17. Income Taxes



The domestic and international components of pre-tax income are as follows:



Domestic pre-tax income includes the results of non-U.S. businesses that are operated in branches owned directly by the U.S. which, therefore, are subject to U.S. income tax.



The income tax provision consists of the following:



The Company previously considered the earnings in its non-U.S. subsidiaries to be indefinitely reinvested and, accordingly, recorded no deferred income taxes. Given the Tax Act’s significant changes and potential opportunities to repatriate cash without significant incremental U.S. federal tax, the Company is in the process of evaluating its current permanent reinvestment assertions. This evaluation includes the possible repatriation of historical earnings (2017 and prior) that have now been taxed under the Tax Act.



The Company had aggregate undistributed earnings and profits (“E&P”) from foreign subsidiaries of approximately $1,407 million at February 3, 2018, which is now classified as previously taxed income (“PTI”) subsequent to the Tax Act. The Company recorded a provisional $86 million “transition tax” in connection with this E&P. Additionally, the Company has recorded a provisional $13 million deferred tax liability as of the date of the change in the Company’s permanent reinvestment assertion primarily for state income taxes and foreign withholding taxes on the future repatriation of PTI. The Company currently considers the remaining financial statement carrying amounts over the tax basis of investments in its foreign subsidiaries to be indefinitely reinvested, and has not recorded a provisional deferred tax liability. The determination of any unrecorded provisional deferred tax liability on this amount is not practicable due to the uncertainty of how these investments would be recovered.



A reconciliation of the significant differences between the federal statutory income tax rate and the effective income tax rate on pre-tax income is as follows:





Deferred income taxes are provided for the effects of temporary differences between the amounts of assets and liabilities recognized for financial reporting purposes and the amounts recognized for income tax purposes. Items that give rise to significant portions of the Company’s deferred tax assets and liabilities are as follows:



As a result of the Tax Act’s corporate income tax rate reduction to 21 percent, the Company remeasured its deferred tax assets and liabilities, and the adjustment was not significant.



Based upon the level of historical taxable income and projections for future taxable income, which are based upon the Company’s long-range strategic plans, management believes it is more likely than not that the Company will realize the benefits of these deductible differences, net of the valuation allowances at February 3, 2018, over the periods in which the temporary differences are anticipated to reverse. However, the amount of the deferred tax asset considered realizable could be adjusted in the future if estimates of taxable income are revised.



As of February 3, 2018, the Company has a valuation allowance of $17 million to reduce its deferred tax assets to an amount that is more likely than not to be realized. A valuation allowance of $15 million was recorded against tax loss carryforwards of certain foreign entities. Based on the history of losses and the absence of prudent and feasible business plans for generating future taxable income in these entities, the Company believes it is more likely than not that the benefit of these loss carryforwards will not be realized. An additional valuation allowance of $2 million relates to the deferred tax assets arising from a capital loss associated with an impairment of the Northern Group note receivable in 2008. The Company does not anticipate realizing capital gains to utilize the capital loss associated with the note receivable impairment.



At February 3, 2018, the Company has U.S. state operating loss carryforwards with a potential tax benefit of $1 million that expire between 2021 and 2037. The Company will have, when realized, a capital loss with a potential benefit of $2 million arising from a note receivable. This loss will carryforward for 5 years after realization. The Company has international minimum tax credit carryforwards with a potential tax benefit of $4 million and operating loss carryforwards with a potential tax benefit of $16 million, a portion of which will expire between 2018 and 2026 and a portion of which will never expire. The state and international operating loss carryforwards do not include unrecognized tax benefits. 



The Company operates in multiple taxing jurisdictions and is subject to audit. Audits can involve complex issues that may require an extended period of time to resolve. A taxing authority may challenge positions that the Company has adopted in its income tax filings. Accordingly, the Company may apply different tax treatments for transactions in filing its income tax returns than for income tax financial reporting. The Company regularly assesses its tax positions for such transactions and records reserves for those differences.



The Company’s U.S. Federal income tax filings have been examined by the Internal Revenue Service through 2016. The Company is participating in the IRS’s Compliance Assurance Process (“CAP”) for 2017, which is expected to conclude during 2018. The Company has started the CAP for 2018. Due to the recent utilization of net operating loss carryforwards, the Company is subject to state and local tax examinations effectively including years from 2000 to the present. To date, no adjustments have been proposed in any audits that will have a material effect on the Company’s financial position or results of operations.



At February 3, 2018 and January 28, 2017, the Company had $44 million and $38 million, respectively, of gross unrecognized tax benefits, and $44 million and $38 million, respectively, of net unrecognized tax benefits that would, if recognized, affect the Company’s annual effective tax rate. The Company has classified certain income tax liabilities as current or noncurrent based on management’s estimate of when these liabilities will be settled. Interest expense and penalties related to unrecognized tax benefits are classified as income tax expense. Interest income was not significant in 2017, was $1 million in 2016, and was not significant for 2015. Accrued interest and penalties was not significant for 2017,  $1 million in 2016, and $2 million in 2015.



The following table summarizes the activity related to unrecognized tax benefits:





It is reasonably possible that the liability associated with the Company’s unrecognized tax benefits will increase or decrease within the next twelve months. These changes may be the result of foreign currency fluctuations, ongoing audits, or the expiration of statutes of limitations. Settlements could increase earnings up to $5 million based on current estimates. Audit outcomes and the timing of audit settlements are subject to significant uncertainty. Although management believes that adequate provision has been made for such issues, the ultimate resolution could have an adverse effect on the earnings of the Company. Conversely, if these issues are resolved favorably in the future, the related provision would be reduced, generating a positive effect on earnings. Due to the uncertainty of amounts and in accordance with its accounting policies, the Company has not recorded any potential consequences of these settlements.