Income Taxes
Tax Cuts and Jobs Act (the “Act”)
On December 22, 2017, the Act was signed into law resulting in significant changes from previous tax law. Some of the more meaningful provisions which will affect us are:
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• | a reduction in the U.S. federal corporate tax rate from 35% to 21%; |
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• | limitation on the deduction of certain interest expense; |
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• | full expense deduction for certain business capital expenditures; |
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• | limitation on the utilization of NOLs arising after December 31, 2017; and |
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• | a system of taxing foreign-sourced income from multinational corporations. |
We have made a reasonable estimate for the measurement and accounting of the reduction in the U.S. federal corporate tax rate and transitional tax on foreign-sourced income from our international operations which have been reflected in the Consolidated Financial Statements as of and for the year ended December 31, 2017. The accounting for the reduction in the U.S. federal corporate tax rate decreased our net deferred tax asset by $559 million which was fully offset by a decrease in our valuation allowance for the year ended December 31, 2017. The accounting for the transitional tax on foreign-sourced income increased our current tax provision by $9 million which was offset by the reduction in our current tax provision associated with our current year operating loss. The Act did not have an adverse material effect on our Consolidated Financial Statements for the year ended December 31, 2017.
Because of the complexity of the new Global Intangible Low Taxed Income (“GILTI”) rules in the Act, we are continuing to evaluate this provision and its application under U.S. GAAP. We are not yet able to reasonably estimate the effect of this provision of the Act. Therefore, we have not made any adjustments related to potential GILTI tax in our Consolidated Financial Statements and have not made a policy decision regarding whether to record deferred taxes on GILTI.
In December 2017, the SEC issued Staff Accounting Bulletin No. 118 “Income Tax Accounting Implications of the Tax Cuts and Jobs Act” (“SAB 118”) which allows a company up to one year to finalize and record the tax effects of the Act. We are currently in the process of finalizing and quantifying the tax effects of the Act, but have recorded provisional amounts based on reasonable estimates for the measurement and accounting of certain effects of the Act in our Consolidated Financial Statements for the year ended December 31, 2017. Under SAB 118, we will complete the required analyses and accounting during the year ended December 31, 2018.
Comprehensive Income — In February 2018, the FASB issued Accounting Standards Update 2018-02, “Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income.” The standard allows an entity to reclassify the income tax effects of the Act on items within AOCI to retained earnings and also requires additional disclosures. The standard is effective for fiscal years beginning after December 15, 2018, with early adoption permitted. We do not anticipate a material effect on our financial condition, results of operations or cash flows as a result of adopting this standard.
Income Tax Expense (Benefit)
The jurisdictional components of income from continuing operations before income tax expense (benefit), attributable to Calpine, for the years ended December 31, 2017, 2016 and 2015, are as follows (in millions):
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| | | | | | | | | | | |
| 2017 | | 2016 | | 2015 |
U.S. | $ | (358 | ) | | $ | 116 |
| | $ | 133 |
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International | 27 |
| | 24 |
| | 26 |
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Total | $ | (331 | ) | | $ | 140 |
| | $ | 159 |
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The components of income tax expense (benefit) from continuing operations for the years ended December 31, 2017, 2016 and 2015, consisted of the following (in millions):
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| | | | | | | | | | | |
| 2017 | | 2016 | | 2015 |
Current: | | | | | |
Federal | $ | (10 | ) | | $ | (10 | ) | | $ | (1 | ) |
State | 18 |
| | 14 |
| | 10 |
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Foreign | (14 | ) | | 1 |
| | 2 |
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Total current | (6 | ) | | 5 |
| | 11 |
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Deferred: | | | | | |
Federal | 5 |
| | 10 |
| | (21 | ) |
State | 6 |
| | 27 |
| | 1 |
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Foreign | 3 |
| | 6 |
| | (67 | ) |
Total deferred | 14 |
| | 43 |
| | (87 | ) |
Total income tax expense (benefit) | $ | 8 |
| | $ | 48 |
| | $ | (76 | ) |
For the years ended December 31, 2017, 2016 and 2015, our income tax rates did not bear a customary relationship to statutory income tax rates, primarily as a result of the effect of our NOLs, valuation allowances and state income taxes. A reconciliation of the federal statutory rate of 35% to our effective rate from continuing operations for the years ended December 31, 2017, 2016 and 2015, is as follows:
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| | | | | | | | |
| 2017 | | 2016 | | 2015 |
Federal statutory tax rate | 35.0 | % | | 35.0 | % | | 35.0 | % |
State tax expense, net of federal benefit | (6.0 | ) | | 19.4 |
| | 5.1 |
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Change in tax rate of net deferred tax asset | (168.8 | ) | | — |
| | — |
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Valuation allowances offsetting tax rate change | 168.8 |
| | — |
| | — |
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Valuation allowances against future tax benefits | (33.0 | ) | | (25.0 | ) | | (46.0 | ) |
Valuation allowance related to foreign taxes | 0.5 |
| | (0.1 | ) | | (49.4 | ) |
Distributions from foreign affiliates and foreign taxes | (2.0 | ) | | (0.6 | ) | | 3.1 |
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Change in unrecognized tax benefits | 5.1 |
| | (0.1 | ) | | 1.2 |
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Disallowed compensation | (0.6 | ) | | 0.9 |
| | 3.1 |
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Stock-based compensation | (0.9 | ) | | 2.2 |
| | 0.6 |
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Equity earnings | (0.8 | ) | | 2.0 |
| | (0.5 | ) |
Other differences | 0.3 |
| | 0.6 |
| | — |
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Effective income tax rate | (2.4 | )% | | 34.3 | % | | (47.8 | )% |
Deferred Tax Assets and Liabilities
The components of deferred income taxes as of December 31, 2017 and 2016, are as follows (in millions):
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| | | | | | | |
| 2017 | | 2016 |
Deferred tax assets: | | | |
NOL and credit carryforwards | $ | 1,810 |
| | $ | 2,728 |
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Taxes related to risk management activities and derivatives | 20 |
| | 38 |
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Reorganization items and impairments | 146 |
| | 222 |
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Other differences | 28 |
| | — |
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Deferred tax assets before valuation allowance | 2,004 |
| | 2,988 |
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Valuation allowance | (1,168 | ) | | (1,581 | ) |
Total deferred tax assets | 836 |
| | 1,407 |
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Deferred tax liabilities: | | | |
Property, plant and equipment | (805 | ) | | (1,266 | ) |
Other differences | — |
| | (93 | ) |
Total deferred tax liabilities | (805 | ) | | (1,359 | ) |
Net deferred tax asset | 31 |
| | 48 |
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Less: Non-current deferred tax liability | (28 | ) | | (14 | ) |
Deferred income tax asset, non-current | $ | 59 |
| | $ | 62 |
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Intraperiod Tax Allocation — In accordance with U.S. GAAP, intraperiod tax allocation provisions require allocation of a tax expense (benefit) to continuing operations due to current OCI gains (losses) with an offsetting amount recognized in OCI. The intraperiod tax allocation included in continuing operations is $6 million, nil and nil for the years ended December 31, 2017, 2016 and 2015.
NOL Carryforwards — As of December 31, 2017, our NOL carryforwards consisted primarily of federal NOL carryforwards of approximately $6.6 billion, which expire between 2024 and 2037, and NOL carryforwards in 27 states and the District of Columbia totaling approximately $3.5 billion, which expire between 2018 and 2037. Substantially all of the federal and state NOLs are offset with a full valuation allowance. Certain of the state NOL carryforwards may be subject to limitations on their annual usage. If a subsequent ownership change, such as the ownership change associated with the impending Merger, were to occur as a result of future transactions in our stock, our ability to utilize the NOL carryforwards will be limited. Although we have not completed our analysis, it is reasonably possible that our federal NOLs available to offset future taxable income could materially decrease. This reduction will be offset by an adjustment to the existing valuation allowance for an equal and offsetting amount. Additionally, our state NOLs available to offset future state income could similarly decrease which would also be offset by an equal and offsetting adjustment to the existing valuation allowance. Given the offsetting adjustments to the existing valuation allowance, any ownership change is not expected to have an adverse material effect on our Consolidated Financial Statements.
We also have approximately $659 million in foreign NOLs, which expire between 2026 and 2037, and the associated deferred tax asset of approximately $165 million is partially offset by a valuation allowance of $106 million. Under Canadian income tax law, our NOL carryfowards can be utilized to reduce future taxable income subject to certain limitations including new applicable limitations resulting from an ownership change which will result in an increase in the valuation allowance and a related charge to deferred tax expense. It is reasonably possible that an increase of approximately $59 million in the valuation allowance and a related charge to deferred tax expense would occur as a result of the impending Merger.
Income Tax Audits — We remain subject to periodic audits and reviews by taxing authorities; however, we do not expect these audits will have a material effect on our tax provision. Any NOLs we claim in future years to reduce taxable income could be subject to IRS examination regardless of when the NOLs were generated. Any adjustment of state or federal returns could result in a reduction of deferred tax assets rather than a cash payment of income taxes in tax jurisdictions where we have NOLs. We are currently under U.S. federal income tax examination for the year ended December 31, 2015 and various state income tax audits for various periods. Our Canadian subsidiaries are currently under examination by the Canada Revenue Agency for the years ended December 31, 2013 through 2016.
Valuation Allowance — U.S. GAAP requires that we consider all available evidence, both positive and negative, and tax planning strategies to determine whether, based on the weight of that evidence, a valuation allowance is needed to reduce the value of deferred tax assets. Future realization of the tax benefit of an existing deductible temporary difference or carryforward ultimately depends on the existence of sufficient taxable income of the appropriate character within the carryback or carryforward periods available under the tax law. Due to our history of losses, we were unable to assume future profits; however, we are able to consider available tax planning strategies.
As of December 31, 2017, we have provided a valuation allowance of approximately $1.2 billion on certain federal, state and foreign tax jurisdiction deferred tax assets to reduce the amount of these assets to the extent necessary to result in an amount that is more likely than not to be realized. The net change in our valuation allowance was a decrease of $413 million for the year ended December 31, 2017 of which $559 million is related to the reduction in the U.S. federal corporate tax rate that was partially offset by $146 million primarily related to losses generated in the current period. We had a reduction in our valuation allowance of $56 million and $199 million for the years ended December 31, 2016 and 2015, respectively, primarily related to income generated in these periods.
Unrecognized Tax Benefits
At December 31, 2017, we had unrecognized tax benefits of $38 million. If recognized, $12 million of our unrecognized tax benefits could affect the annual effective tax rate and $26 million, related to deferred tax assets could be offset against the recorded valuation allowance resulting in no effect to our effective tax rate. We had accrued interest and penalties of $4 million and $12 million for income tax matters at December 31, 2017 and 2016, respectively. We recognize interest and penalties related to unrecognized tax benefits in income tax expense (benefit) on our Consolidated Statements of Operations and recorded $(8) million, nil and $1 million for the years ended December 31, 2017, 2016 and 2015, respectively. We believe that it is reasonably possible that a decrease within the range of nil and $18 million in unrecognized tax benefits could occur within the next twelve months primarily related to foreign tax issues and the lapse of applicable statute of limitations.
A reconciliation of the beginning and ending amounts of our unrecognized tax benefits for the years ended December 31, 2017, 2016 and 2015, is as follows (in millions):
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| | | | | | | | | | | |
| 2017 | | 2016 | | 2015 |
Balance, beginning of period | $ | (59 | ) | | $ | (58 | ) | | $ | (56 | ) |
Decreases related to prior year tax positions | 11 |
| | 1 |
| | 3 |
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Increases related to current year tax positions | (2 | ) | | (2 | ) | | (5 | ) |
Decreases related to change in tax rate of net deferred tax asset | 12 |
| | — |
| | — |
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Balance, end of period | $ | (38 | ) | | $ | (59 | ) | | $ | (58 | ) |