COMMERCIAL METALS CO

NOTE 14. INCOME TAX

The components of earnings from continuing operations before income taxes are as follows:



	Year Ended August 31,
(in thousands)	2017		2016		2015
United States	$	15,739	$	47,076	$	81,619
Foreign	29,265		21,634		14,843
Total	$	45,004	$	68,710	$	96,462

The income taxes (benefit) included in the consolidated statements of earnings are as follows:



	Year Ended August 31,
(in thousands)	2017			2016			2015
Current:
United States	$	11,345		$	5,224		$	53,258
Foreign	9,464			6,991			3,329
State and local	2,654			4,130			2,830
Current taxes	$	23,463		$	16,345		$	59,417
Deferred:
United States	$	(13,548	)	$	(4,423	)	$	(14,219	)
Foreign	(917		)	254			722
State and local	281			303			488
Deferred taxes	$	(14,184	)	$	(3,866	)	$	(13,009	)
Total income taxes on income	$	9,279		$	12,479		$	46,408
Income taxes (benefit) on discontinued operations	(3,175		)	1,669			12,950
Income taxes on continuing operations	$	12,454		$	10,810		$	33,458

A reconciliation of the federal statutory rate to the Company's effective income tax rate from continuing operations is as follows:



	Year Ended August 31,
(in thousands)	2017			2016			2015
Income tax expense at statutory rate of 35%	$	15,751		$	24,050		$	33,761
Change in valuation allowance	113,089			75,076			16,194
Foreign tax impairment on valuation of subsidiaries	(92,321		)	(60,204		)	—
Nontaxable foreign interest	(19,259		)	(16,063		)	(16,712		)
Foreign rate differential	(5,534		)	(1,522		)	(1,872		)
Deferred compensation	(2,101		)	(1,375		)	772
State and local taxes	1,698			1,950			1,802
Section 199 manufacturing deduction	(1,407		)	(4,694		)	(4,017		)
Audit settlement	(659		)	(10,264		)	—
Other	3,197			3,856			3,530
Income tax expense on continuing operations	$	12,454		$	10,810		$	33,458
Effective income tax rates from continuing operations	27.7		%	15.7		%	34.7		%

The Company's effective income tax rate from continuing operations was 27.7% for the year ended August 31, 2017, compared to the statutory rate of 35%. Several factors influence the effective tax rate. Items that benefited the effective tax rate include:

(i) benefit for domestic production activity income under Section 199 of the Internal Revenue Code ("Section 199"),

(ii) a non-taxable gain on assets related to the Company's nonqualified Benefits Restoration Plan ("BRP"), and

(iii) the proportion of the Company's global income from operations in jurisdictions with lower statutory tax rates than the U.S., including Poland, which has a statutory income tax rate of 19%.

Items negatively impacting the effective tax rate include:

(a) U.S. state and local taxes imposed on income from domestic operations, and

(b) losses from operations in certain jurisdictions where the Company maintains a valuation allowance, thus providing no benefit for such losses.

For the year ended August 31, 2016, the effective income tax rate from continuing operations was 15.7% compared to the statutory rate of 35%. Items that benefited the effective tax rate include:

(i) net favorable adjustments resulting from the settlement of an audit, including the release of certain unrecognized tax benefits for which the accruals were greater than the amount assessed,

(ii) benefit for domestic production activity income under Section 199,

(iii) a non-taxable gain on assets related to the Company's nonqualified BRP, and

(iv) the proportion of the Company's global income from operations in jurisdictions with lower statutory tax rates than the U.S., including Poland, which has a statutory income tax rate of 19%.

Items negatively impacting the effective tax rate include:

(a) U.S. state and local taxes imposed on the release of unrecognized tax benefits, and

(b) losses from operations in certain jurisdictions where the Company maintains a valuation allowance, thus providing no benefit for such losses.

For the year ended August 31, 2015, the effective income tax rate from continuing operations was 34.7% compared to the statutory rate of 35%. Items that benefited the effective tax rate include:

(i) income from operations in jurisdictions with lower statutory tax rates than the U.S., including Poland, and

(ii) benefit for domestic production activity under Section 199.

Items negatively impacting the effective tax rate include:

(a) U.S. state and local taxes imposed on income from domestic operations,

(b) losses from operations in certain jurisdictions where the Company maintains a valuation allowance, thus providing no benefit for such losses, and

The Company's tax benefit from discontinued operations for the year ended August 31, 2017 was $3.2 million, or an effective income tax rate of (29.9)%. The tax benefit in discontinued operations is largely attributed to domestic operations losses related to CMC Cometals. Additionally, income in discontinued operations from the International Marketing and Distribution segment was primarily earned in foreign jurisdictions that benefit from group loss sharing provisions. Such losses, which carry a full valuation allowance, are utilized to absorb the International Marketing and Distribution income; thus there is no tax expense or benefit associated with the income from discontinued operations earned in foreign jurisdictions.

The Company’s tax expense from discontinued operations for the year ended August 31, 2016 was $1.7 million, or an effective income tax rate of (113.6)%. The International Marketing and Distribution segment's incurred net pre-tax losses in foreign jurisdictions in excess of the pre-tax income earned in the U.S., producing a nominal pre-tax loss in discontinued operations. The tax expense associated with discontinued operations is primarily related to the tax effect of income earned in the U.S.

The Company’s tax expense from discontinued operations for the year ended August 31, 2015 was $13.0 million, or an effective income tax rate of 44.1%. Pre-tax income from CMC Cometals operations in the U.S., subject to tax at the statutory rate of 35%, is offset by net pre-tax losses in the International Marketing and Distribution segment's foreign operations. Such foreign pre-tax losses were recorded in jurisdictions where the Company maintains a full valuation allowance, thus providing no tax benefit for such losses.

The Company made net payments of $31.0 million, $50.2 million and $61.0 million for income taxes for the years ended August 31, 2017, 2016 and 2015, respectively.

The income tax effects of significant temporary differences giving rise to deferred tax assets and liabilities are as follows:



	August 31,
(in thousands)	2017			2016
Deferred tax assets:
Deferred compensation and employee benefits	$	46,898		$	45,496
Net operating losses and credits	273,549			154,606
Reserves and other accrued expenses	21,727			18,831
Allowance for doubtful accounts	3,223			2,438
Intangibles	3,924			6,214
Other	2,314			768
Total deferred tax assets	351,635			228,353
Valuation allowance for deferred tax assets	(273,991		)	(153,011		)
Deferred tax assets, net	$	77,644		$	75,342
Deferred tax liabilities:
Fixed assets	$	101,707		$	96,100
Inventory	12,731			30,822
Other	2,455			2,799
Total deferred tax liabilities	$	116,893		$	129,721
Net deferred tax liabilities	$	(39,249	)	$	(54,379	)

Net operating losses giving rise to deferred tax assets consist of $382.9 million of state net operating losses that expire during the tax years ending from 2018 to 2037 and foreign net operating losses of $840.4 million that expire in varying amounts beginning in 2018 (with certain amounts having indefinite lives). These assets will be reduced as income tax expense is recognized in future periods.

The Company maintains a valuation allowance to reduce certain deferred tax assets to amounts that are more likely than not to be realized. During the years ended August 31, 2017 and August 31, 2016, the Company recorded valuation allowances of $121.0 million and $73.0 million, respectively, related to net operating loss carryforwards in certain state and foreign jurisdictions due to the uncertainty of their realization. Such valuation allowances are largely attributed to losses generated by foreign tax impairment charges on valuation of subsidiaries.

In general, it is the practice and intention of the Company to reinvest the earnings of its non-U.S. subsidiaries in those operations. As of August 31, 2017, the Company had not made a provision for U.S. or additional foreign withholding taxes on approximately $578.1 million of undistributed earnings and profits associated with the excess of the amount for financial reporting over the income tax basis of investments in foreign subsidiaries that is indefinitely reinvested. Generally, such amounts become subject to U.S. taxation upon the remittance of dividends and under certain other circumstances. It is not practicable to estimate the amount of deferred tax liability related to investments in these foreign subsidiaries.

The unrecognized income tax benefits as of August 31, 2017 and August 31, 2016 were $9.3 million and $9.5 million, respectively, all of which, if recognized, would have impacted the Company's effective income tax rate at the end of fiscal 2017 and 2016, respectively. The unrecognized income tax benefits as of August 31, 2015 were $27.3 million, of which $12.0 million, if recognized, would have impacted the Company's effective tax rate for the end of fiscal 2015.

A reconciliation of the beginning and ending amounts of unrecognized income tax benefits is as follows:



	August 31,
(in thousands)	2017			2016			2015
Balance at September 1	$	9,522		$	27,349		$	27,349
Change in tax positions of current year	—			—			—
Change for tax positions of prior years	—			—			—
Reductions due to settlements with taxing authorities	(239		)	(17,827		)	—
Balance at August 31	$	9,283		$	9,522		$	27,349

The Company's policy classifies interest recognized on an underpayment of income taxes and any statutory penalties recognized on a tax position as income tax expense, and the balances at the end of a reporting period are recorded as part of the current or noncurrent liability for uncertain income tax positions. At August 31, 2017 and 2016, the Company had accrued interest and penalties related to uncertain tax positions of $1.2 million and $1.0 million, respectively.

During the twelve months ending August 31, 2018, we anticipate that the statute of limitations pertaining to positions of the Company in prior year income tax returns may lapse or that income tax audits in various taxing jurisdictions will be finalized. As a result of such statute lapses or audit settlements, it is reasonably possibly that the amount of unrecognized tax benefits may decrease by $9.3 million.

The Company files income tax returns in the U.S. and multiple foreign jurisdictions with varying statutes of limitations. In the normal course of business, the Company and its subsidiaries are subject to examination by various taxing authorities. The following is a summary of tax years subject to examination:

U.S. Federal — 2009 and forward

U.S. States — 2009 and forward

Foreign — 2011 and forward

During the fiscal year ended August 31, 2016, the Company completed an IRS exam for the years 2009 through 2011 and received confirmation from the United States Congress Joint Committee on Taxation that all matters were settled with the exception of R&D credits, which are still under review as of August 31, 2017. In addition, the Company is under examination with certain state revenue authorities for the years 2009 to 2015. Management believes the Company's recorded income tax liabilities as of August 31, 2017 sufficiently reflect the anticipated outcome of these examinations.