Sempra Energy

INCOME TAXES

Reconciliation of net U.S. statutory federal income tax rates to the ETRs is as follows:



RECONCILIATION OF FEDERAL INCOME TAX RATES TO EFFECTIVE INCOME TAX RATES

	Years ended December 31,
	2017		2016		2015
Sempra Energy Consolidated:
U.S. federal statutory income tax rate	35	%	35	%	35	%
Effects of the TCJA	55		—		—
Utility depreciation	6		4		5
Foreign exchange and inflation effects⁽¹⁾	3		(2	)	(2	)
State income taxes, net of federal income tax benefit	1		1		1
Utility repairs expenditures	(6	)	(4	)	(5	)
Tax credits	(4	)	(3	)	(4	)
Self-developed software expenditures	(4	)	(3	)	(3	)
Non-U.S. earnings taxed at lower statutory income tax rates⁽²⁾	(3	)	(3	)	(2	)
Allowance for equity funds used during construction	(3	)	(2	)	(2	)
Resolution of prior years’ income tax items	(2	)	—		(3	)
Share-based compensation	—		(2	)	—
Other, net	3		—		—
Effective income tax rate	81	%	21	%	20	%
SDG&E:
U.S. federal statutory income tax rate	35	%	35	%	35	%
Depreciation	7		5		4
Effects of the TCJA	5		—		—
State income taxes, net of federal income tax benefit	3		5		5



Repairs expenditures	(8	)	(4	)	(4	)
Self-developed software expenditures	(6	)	(3	)	(3	)
Allowance for equity funds used during construction	(4	)	(2	)	(2	)
Resolution of prior years’ income tax items	(4	)	(1	)	(2	)
Share-based compensation	—		(1	)	—
Other, net	(1	)	(1	)	(1	)
Effective income tax rate	27	%	33	%	32	%
SoCalGas:
U.S. federal statutory income tax rate	35	%	35	%	35	%
Depreciation	9		9		8
State income taxes, net of federal income tax benefit	3		2		4
Repairs expenditures	(8	)	(9	)	(10	)
Self-developed software expenditures	(5	)	(6	)	(6	)
Allowance for equity funds used during construction	(3	)	(2	)	(2	)
Resolution of prior years’ income tax items	(2	)	2		(3	)
Share-based compensation	—		(1	)	—
Other, net	—		(1	)	(1	)
Effective income tax rate	29	%	29	%	25	%

⁽¹⁾

Primarily due to fluctuation of the Mexican peso against the U.S. dollar. We record income tax expense (benefit) from the transactional effects of foreign currency and inflation because of significant appreciation (depreciation) of the Mexican peso. We also recognize gains (losses) in Other Income, Net, on the Consolidated Statements of Operations from foreign currency derivatives that are partially hedging Sempra Mexico parent’s exposure to movements in the Mexican peso from its controlling interest in IEnova.


⁽²⁾	Related to operations in Mexico, Chile and Peru.

On December 22, 2017, the TCJA was signed into law. This legislation significantly changes the IRC. Under U.S. GAAP, certain effects of the TCJA are required to be recognized upon enactment, and, as a result, Sempra Energy, SDG&E, and SoCalGas recorded the related effects in 2017.

The TCJA reduces the U.S. statutory corporate income tax rate from 35 percent to 21 percent, effective January 1, 2018, which will be applied to future U.S. earnings. U.S. GAAP requires that deferred income tax assets and liabilities, including NOLs, be remeasured at the income tax rate expected to apply when those temporary differences reverse and that the effects of any change to such income tax rate be recognized in the period when the change was enacted. This remeasurement resulted in significant reductions in deferred income tax balances at Sempra Energy Consolidated, SDG&E and SoCalGas.

The remeasurement of deferred income tax balances at SDG&E and SoCalGas resulted in excess deferred income taxes that previously have been collected from ratepayers at the higher rate. These excess deferred income taxes have been recorded as regulatory liabilities as of December 31, 2017 and will be refunded to ratepayers in accordance with the IRC’s normalization provisions and as determined by the CPUC and FERC.

Our 2017 financial statements were materially impacted by the effects of the TCJA, primarily related to two provisions:

▪

Lower U.S. statutory corporate income tax rate: The change in the U.S. statutory corporate federal income tax rate from 35 percent to 21 percent resulted in income tax expense of $182 million for the year ended December 31, 2017 for Sempra Energy Consolidated because of the remeasurement of deferred income tax balances. SDG&E’s and SoCalGas’ impacts were primarily offset with adjustments to regulatory liabilities, however, they also recorded $28 million and $2 million of income tax expense, respectively, for the year ended December 31, 2017 associated with the TCJA.

▪

Deemed repatriation: The TCJA imposes a one-time tax for deemed repatriation of foreign undistributed earnings as determined under U.S. federal tax law. Under this provision, a U.S. shareholder must include in taxable income its pro-rata share of foreign undistributed earnings, which are taxed at 15.5 percent on cash or cash equivalents and 8 percent on cumulative other earnings. Sempra Energy Consolidated recorded deemed repatriation tax expense of $328 million. Based on our preliminary analysis, we currently anticipate using our existing NOLs to offset the deemed repatriation tax liability. In addition, we plan to repatriate these foreign undistributed earnings (estimated to be approximately $4 billion) that have now been taxed at the U.S. federal level. As a result, for the year ended December 31, 2017, we accrued $360 million of U.S. state and non-U.S. withholding tax expense on this expected future repatriation. This liability could change as a result of various factors, such as interpretation and clarification of the TCJA provisions, changes in foreign tax laws, foreign currency movements, the source of cash to be repatriated or adjustments to our provisional estimates, as we discuss below.

We have not recorded deferred income tax with respect to remaining basis differences of approximately $1 billion between financial statement and income tax investment amounts in our non-U.S subsidiaries as of December 31, 2017 because we consider them to be indefinitely reinvested. It is not practicable to determine the hypothetical amount of tax that might be payable if the underlying basis differences were realized. If these basis differences were realized, we would need to adjust our income tax provision in the period we determine that they are no longer indefinitely reinvested.



EFFECTS OF THE TAX CUTS AND JOBS ACT OF 2017
(Dollars in millions)
	Sempra Energy Consolidated			SDG&E			SoCalGas
Consolidated Balance Sheets:
Decrease in net deferred income tax liabilities due
to remeasurement	$	(2,220	)	$	(1,400	)	$	(972	)
Increase in net regulatory liabilities from remeasurement of
deferred income tax assets and liabilities	$	2,402		$	1,428		$	974

Consolidated Statements of Operations:
Income tax expense related to remeasurement of deferred
income tax assets and liabilities	$	182		$	28		$	2
Income tax expense related to deemed repatriation	328			—			—
U.S. state and non-U.S. withholding tax expense related to
expected future repatriation of foreign earnings	360			—			—
Total increase in income tax expense	$	870		$	28		$	2

We recorded the effects of the TCJA in 2017 using our best estimates and the information available to us through the date the financial statements were issued. However, our analysis is ongoing and as such, the income tax effects that we have recorded are provisional.

As permitted by and in accordance with the guidance issued by the SEC, we may adjust our provisional estimates in future reporting periods throughout 2018 as we complete our analysis and as more information becomes available, and these adjustments may affect earnings. Events and information that may result in adjustments to our provisional estimates include interpretations or rulings by the U.S. Department of the Treasury or states, the filing of our 2017 income tax return and the finalization of our calculation of foreign undistributed earnings.

For SDG&E and SoCalGas, the CPUC requires flow-through rate-making treatment for the current income tax benefit or expense arising from certain property-related and other temporary differences between the treatment for financial reporting and income tax, which will reverse over time. Under the regulatory accounting treatment required for these flow-through temporary differences, deferred income tax assets and liabilities are not recorded to deferred income tax expense, but rather to a regulatory asset or liability, which impacts the current ETR. As a result, changes in the relative size of these items compared to pretax income, from period to period, can cause variations in the ETR. The following items are subject to flow-through treatment:


▪	repairs expenditures related to a certain portion of utility plant fixed assets


▪	the equity portion of AFUDC


▪	a portion of the cost of removal of utility plant assets


▪	utility self-developed software expenditures


▪	depreciation on a certain portion of utility plant assets


▪	state income taxes

The AFUDC related to equity recorded for regulated construction projects at Sempra Mexico has similar flow-through treatment.

The 2016 GRC FD issued by the CPUC in June 2016 required SDG&E and SoCalGas to each establish a two-way income tax expense memorandum account to track certain revenue variances resulting from certain differences between the income tax expense forecasted in the GRC and the income tax expense incurred from 2016 through 2018. The tracking accounts will remain open until the CPUC decides to close the accounts, which we expect will be reviewed in the 2019 GRC proceedings. We expect that certain amounts recorded in the tracking accounts may give rise to regulatory assets or liabilities. We discuss the tracking accounts further in Note 14.

The geographic components of Income Before Income Taxes and Equity Earnings of Certain Unconsolidated Subsidiaries at Sempra Energy Consolidated are as follows:



GEOGRAPHIC COMPONENTS
(Dollars in millions)
	Pretax book income
	Years ended December 31,
	2017		2016		2015
U.S.	$	878	$	773	$	1,189
Non-U.S.	707		1,057		515
Total	$	1,585	$	1,830	$	1,704

U.S. pretax book income decreased in 2016 compared to 2015 at the California Utilities primarily due to the reallocation of 2012-2015 income tax benefits generated from income tax repairs deductions to ratepayers pursuant to the 2016 GRC FD, as we discuss in Note 14; at Sempra LNG & Midstream for the loss on permanent release of pipeline capacity, as we discuss in Note 15; and the impairment charge related to the investment in Rockies Express, as we discuss in Note 3. U.S. pretax income remained lower in 2017 due to the write-off of SDG&E’s wildfire regulatory asset, as we discuss in Note 15. Non-U.S. pretax book income was lower in 2017 and 2015 compared to 2016 primarily due to the noncash gain in 2016 associated with the remeasurement of our equity interest in IEnova Pipelines, as we discuss in Note 3.

The components of income tax expense are as follows:



INCOME TAX EXPENSE (BENEFIT)
(Dollars in millions)
	Years ended December 31,
	2017			2016			2015
Sempra Energy Consolidated:
Current:
U.S. federal	$	—		$	—		$	3
U.S. state	—			1			(24		)
Non-U.S.	116			171			123
Total	116			172			102
Deferred:
U.S. federal	536			78			242
U.S. state	297			9			34
Non-U.S.	327			135			(32		)
Total	1,160			222			244
Deferred investment tax credits	—			(5		)	(5		)
Total income tax expense	$	1,276		$	389		$	341
SDG&E:
Current:
U.S. federal	$	100		$	—		$	12
U.S. state	65			22			77
Total	165			22			89
Deferred:
U.S. federal	29			223			233
U.S. state	(41		)	38			(35		)
Total	(12		)	261			198
Deferred investment tax credits	2			(3		)	(3		)
Total income tax expense	$	155		$	280		$	284
SoCalGas:
Current:
U.S. federal	$	—		$	—		$	(1	)
U.S. state	23			40			12
Total	23			40			11
Deferred:
U.S. federal	144			123			122
U.S. state	(5		)	(18		)	7
Total	139			105			129
Deferred investment tax credits	(2		)	(2		)	(2		)
Total income tax expense	$	160		$	143		$	138

We show the components of deferred income taxes, which reflect the effects of the TCJA, at December 31 for Sempra Energy Consolidated, SDG&E and SoCalGas in the tables below:



DEFERRED INCOME TAXES – SEMPRA ENERGY CONSOLIDATED
(Dollars in millions)
	December 31,
	2017		2016
Deferred income tax liabilities:
Differences in financial and tax bases of fixed assets, investments and other assets⁽¹⁾	$	4,233	$	6,111
U.S. state and non-U.S. withholding tax on repatriation of foreign earnings	360		—
Regulatory balancing accounts	376		783
Property taxes	37		63
Other deferred income tax liabilities	117		143
Total deferred income tax liabilities	5,123		7,100
Deferred income tax assets:
Tax credits	1,066		431
Net operating losses	968		2,304
Compensation-related items	199		252
Postretirement benefits	251		434
Other deferred income tax assets	115		87
Accrued expenses not yet deductible	60		112
Deferred income tax assets before valuation allowances	2,659		3,620
Less: valuation allowances	133		31
Total deferred income tax assets	2,526		3,589
Net deferred income tax liability⁽²⁾	$	2,597	$	3,511


⁽¹⁾	In addition to the financial over tax basis differences in fixed assets, the amount also includes financial over tax basis differences in various interests in partnerships and certain subsidiaries.


⁽²⁾	At December 31, 2017 and 2016, includes $170 million and $234 million, respectively, recorded as a noncurrent asset and $2,767 million and $3,745 million, respectively, recorded as a noncurrent liability on the Consolidated Balance Sheets.



DEFERRED INCOME TAXES – SDG&E AND SOCALGAS
(Dollars in millions)
	SDG&E				SoCalGas
	December 31,				December 31,
	2017		2016		2017		2016
Deferred income tax liabilities:
Differences in financial and tax bases of
utility plant and other assets	$	1,472	$	2,549	$	987	$	1,699
Regulatory balancing accounts	113		379		271		411
Property taxes	26		42		12		21
Other	10		10		1		4
Total deferred income tax liabilities	1,621		2,980		1,271		2,135
Deferred income tax assets:
Net operating losses	—		—		58		83
Tax credits	7		27		15		17
Postretirement benefits	43		98		152		244
Compensation-related items	5		8		25		32
State income taxes	14		—		7		19
Accrued expenses not yet deductible	3		7		12		20
Other	19		11		7		11
Total deferred income tax assets	91		151		276		426
Net deferred income tax liability	$	1,530	$	2,829	$	995	$	1,709

The following table summarizes our unused NOLs and tax credit carryforwards at December 31, 2017.



NET OPERATING LOSSES AND TAX CREDIT CARRYFORWARDS
(Dollars in millions)
	Unused amount at December 31, 2017		Year expiration begins
Sempra Energy Consolidated:
U.S. federal:
NOLs⁽¹⁾	$	3,145	2031
General business tax credits⁽¹⁾	389		2032
Foreign tax credits⁽²⁾	631		2024
U.S. state⁽²⁾:
NOLs	2,295		2019
General business tax credits	51		2018
Non-U.S.⁽²⁾
NOLs	607		2018
SoCalGas:
U.S. federal⁽¹⁾:
NOLs	$	334	2032
General business tax credits	12		2031


⁽¹⁾	We have recorded deferred income tax benefits on these NOLs and tax credits, in total, because we currently believe they will be realized on a more-likely-than-not-basis.


⁽²⁾	We have not recorded deferred income tax benefits on a portion of these NOLs and tax credits because we currently believe they will not be realized on a more-likely-than-not-basis, as discussed below.

At December 31, 2017, Sempra Energy recorded a valuation allowance against a portion of its total deferred income tax assets, as shown above in the “Deferred Income Taxes – Sempra Energy Consolidated” table. A valuation allowance is recorded when, based on more-likely-than-not criteria, negative evidence outweighs positive evidence with regard to our ability to realize a deferred income tax asset in the future. Of the valuation allowances recorded to date, the negative evidence outweighs the positive evidence primarily due to cumulative pretax losses in various U.S. state and non-U.S. jurisdictions resulting in a deferred income tax asset related to NOLs, as shown in the “Net Operating Losses and Tax Credit Carryforwards” table above, that we currently do not believe will be realized on a more-likely-than-not basis. Of Sempra Energy’s total valuation allowance of $133 million at December 31, 2017, $20 million is related to non-U.S. NOLs and tax credits, $30 million to U.S. state NOLs and tax credits, and $83 million to U.S. foreign tax credits. Of Sempra Energy’s total valuation allowance of $31 million at December 31, 2016, $1 million was related to non-U.S. NOLs and $30 million to U.S. state NOLs and tax credits.

Following is a reconciliation of the changes in unrecognized income tax benefits and the potential effect on our ETR for the years ended December 31:



RECONCILIATION OF UNRECOGNIZED INCOME TAX BENEFITS
(Dollars in millions)
	2017			2016			2015
Sempra Energy Consolidated:
Balance at January 1	$	90		$	87		$	117
Increase in prior period tax positions	22			2			10
Decrease in prior period tax positions	(15		)	(2		)	—
Increase in current period tax positions	4			6			8
Settlements with taxing authorities	(12		)	(3		)	(48		)
Balance at December 31	$	89		$	90		$	87
Of December 31 balance, amounts related to tax positions that
if recognized in future years would
decrease the effective tax rate⁽¹⁾	$	(77	)	$	(87	)	$	(83	)
increase the effective tax rate⁽¹⁾	20			36			32
SDG&E:
Balance at January 1	$	22		$	20		$	14
Increase in prior period tax positions	9			—			5
Decrease in prior period tax positions	(11		)	—			—
Increase in current period tax positions	—			2			2
Settlements with taxing authorities	(10		)	—			(1		)
Balance at December 31	$	10		$	22		$	20
Of December 31 balance, amounts related to tax positions that
if recognized in future years would
decrease the effective tax rate⁽¹⁾	$	(7	)	$	(19	)	$	(16	)
increase the effective tax rate⁽¹⁾	1			13			11
SoCalGas:
Balance at January 1	$	29		$	27		$	19
Increase in prior period tax positions	3			—			2
Decrease in prior period tax positions	—			(2		)	—
Increase in current period tax positions	4			4			6
Settlements with taxing authorities	(1		)	—			—
Balance at December 31	$	35		$	29		$	27
Of December 31 balance, amounts related to tax positions that
if recognized in future years would
decrease the effective tax rate⁽¹⁾	$	(26	)	$	(29	)	$	(27	)
increase the effective tax rate⁽¹⁾	20			24			21


⁽¹⁾	Includes temporary book and tax differences that are treated as flow-through for ratemaking purposes, as discussed above.

It is reasonably possible that within the next 12 months, unrecognized income tax benefits could decrease due to the following:



POSSIBLE DECREASES IN UNRECOGNIZED INCOME TAX BENEFITS WITHIN 12 MONTHS
(Dollars in millions)
	At December 31,
	2017			2016			2015
Sempra Energy Consolidated:
Expiration of statutes of limitations on tax assessments	$	—		$	(2	)	$	(2	)
Potential resolution of audit issues with various
U.S. federal, state and local and non-U.S. taxing authorities	(8		)	(36		)	(32		)
	$	(8	)	$	(38	)	$	(34	)
SDG&E:
Expiration of statutes of limitations on tax assessments	$	—		$	(1	)	$	(1	)
Potential resolution of audit issues with various
U.S. federal, state and local taxing authorities	(6		)	(10		)	(8		)
	$	(6	)	$	(11	)	$	(9	)
SoCalGas:
Potential resolution of audit issues with various
U.S. federal, state and local taxing authorities	$	(2	)	$	(25	)	$	(22	)

Amounts accrued for interest and penalties associated with unrecognized income tax benefits are included in Income Tax Expense on the Consolidated Statements of Operations. Sempra Energy Consolidated accrued a negligible amount and $1 million for interest expense and penalties at December 31, 2017 and 2016, respectively, on the Consolidated Balance Sheets, and recorded negligible amounts of interest income and penalties in each of 2017 and 2016 and $2 million in 2015 on the Consolidated Statements of Operations. SDG&E and SoCalGas accrued negligible amounts of interest expense and penalties at December 31, 2017 and 2016 on the Consolidated Balance Sheets, and recorded negligible amounts of interest expense and penalties in 2017, 2016 and 2015 on the Consolidated Statements of Operations.

INCOME TAX AUDITS

Sempra Energy is subject to U.S. federal income tax as well as income tax of multiple state and non-U.S. jurisdictions. We remain subject to examination for U.S. federal tax years after 2013. We are subject to examination by major state tax jurisdictions for tax years after 2008. Certain major non-U.S. income tax returns for tax years 2008 through the present are open to examination. We are also open to examination for non-U.S. income tax returns related to our prior interest in our commodities business, which we divested in 2010, for years 1996 through 2010.

In addition, we have filed state refund claims for tax years back to 2006. The pre-2009 tax years for our major state tax jurisdictions are closed to new issues; therefore, no additional tax may be assessed by the taxing authorities for these tax years.

SDG&E and SoCalGas are subject to U.S. federal income tax as well as income tax of state jurisdictions. They remain subject to examination for U.S. federal tax years after 2013 and by state tax jurisdictions for tax years after 2008.