance sheet and the remaining $5.7 million, which is associated with a tax position taken in tax years with NOL carryforwards, was presented as a reduction of deferred tax assets. If recognized, $130.3 million of the $147.6 million unrecognized tax benefits as of December 31, 2017 would impact our consolidated effective income tax rate. A reconciliation of the beginning and ending amount of unrecognized tax benefits for the years ended December 31, 2017 and 2016 is as follows (in millions):
|
| | | | | | | | |
| | 2017 | | 2016 |
Balance, beginning of year | | $ | 122.0 |
| | $ | 140.6 |
|
Increases in unrecognized tax benefits as a result of the Merger | | 22.2 |
| | — |
|
Increases in unrecognized tax benefits as a result of tax positions taken during the current year | | 5.4 |
| | 7.6 |
|
Increases in unrecognized tax benefits as a result of tax positions taken during prior years | | .7 |
| | 4.9 |
|
Settlements with taxing authorities | | (10.2 | ) | | (27.6 | ) |
Lapse of applicable statutes of limitations | | (.4 | ) | | (.2 | ) |
Decreases in unrecognized tax benefits as a result
of tax positions taken during prior years | | (.2 | ) | | (.5 | ) |
Impact of foreign currency exchange rates | | 8.1 |
| | (2.8 | ) |
Balance, end of year | | $ | 147.6 |
| | $ | 122.0 |
|
Accrued interest and penalties totaled $38.6 million and $26.6 million as of December 31, 2017 and 2016, respectively, and were included in other liabilities on our consolidated balance sheets. Accrued interest and penalties included $7.7 million as a result of the Merger as of December 31, 2017. We recognized a net expense of $4.4 million, a net benefit of $3.8 million and a net expense of $3.9 million associated with interest and penalties during the years ended December 31, 2017, 2016 and 2015, respectively. Interest and penalties are included in current income tax expense in our consolidated statements of operations.
Our 2011 and subsequent years remain subject to examination for U.S. federal tax returns. Tax years as early as 2005 remain subject to examination in the other major tax jurisdictions in which we operated.
Statutes of limitations applicable to certain of our tax positions lapsed during 2017, 2016 and 2015, resulting in net income tax benefits, inclusive of interest and penalties, of $1.1 million, $0.6 million and $7.6 million, respectively.
Absent the commencement of examinations by tax authorities, statutes of limitations applicable to certain of our tax positions will lapse during 2018. Therefore, it is reasonably possible that our unrecognized tax benefits will decline during the next 12 months by $3.6 million, inclusive of $1.0 million of accrued interest and penalties, all of which would impact our consolidated effective income tax rate if recognized.
Intercompany Transfer of Drilling Rigs
In October 2016, the FASB issued Accounting Standards Update 2016-16, Income Taxes (Topic 740): Intra-Entity Transfers of Assets Other Than Inventory (“Update 2016-16”), which requires entities to recognize the income tax consequences of an intra-entity transfer of an asset other than inventory when the transaction occurs as opposed to deferring tax consequences and amortizing them into future periods. We adopted Update 2016-16 on a modified retrospective basis effective January 1, 2017. As a result of modified retrospective application, we reduced prepaid taxes on intercompany transfers of property and related deferred tax liabilities resulting in the recognition of a cumulative-effect reduction in retained earnings of $14.1 million on our consolidated balance sheet as of January 1, 2017.
As of December 31, 2016, the unamortized balance associated with deferred charges for income taxes incurred in connection with intercompany transfers of drilling rigs totaled $33.0 million and was included in other assets, net, on our consolidated balance sheet. Current income tax expense for the years ended December 31, 2016 and 2015 included $4.1 million and $2.6 million, respectively, of amortization of income taxes incurred in connection with intercompany transfers of drilling rigs.
As of December 31, 2016, the unamortized balance associated with the deferred tax liability for reversing temporary differences of transferred drilling rigs totaled $18.9 million, respectively, and was included in other liabilities on our consolidated balance sheet. Deferred income tax benefit for the years ended December 31, 2016 and 2015 included benefits of $2.3 million and $1.8 million, respectively, of amortization of deferred reversing temporary differences associated with intercompany transfers of drilling rigs.
Undistributed Earnings
Dividend income received by Ensco plc from its subsidiaries is exempt from U.K. taxation. We do not provide deferred taxes on undistributed earnings of certain subsidiaries because our policy and intention is to reinvest such earnings indefinitely. Each of the subsidiaries for which we maintain such policy has sufficient net assets, liquidity, contract backlog and/or other financial resources available to meet operational and capital investment requirements, which allows us to continue to maintain our policy of reinvesting the undistributed earnings indefinitely.
The deferred foreign income of our U.S. subsidiaries was deemed to be repatriated under U.S. tax reform, and we recognized a $38.5 million tax expense associated with the repatriation on a provisional basis. We are currently analyzing the potential non-U.S. tax liabilities that would arise on an actual repatriation, and we have not changed our prior assertion regarding the foreign earnings of our U.S. subsidiaries. We will record the tax effects of any change in our prior assertion upon completion of our analysis during the measurement period provided in Staff Accounting Bulletin No. 118 and disclose any unrecognized deferred tax liability associated with our assertion, if practicable.