Income Taxes
On December 22, 2017, the Tax Cuts and Jobs Act (the "Tax Act") was signed into law. The Tax Act significantly changes U.S. tax law. The Tax Act reduces the U.S. corporate income tax rate from a maximum of 35% to 21% for all corporations, effective January 1, 2018, and makes certain changes to U.S. taxation of income earned by foreign subsidiaries, capital expenditures, interest expense and various other items.
As a result of the reduction in the U.S. corporate income tax rate from 35% to 21%, we revalued our net deferred tax assets at December 31, 2017 and recognized a provisional $195 million tax expense in our consolidated statement of operations for the year ended December 31, 2017.
The Tax Act imposed a one-time repatriation tax on certain earnings of foreign subsidiaries. The Tax Act also includes certain anti-abuse and base erosion provisions that may impact the amount of U.S. tax that we pay with respect to income earned by our foreign subsidiaries. We have not yet been able to make a reasonable estimate of the impact of these provisions and continue to account for these items based on our existing accounting under U.S. GAAP and the provisions of the tax laws that were in effect prior to the Tax Act's enactment.
On December 22, 2017, the SEC staff addressed the application of U.S. GAAP in situations when a registrant does not have the necessary information available, prepared, or analyzed (including computations) in reasonable detail to complete the accounting for certain income tax effects of the Tax Act. We have provisionally recognized the tax impacts related to the revaluation of deferred tax assets and liabilities in the amount noted above in our consolidated financial statements for the year ended December 31, 2017. The ultimate impact may differ from our provisional amount due to additional analysis, changes in interpretations and assumptions we have made, additional regulatory guidance that may be issued, and actions we may take as a result of the Tax Act. The change from our current provisional estimates will be reflected in our future statements of operations and could be material. We expect to complete the accounting by the time CenturyLink files its 2017 U.S. corporate income tax return in the fourth quarter of 2018, although we cannot assure you of this.
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| | | | | | | | | | | | | |
| Successor | | | Predecessor |
| Period Ended December 31, 2017 | | | Period Ended October 31, 2017 | | Year Ended December 31, 2016 | | Year Ended December 31, 2015 |
| (Dollars in millions) |
Income tax expense (benefit) was as follows: | | | | | | | | |
Federal | | | | | | | | |
Current | $ | — |
| | | — |
| | — |
| | — |
|
Deferred | 231 |
| | | 193 |
| | 177 |
| | (2,941 | ) |
State | | | | | | | | |
Current | 2 |
| | | 7 |
| | 4 |
| | 3 |
|
Deferred | 6 |
| | | 16 |
| | 27 |
| | (246 | ) |
Foreign | | | | | | | | |
Current | 4 |
| | | 39 |
| | 41 |
| | 33 |
|
Deferred | (9 | ) | | | 13 |
| | (84 | ) | | 1 |
|
Total income tax expense (benefit) | $ | 234 |
| | | 268 |
| | 165 |
| | (3,150 | ) |
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| | | | | | | | | | | | | |
| Successor | | | Predecessor |
| Period Ended December 31, 2017 | | | Period Ended October 31, 2017 | | Year Ended December 31, 2016 | | Year Ended December 31, 2015 |
| (Dollars in millions) |
Income tax expense was allocated as follows: | | | | | | | | |
Income tax expense in the consolidated statements of operations: | | | | | | | | |
Attributable to income | $ | 234 |
| | | 268 |
| | 165 |
| | (3,150 | ) |
Member's/Stockholders' equity: | | | | | | | | |
Tax effect of the change in accumulated other comprehensive loss | $ | 17 |
| | | 49 |
| | (43 | ) | | (11 | ) |
The following is a reconciliation from the statutory federal income tax rate to our effective income tax rate:
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| | | | | | | | | | | | |
| Successor | | | Predecessor |
| Period Ended December 31, 2017 | | | Period Ended October 31, 2017 | | Year Ended December 31, 2016 | | Year Ended December 31, 2015 |
| (Dollars in millions) |
Statutory federal income tax rate | 35.0 | % | | | 35.0 | % | | 35.0 | % | | 35.0 | % |
State income taxes, net of federal income tax benefit | 3.6 | % | | | 2.9 | % | | 3.7 | % | | 5.2 | % |
Tax Reform/US Federal Law Changes | 210.6 | % | | | — | % | | (13.2 | )% | | — | % |
Transaction costs | 11.3 | % | | | — | % | | — | % | | — | % |
Change in liability of unrecognized tax position | 1.2 | % | | | 0.1 | % | | 0.1 | % | | (0.1 | )% |
Net foreign income tax | (19.3 | )% | | | 0.9 | % | | (6.7 | )% | | 26.6 | % |
Permanent items | 5.0 | % | | | 1.8 | % | | 1.2 | % | | 2.6 | % |
Change in US valuation allowance | — | % | | | — | % | | — | % | | (1,199.8 | )% |
Adoption of ASU 2016-09, Improvements to Employee Share-Based Payment Accounting
| 0.1 | % | | | (0.5 | )% | | (2.4 | )% | | — | % |
Research and development costs | (0.9 | )% | | | (1.2 | )% | | — | % | | — | % |
Non-deductible loss on deconsolidation | — | % | | | — | % | | — | % | | 20.2 | % |
Other, net | 5.0 | % | | | (0.3 | )% | | 1.9 | % | | (2.7 | )% |
Effective income tax rate | 251.6 | % | | | 38.7 | % | | 19.6 | % | | (1,113.0 | )% |
The successor period ended December 31, 2017 effective tax rate is 251.6% compared to 38.7% for the predecessor period ended October 31, 2017, 19.6% for the predecessor year ended December 31, 2016 and (1,113)% for the predecessor year ended December 31, 2015. The effective tax rate for the successor period ended December 31, 2017 reflects $195 million of an estimated one-time income tax expense related to income tax law changes under the Tax Act enacted in 2017. The predecessor year ended December 31, 2016 reflects a $110 million estimated one-time income tax benefit related to newly issued regulations under Internal Revenue Code Section 987 addressing the taxation of foreign currency translations gains and losses arising from foreign branches, as well as $82 million of income tax benefit related to the release of foreign valuation allowances, primarily in Germany, Brazil and Mexico. The predecessor year ended December 31, 2015 effective tax rate reflects an estimated $3.3 billion income tax benefit related to the release of the majority of the valuation allowance against our U.S. federal and state deferred tax assets.
The tax effects of temporary differences that gave rise to significant portions of the deferred tax assets and deferred tax liabilities were as follows:
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| | | | | | | |
| Successor | | | Predecessor |
| December 31,
2017 | | | December 31,
2016 |
| (Dollars in millions) |
Deferred tax assets | | | | |
Deferred revenue | $ | 256 |
| | | 364 |
|
Net operating loss carry forwards | 3,633 |
| | | 4,550 |
|
Property, plant and equipment | 63 |
| | | 95 |
|
Other | 282 |
| | | 471 |
|
Gross deferred tax assets | 4,234 |
| | | 5,480 |
|
Less valuation allowance | (942 | ) | | | (862 | ) |
Net deferred tax assets | 3,292 |
| | | 4,618 |
|
Deferred tax liabilities | | | | |
Deferred revenue | (44 | ) | | | (57 | ) |
Property, plant and equipment | (689 | ) | | | (962 | ) |
Intangible assets | (2,329 | ) | | | (357 | ) |
Other | (16 | ) | | | (120 | ) |
Gross deferred tax liabilities | (3,078 | ) | | | (1,496 | ) |
Net deferred tax assets | $ | 214 |
| | | 3,122 |
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Of the $214 million and $3.122 billion net deferred tax assets at December 31, 2017 and 2016, respectively, $212 million and $248 million is reflected as a long-term liability and $426 million and $3.370 billion is reflected as a net noncurrent deferred tax asset at December 31, 2017 and 2016, respectively.
During the twelve months ended December 31, 2017, we completed an extensive analysis of our Internal Revenue Code ("IRC") Section 382 limitation that resulted in an increase of the amount of net operating loss carry forwards as of December 31, 2017 by approximately $1.0 billion on a pre-tax basis that was recorded in purchase accounting. At December 31, 2017, we had federal NOLs of $9.9 billion and state NOLs of $10 billion. If unused, the NOLs will expire between 2022 and 2035. At the successor date of December 31, 2017, we had $15 million of federal tax credits. At December 31, 2017, we had foreign NOLs of $5.8 billion.
We establish valuation allowances when necessary to reduce the deferred tax assets to amounts we expect to realize. As of December 31, 2017, a valuation allowance of $0.9 billion was established as it is more likely than not that this amount of net operating loss and tax credit carryforwards will not be utilized prior to expiration. Our valuation allowance at December 31, 2017 and 2016 is primarily related to foreign and state NOL carryforwards. This valuation allowance increased by $80 million during 2017.
We recognize deferred tax assets and liabilities for our domestic and non-U.S. operations, for operating loss and other credit carry forwards and the expected tax consequences of temporary differences between the tax basis of assets and liabilities and their reported amounts using enacted tax rates in effect for the year the differences are expected to reverse. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. The valuation of deferred tax assets requires judgment in assessing the likely future tax consequences of events that have been recognized in our financial statements or tax returns, and future profitability by tax jurisdiction. We have historically provided a valuation allowance to reduce our U.S. federal and state and foreign deferred tax assets to the amount that is more likely than not to be realized. We monitor our cumulative loss position and other evidence each quarter to determine the appropriateness of our valuation allowance. Although we believe our estimates are reasonable, the ultimate determination of the appropriate amount of valuation allowance involves significant judgment.
In the fourth quarter of 2015, we released the majority of the valuation allowance against our U.S. federal and state deferred tax assets, resulting in a non-cash benefit to income tax expense of approximately $3.3 billion, $3.1 billion of which was related to future years’ earnings. In making the determination to release the valuation allowance against U.S. federal and state deferred tax assets, we took into consideration our movement into a cumulative income position for the most recent 3-year period, including pro forma adjustments for acquired entities, our 8 out of 9 consecutive quarters of pre-tax operating income, and forecasts of future earnings for our U.S. business. We expect to continue to generate income before taxes in the United States in future periods.
During 2016, we recognized a $22 million income tax benefit from the vesting of share based compensation due to the adoption of ASU 2016-09, Improvements to Employee Share-Based Payment Accounting. We also recognized $82 million of income tax benefit related to the release of deferred tax asset valuation allowances primarily in Germany, Brazil, and Mexico. The determinations to release the foreign valuation allowances were driven by our projection of future profitability for each legal entity due to the recapitalization of our German subsidiary, the planned action to restructure our Brazilian business, and the merger of our Mexican subsidiaries.
With respect to our foreign corporate subsidiaries, we provide for U.S. income taxes on the undistributed earnings and the other outside basis temporary differences (differences between a parent's book and tax basis in a subsidiary, including currency translation adjustments) unless they are considered indefinitely reinvested outside the United States. The amount of temporary differences related to undistributed earnings and other outside basis temporary differences of investments in foreign subsidiaries upon which U.S. income taxes have not been provided was immaterial.
With respect to our foreign branches, we had historically established deferred tax liabilities for foreign branches with an overall cumulative translation gain, but had not established deferred tax assets for those with an overall translation loss as we had no plans to trigger realization of the losses in the foreseeable future. On December 7, 2016, the Internal Revenue Service issued regulations under Internal Revenue Code Section 987 addressing the taxation of foreign currency translations gains and losses arising from foreign branches. The new regulations require a “fresh start” recalculation of the unrealized gains and losses as of the adoption date. The regulations provide that the tax bases of specified assets, such as fixed assets, will be translated at historic foreign exchange rates. As a result, the deferred taxes related to such foreign currency translation are expected to reverse through the operations of the branch thereby allowing the recognition of deferred tax assets arising from translation losses as well. The issuance of the regulations resulted in us recognizing an estimated one-time tax benefit of $110 million during the fourth quarter 2016.
A reconciliation of the change in our gross unrecognized tax benefits (excluding both interest and any related federal benefit) from the successor period November 1 to December 31, 2017, the predecessor period January 1 to October 31, 2017 and the predecessor year ended December 31, 2016 is as follows:
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| | | | | | | | | | |
| Successor | | | Predecessor |
| Period Ended December 31, 2017 | | | Period Ended October 31, 2017 | | Year Ended December 31, 2016 |
| (Dollars in millions) |
Unrecognized tax benefits at beginning of period | $ | 20 |
| | | 18 |
| | 18 |
|
Tax positions of prior periods netted against deferred tax assets | — |
| | | — |
| | (1 | ) |
Increase (decrease) in tax positions taken in the prior period | 1 |
| | | — |
| | (1 | ) |
Increase in tax positions taken in the current period | — |
| | | 2 |
| | 2 |
|
Decrease from the lapse of statute of limitations | — |
| | | — |
| | — |
|
Unrecognized tax benefits at end of period | $ | 21 |
| | | 20 |
| | 18 |
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The total amount of unrecognized tax benefits that, if recognized, would impact the effective income tax rate was $20 million, $19 million and $17 million for the successor period ended December 31, 2017, the predecessor period ended October 31, 2017 and the predecessor year ended 2016, respectively.
Our policy is to reflect interest expense associated with unrecognized tax benefits in income tax expense. We had accrued interest (presented before related tax benefits) of approximately $20 million and $18 million at December 31, 2017 and 2016, respectively.
We, or at least one of our affiliates, file income tax returns in the U.S. federal jurisdiction and various states and foreign jurisdictions. With few exceptions, we are no longer subject to U.S. federal, state and local, or non-U.S. income tax examinations by tax authorities for years before 2003. The Internal Revenue Service and state and local taxing authorities reserve the right to audit any period where net operating loss carry forwards are available.
Based on our current assessment of various factors, including (i) the potential outcomes of these ongoing examinations, (ii) the expiration of statute of limitations for specific jurisdictions, (iii) the negotiated settlement of certain disputed issues, and (iv) the administrative practices of applicable taxing jurisdictions, it is reasonably possible that the related unrecognized tax benefits for uncertain tax positions previously taken may decrease by up to $3 million within the next 12 months. The actual amount of such decrease, if any, will depend on several future developments and events, many of which are outside our control.
We incur tax expense attributable to income in various subsidiaries that are required to file state or foreign income tax returns on a separate legal entity basis. We also recognize accrued interest and penalties in income tax expense related to uncertain tax benefits. Our tax rate is volatile and may move up or down with changes in, among other things, the amount and source of income or loss, our ability to utilize foreign tax credits, changes in tax laws, and the movement of liabilities established for uncertain tax positions as statutes of limitations expire or positions are otherwise effectively settled.