CATERPILLAR FINANCIAL SERVICES CORPORATION

INCOME TAXES

On December 22, 2017, U.S. tax legislation was enacted containing a broad range of tax reform provisions including a corporate tax rate reduction and changes in the U.S. taxation of non-U.S. earnings. We have not completed our accounting for the income tax effects of U.S. tax reform. However, we have made a reasonable estimate of the 2017 financial statement impact as of January 18, 2018, and recognized a provisional net benefit of $151 million. We will continue to update our calculations as additional required information is prepared and analyzed, interpretations and assumptions are refined, additional guidance is issued, and due to actions we may take as a result of the legislation. These updates could significantly impact the provision for income taxes, the amount of taxes payable, and the deferred tax asset and liability balances.

The provisionally estimated net benefit includes a $334 million write-down of net deferred tax liabilities to reflect the reduction in the U.S. corporate tax rate from 35 percent to 21 percent beginning January 1, 2018. We are still analyzing certain aspects of the law and refining our calculations of basis differences as of December 31, 2017, which could affect the measurement of these balances.

The provisionally estimated net benefit includes $183 million for the estimated cost of a mandatory deemed repatriation of non-U.S. earnings. The resulting tax liability, net of available foreign tax credits, is $131 million, payable over eight years and is included in Income taxes payable in the Consolidated Statements of Financial Position. The U.S. federal tax cost for the mandatory deemed repatriation is computed at 15.5 percent for non-U.S. earnings held in liquid assets and 8 percent for non-liquid assets, reduced by applicable foreign tax credits. These estimates are provisional due to additional information and analysis required to determine cumulative taxable earnings since 1986 for non-U.S. subsidiaries at two separate points in time and to determine the amount of earnings that are held in liquid versus non-liquid assets as defined in the new legislation at several different measurement periods. In addition, information is being gathered and analyzed to support available foreign tax credits including estimates of credit utilization and valuation allowance considerations for any remaining foreign tax credit carryforward. Due to uncertainty about aspects of the tax law, we have made various assumptions to determine our reasonable estimate that we expect to refine as additional guidance is issued.

As a result of U.S. tax reform legislation, distributions of profits from non-U.S. subsidiaries are expected to have minimal U.S. tax impact in the future. However, these distributions may be subject to non-U.S. withholding taxes if profits are distributed in certain jurisdictions. We have not recorded a deferred tax liability for withholding taxes in non-U.S. jurisdictions where earnings are considered indefinitely reinvested. If management intentions or U.S. tax law changes in the future, there could be an impact on the provision for income taxes to record an incremental tax liability in the period the change occurs.

A reconciliation of the U.S. federal statutory rate to the effective rate for the years ended December 31, was as follows:



(Millions of dollars)
	2017					2016					2015
Taxes computed at U.S. statutory rates	$	206		35.0	%	$	196		35.0	%	$	217		35.0	%
(Decreases) increases in taxes resulting from:
State Income Tax, net of Federal Tax	2			0.3	%	2			0.4	%	3			0.5	%
Subsidiaries' results subject to tax rates other than U.S. statutory rates	(31		)	(5.3	)%	(36		)	(6.5	)%	(25		)	(4.0	)%
Income from non-U.S. subsidiaries taxed at U.S. statutory rates, net of foreign tax credits⁽¹⁾	(16		)	(2.7	)%	2			0.3	%	(39		)	(6.3	)%
Foreign currency translation taxed at non-U.S. subsidiaries	(12		)	(2.0	)%	13			2.3	%	6			0.9	%
U.S. deferred tax rate change	(334		)	(56.6	)%	—			—	%	—			—	%
Mandatory deemed repatriation of non-U.S. earnings	183			31.0	%	—			—	%	—			—	%
Other, net	(2		)	(0.4	)%	(6		)	(1.1	)%	(4		)	(0.6	)%
Provision (benefit) for income taxes	$	(4	)	(0.7	)%	$	171		30.4	%	$	158		25.5	%

⁽¹⁾Excludes provisionally estimated net benefit from 2017 U.S. tax reform.

The components of Profit before income taxes for the years ended December 31, were as follows:



(Millions of dollars)
	2017		2016		2015
U.S.	$	285	$	249	$	230
Non-U.S.	305		312		389
Total	$	590	$	561	$	619

Profit before income taxes, as shown above, is based on the location of the entity to which such earnings are attributable. Where an entity’s earnings are subject to taxation, however, may not correlate solely to where an entity is located. Thus, the income tax provision shown below as U.S. or non-U.S. may not correspond to the earnings shown above.

The components of the Provision (benefit) for income taxes were as follows for the years ended December 31:



(Millions of dollars)
	2017			2016			2015
Current income tax provision (benefit):
U.S.	$	157		$	(18	)	$	(21	)
Non-U.S.	102			111			109
State (U.S.)	1			—			2
	260			93			90

Deferred income tax provision (benefit):
U.S.	(239		)	90			45
Non-U.S.	(28		)	(15		)	21
State (U.S.)	3			3			2
	(264		)	78			68

Total Provision (benefit) for income taxes	$	(4	)	$	171		$	158

Current income tax provision is the amount of income taxes reported or expected to be reported on our income tax returns. We join Caterpillar in the filing of a consolidated U.S. Federal income tax return and certain state income tax returns. In accordance with our tax sharing agreement with Caterpillar, we generally pay to or receive from Caterpillar our allocated share of income taxes or credits reflected in these consolidated filings. This amount is calculated on a separate return basis by taking taxable income times the applicable statutory tax rate and includes payment for certain tax attributes earned during the year.

Accounting for income taxes under generally accepted accounting principles in the United States of America requires individual tax-paying entities of the Company to offset deferred income tax assets and liabilities within each particular tax jurisdiction and present them as a single amount in the Consolidated Statements of Financial Position. Amounts in different tax jurisdictions cannot be offset against each other. The amounts of deferred income taxes at December 31, included in the following lines in our Consolidated Statements of Financial Position were:



(Millions of dollars)
	2017			2016
Assets:
Deferred and refundable income taxes	$	101		$	89
Liabilities:
Deferred income taxes and other liabilities	(579		)	(939		)
Deferred income taxes, net	$	(478	)	$	(850	)

Our consolidated deferred income taxes consisted of the following components as of December 31:



(Millions of dollars)
	2017			2016
Deferred income tax assets:
Allowance for credit losses	$	96		$	148
Tax carryforwards	43			73
	139			221

Deferred income tax liabilities (primarily lease basis differences)	(441		)	(693		)

Valuation allowance for deferred income tax assets	(11		)	(10		)

Deferred income tax on translation adjustment	(165		)	(368		)

Deferred income taxes, net	$	(478	)	$	(850	)

As of December 31, 2017, amounts and expiration dates of net operating loss (NOL) carryforwards in various U.S. state taxing jurisdictions were:



(Millions of dollars)
2018		2019		2020		2021		2022-2037		Total
$	6	$	4	$	1	$	5	$	137	$	153

The gross deferred income tax asset associated with these NOL carryforwards is $12 million as of December 31, 2017, partially offset by a valuation allowance of $1 million.

In some U.S. state income tax jurisdictions, we join with other Caterpillar entities in filing combined income tax returns. In other U.S. state income tax jurisdictions, we file on a separate, stand-alone basis.

As of December 31, 2017, amounts and expiration dates of NOL carryforwards in various non-U.S. taxing jurisdictions were:



(Millions of dollars)
2018		2019		2020		2021		2022-2037		Unlimited		Total
$	—	$	—	$	—	$	26	$	45	$	53	$	124

Valuation allowances totaling $10 million have been recorded at certain non-U.S. subsidiaries that have not yet demonstrated consistent and/or sustainable profitability to support the recognition of net deferred income tax assets.

A reconciliation of the beginning and ending amounts of gross unrecognized income tax benefits for uncertain income tax positions, including positions impacting only the timing of income tax benefits was as follows:



(Millions of dollars)
	2017			2016
Reconciliation of unrecognized income tax benefits⁽¹⁾:
Balance at beginning of year	$	4		$	—
Additions for income tax positions related to current year	—			1
Additions for income tax positions related to prior year	—			3
Reductions for income tax positions related to settlements⁽²⁾	(4		)	—
Balance at end of year	$	—		$	4

Amount that, if recognized, would impact the effective tax rate	$	—		$	—

⁽¹⁾Foreign currency translation amounts are included within each line as applicable.

⁽²⁾Includes cash payment or other reduction of assets to settle liability.

We classify interest and penalties on income taxes as a component of the provision for income taxes. During the years ended December 31, 2017, 2016 and 2015, we recognized an expense of $2 million, a benefit of less than $1 million and an expense of less than $1 million in interest and penalties, respectively. As of December 31, 2017 and 2016, the total amount of accrued interest and penalties was less than $1 million and $2 million, respectively.

On January 31, 2018, Caterpillar received a Revenue Agent's Report (RAR) from the IRS indicating the end of field examination of our U.S. tax returns for 2010 to 2012. Tax years prior to 2007 are generally no longer subject to U.S. tax assessment. In our major non-U.S. jurisdictions, tax years are typically subject to examination for three to seven years. Due to the uncertainty related to the timing and potential outcome of audits, we cannot estimate the range of reasonably possible change in unrecognized tax benefits in the next 12 months.