Income Taxes
Domestic and foreign income (loss) before income taxes and details of the income tax expense (benefit) are as follows (amounts in millions):
|
| | | | | | | | | | | |
| For the Years Ended December 31, |
| 2017 | | 2016 | | 2015 |
Income before income tax expense: | |
| | |
| | |
|
Domestic | $ | 185 |
| | $ | 228 |
| | $ | 355 |
|
Foreign | 966 |
| | 878 |
| | 766 |
|
| $ | 1,151 |
| | $ | 1,106 |
| | $ | 1,121 |
|
Income tax expense (benefit): | |
| | |
| | |
|
Current: | |
| | |
| | |
|
Federal | $ | 696 |
| | $ | (15 | ) | | $ | 169 |
|
State | 26 |
| | 16 |
| | 31 |
|
Foreign | 335 |
| | 150 |
| | 40 |
|
Total current | 1,057 |
| | 151 |
| | 240 |
|
Deferred: | | | | | |
Federal | (111 | ) | | 40 |
| | 1 |
|
State | (32 | ) | | (13 | ) | | (21 | ) |
Foreign | (36 | ) | | (38 | ) | | 9 |
|
Total deferred | (179 | ) | | (11 | ) | | (11 | ) |
| | | | | |
Income tax expense | $ | 878 |
| | $ | 140 |
| | $ | 229 |
|
For the year ended December 31, 2017 and 2016, excess tax benefits attributable to share-based compensation transactions are recognized to the extent that tax deduction on share-based compensation exceeds the corresponding compensation cost recorded on the financial statement. For the years ended December 31, 2017 and 2016, we recognized $113 million and $81 million, respectively, of excess tax benefits from share-based payments as a reduction to income tax expense due to our adoption of a new accounting standard in 2016. For periods prior to 2016, such excess tax benefits were recorded to shareholders' equity.
The items accounting for the difference between income taxes computed at the U.S. federal statutory income tax rate and the income tax expense (benefit) at the effective tax rate for each of the years are as follows (amounts in millions):
|
| | | | | | | | | | | | | | | | | | | | |
| For the Years Ended December 31, |
| 2017 | | 2016 | | 2015 |
Federal income tax provision at statutory rate | $ | 403 |
| | 35 | % | | $ | 387 |
| | 35 | % | | $ | 392 |
| | 35 | % |
State taxes, net of federal benefit | 4 |
| | — |
| | 9 |
| | 1 |
| | 5 |
| | — |
|
Research and development credits | (26 | ) | | (2 | ) | | (36 | ) | | (3 | ) | | (26 | ) | | (2 | ) |
Foreign rate differential | (271 | ) | | (24 | ) | | (239 | ) | | (22 | ) | | (228 | ) | | (20 | ) |
Change in tax reserves | 291 |
| | 25 |
| | 210 |
| | 19 |
| | 136 |
| | 12 |
|
Net operating loss tax attribute assumed from the Purchase Transaction | (36 | ) | | (3 | ) | | (114 | ) | | (10 | ) | | (63 | ) | | (6 | ) |
Excess tax benefits related to share-based payments | (113 | ) | | (10 | ) | | (81 | ) | | (7 | ) | | — |
| | — |
|
U.S. Tax Reform Act | 636 |
| | 55 |
| | — |
| | — |
| | — |
| | — |
|
Other | (10 | ) | | — |
| | 4 |
| | — |
| | 13 |
| | 1 |
|
Income tax expense | $ | 878 |
| | 76 | % | | $ | 140 |
| | 13 | % | | $ | 229 |
| | 20 | % |
The Company’s tax rate is affected by the tax rates in the jurisdictions in which the Company operates, the relative amount of income earned by jurisdiction, and the jurisdictions with a statutory tax rate less than the U.S. rate of 35%.
On December 22, 2017, the U.S. Tax Reform Act was enacted. The U.S. Tax Reform Act, among other things, reduced the U.S. corporate income tax rate from 35% to 21% beginning in 2018 and implemented a modified territorial tax system that imposes a one-time tax on deemed repatriated earnings of foreign subsidiaries (“Transition Tax”).
On December 22, 2017, the SEC staff issued SAB 118, which provides guidance on how to account for the effects of the U.S. Tax Reform Act under ASC 740. SAB 118 enables companies to record a provisional amount for the effects of the U.S. Tax Reform Act based on a reasonable estimate, subject to adjustment during a measurement period of up to one year, until accounting is complete.
We recorded a provisional amount for the effects of the U.S. Tax Reform Act based on a reasonable estimate in the fourth quarter of 2017 resulting in a charge of $636 million. This includes current tax expense of $555 million related to the Transition Tax, which is payable over eight years, and deferred tax expense of $81 million related to the remeasurement of deferred taxes resulting from the U.S. corporate income tax rate reduction. Accounting for the income tax effects of the U.S. Tax Reform Act requires complex new calculations to be performed and significant judgments in interpreting the legislation. Additional guidance may be issued on how the provisions of the U.S. Tax Reform Act will be applied or otherwise administered that is different from our interpretation. We may make adjustments to the provisional amounts as we collect and prepare the data necessary to finalize our calculations, interpret the U.S. Tax Reform Act and any additional guidance issued, and consider the effects of any additional actions we may take as a result of the U.S. Tax Reform Act.
We continue to analyze the prospective effects of the U.S. Tax Reform Act, including new provisions impacting certain foreign income, such as GILTI, BEAT, and FDII, potential limitations on interest expense deductions, and changes to the provisions of Section 162(m) of the Internal Revenue Code, among other provisions of the U.S. Tax Reform Act.
In 2013, in connection with the October 11, 2013 repurchase of approximately 429 million shares of our common stock (“Purchase Transaction”), we assumed certain tax attributes, generally consisting of net operating loss (“NOL”) carryforwards of approximately $760 million, which represent a potential tax benefit of approximately $266 million. The Company also obtained indemnification from Vivendi against losses attributable to the disallowance of claimed utilization of such NOL carryforwards of up to $200 million in unrealized tax benefits in the aggregate, limited to taxable years ending on or prior to December 31, 2016. No benefit for these tax attributes or indemnification was recorded upon the close of the Purchase Transaction. As of December 31, 2017, we had utilized approximately $760 million of the original NOL and had recorded an indemnification asset of $200 million in “Other assets.” Correspondingly, the same amount was recorded as a reduction to the consideration paid for the shares repurchased in “Treasury stock.” In each of the years ended December 31, 2017, 2016, and 2015, we utilized $103 million, $326 million, and $180 million of the NOL and recognized a corresponding reserve of $36 million, $114 million, and $63 million in each of those years ended, respectively.
Deferred income taxes reflect the net tax effects of temporary differences between the amounts of assets and liabilities for accounting purposes and the amounts used for income tax purposes. The components of the net deferred tax assets (liabilities) are as follows (amounts in millions):
|
| | | | | | | |
| As of December 31, |
| 2017 | | 2016 |
Deferred tax assets: | |
| | |
|
Allowance for sales returns and price protection | $ | 47 |
| | $ | 64 |
|
Inventory reserve | 5 |
| | 9 |
|
Accrued expenses | 26 |
| | 25 |
|
Deferred revenue | 245 |
| | 233 |
|
Tax credit carryforwards | 60 |
| | 48 |
|
Net operating loss carryforwards | 11 |
| | 10 |
|
Share-based compensation | 59 |
| | 61 |
|
Acquired intangibles | 149 |
| | 111 |
|
State taxes | 22 |
| | 24 |
|
Other | 39 |
| | 28 |
|
Deferred tax assets | 663 |
| | 613 |
|
Valuation allowance | — |
| | — |
|
Deferred tax assets, net of valuation allowance | 663 |
| | 613 |
|
Deferred tax liabilities: | |
| | |
|
Acquired intangibles | (146 | ) | | (219 | ) |
Prepaid royalties | (19 | ) | | (60 | ) |
Capitalized software development expenses | (55 | ) | | (91 | ) |
Other | (5 | ) | | (4 | ) |
Deferred tax liabilities | (225 | ) | | (374 | ) |
Net deferred tax assets | $ | 438 |
| | $ | 239 |
|
As of December 31, 2017, we had gross tax credit carryforwards of $152 million for state purposes. The tax credit carryforwards are presented in “Deferred tax assets” net of unrealized tax benefits that would apply upon the realization of uncertain tax positions. In addition, we had foreign NOL carryforwards of $33 million at December 31, 2017, attributed mainly to losses in France which can be carried forward indefinitely.
We evaluate our deferred tax assets, including net operating losses and tax credits, to determine if a valuation allowance is required. We assess whether a valuation allowance should be established or released based on the consideration of all available evidence using a “more-likely-than-not” standard. Realization of the U.S. deferred tax assets is dependent upon the continued generation of sufficient taxable income. In making such judgments, significant weight is given to evidence that can be objectively verified. Although realization is not assured, management believes it is more likely than not that the net carrying value of the U.S. deferred tax assets will be realized. At December 31, 2017 and 2016, there are no valuation allowances on deferred tax assets.
As of December 31, 2017, we no longer consider the available cash balances related to undistributed earnings of our most significant foreign subsidiaries to be indefinitely reinvested. As a result of the U.S. Tax Reform Act, we continue to assess and may change our intentions related to the indefinite reinvestment assertion. Any impact resulting from such a change in this assertion during the SAB 118 measurement period will be recorded as an adjustment to the provisional amount recorded for the effects of the U.S. Tax Reform Act in the period in which such determination is made.
Activision Blizzard’s tax years 2009 through 2016 remain open to examination by the major taxing jurisdictions to which we are subject. The IRS is currently examining the Company’s federal tax returns for the 2009 through 2011 tax years, and during February 2018, the Company was notified that our tax returns for 2012 through 2016 tax years will be subject to examination. The Company also has several state and non-U.S. audits pending. In addition, as part of purchase price accounting for the King Acquisition, the Company assumed $74 million of uncertain tax positions primarily related to the transfer pricing on King tax years occurring prior to the King Acquisition. The Company is currently in negotiations with the relevant jurisdictions and taxing authorities with respect to King’s transfer pricing, which could result in a different allocation of profits and losses between the relevant jurisdictions.
On December 28, 2017, we received a Notice of Reassessment from the French Tax Authority (“FTA”) related to transfer pricing concerning intercompany transactions involving one of our French subsidiaries for the 2011 through 2013 tax years. The total assessment, including penalties and interest, was approximately €571 million ($680 million). We disagree with the proposed assessment and intend to vigorously contest it. We plan to pursue all remedies available to us to successfully resolve this matter, including administrative remedies with the FTA, and judicial remedies, if necessary. While we believe our tax provisions at December 31, 2017 are appropriate, until such time as this matter is ultimately resolved we could be subject to significant additional tax liabilities. In addition to the risk of additional tax for years 2011 through 2013, if litigation regarding this matter were adversely determined and/or if the FTA were to seek adjustments of a similar nature for subsequent years, we could be subject to significant additional tax liabilities.
In addition, certain of our subsidiaries are under examination or investigation or may be subject to examination or investigation by tax authorities in various jurisdictions. These proceedings may lead to adjustments or proposed adjustments to our taxes or provisions for uncertain tax positions. Such proceedings may have a material adverse effect on the Company’s consolidated financial position, liquidity or results of operations in the period or periods in which the matters are resolved or in which appropriate tax provisions are taken into account in our financial statements. If we were to receive a materially adverse assessment from a taxing jurisdiction, we would plan to vigorously contest it and consider all of our options, including the pursuit of judicial remedies.
As of December 31, 2017, we had approximately $1,138 million of gross unrecognized tax benefits, of which $1,114 million would affect our effective tax rate, if recognized. A reconciliation of total gross unrecognized tax benefits is as follows (amounts in millions):
|
| | | | | | | | | | | |
| For the Years Ended December 31, |
| 2017 | | 2016 | | 2015 |
Unrecognized tax benefits balance at January 1 | $ | 846 |
| | $ | 552 |
| | $ | 419 |
|
Gross increase for tax positions of prior-years | 66 |
| | 89 |
| | 8 |
|
Gross decrease for tax positions of prior-years | — |
| | (17 | ) | | (11 | ) |
Gross increase for tax positions of current year | 229 |
| | 240 |
| | 136 |
|
Settlement with taxing authorities | (1 | ) | | (18 | ) | | — |
|
Lapse of statute of limitations | (2 | ) | | — |
| | — |
|
Unrecognized tax benefits balance at December 31 | $ | 1,138 |
| | $ | 846 |
| | $ | 552 |
|
As of December 31, 2017 and 2016, we had approximately $121 million and $71 million, respectively, of accrued interest and penalties related to uncertain tax positions. For the year ended December 31, 2017, 2016, and 2015, we recorded $28 million, $17 million, and $10 million, respectively, of interest expense related to uncertain tax positions.
The final resolution of the Company’s global tax disputes is uncertain. There is significant judgment required in the analysis of disputes, including the probability determination and estimation of the potential exposure. Based on current information, in the opinion of the Company’s management, the ultimate resolution of these matters is not expected to have a material adverse effect on the Company’s consolidated financial position, liquidity or results of operations, except as noted above.