| 15. | Income Taxes |
On December 22, 2017, the President of the United States signed into law the Tax Cuts and Jobs Act, commonly referred to as the Tax Reform Act. The Tax Reform Act amended the Internal Revenue Code in several areas that had a direct and immediate effect on our results of operations and statement of financial position as of and for the year ended December 31, 2017, including, among other items, a one-time mandatory deemed repatriation of accumulated earnings of our foreign subsidiaries as of December 31, 2017 and a reduction in the U.S corporate income tax rate from 35% to 21% beginning in January 2018. As a result of these changes, we recorded a provisional net tax expense of $1.1 million during the fourth quarter of 2017, consisting of (i) a $75.4 million charge relating to the one-time mandatory repatriation of previously deferred earnings of certain non-US subsidiaries that are owned either wholly or partially by our U.S. subsidiaries, inclusive of the utilization of certain tax attributes offset by a provisional liability for uncertain tax positions related to such attributes and (ii) a $74.3 million credit resulting from the remeasurement of our net U.S. deferred tax liabilities at the lower corporate income tax rate.
Also on December 22, 2017, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 118, which allows companies to report the income tax effects of the Tax Reform Act as a provisional amount based on a reasonable estimate, which would be subject to adjustment during a reasonable measurement period, not to exceed twelve months, until the accounting and analysis under ASC 740 is complete. Due to the timing of the enactment of the Tax Reform Act, there continues to be a significant amount of uncertainty as to the appropriate application of a number of the underlying provisions, pending further guidance and clarification from the relevant authorities. We will continue to monitor developments in this area and adjust our estimates throughout the year in 2018, as and if necessary, as additional guidance and clarification becomes available. Our provisional estimate of the tax effect of the Tax Reform Act is a net charge of $1.1 million as discussed above. We are still in the process of evaluating our estimate as it relates to the tax effect of (i) the mandatory, deemed repatriation aspect of the Tax Reform Act, (ii) the amount of deferred tax assets and liabilities subject to the income tax rate change from 35% to 21%, and (iii) the ability to more likely than not realize the benefit of deferred tax assets, including net operating losses and foreign tax credits. Any adjustments to these provisional amounts will be reported as a component of “Tax expense (benefit)” in the reporting period in which such adjustments are determined, which will be no later than the fourth quarter of 2018.
Our income tax expense is a function of the mix between our domestic and international pre-tax earnings or losses, as well as the mix of international tax jurisdictions in which we operate. Certain of our rigs are owned and operated, directly or indirectly, by Diamond Foreign Asset Company, or DFAC. We currently intend to indefinitely reinvest the earnings of DFAC and its foreign subsidiaries to finance foreign activities. Except to the extent of the U.S. tax provided under the Tax Reform Act or other required U.S. tax provision, we have not provided tax on the outside basis difference of this subsidiary nor provided for any withholding or other tax that may be applicable should a future distribution be made from any unremitted earnings of this subsidiary. It is not practical to estimate this potential liability.
The components of income tax expense (benefit) are as follows:
| Year Ended December 31, | ||||||||||||
| 2017 | 2016 | 2015 | ||||||||||
| (In thousands) | ||||||||||||
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Federal — current |
$ | 6,994 | $ | 230 | $ | 63,223 | ||||||
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State — current |
95 | (60 | ) | 93 | ||||||||
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Foreign — current |
25,252 | 10,297 | 71,655 | |||||||||
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Total current |
32,341 | 10,467 | 134,971 | |||||||||
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Federal — deferred |
(85,066 | ) | (108,274 | ) | (245,045 | ) | ||||||
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Foreign — deferred |
12,939 | 2,011 | 3,011 | |||||||||
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Total deferred |
(72,127 | ) | (106,263 | ) | (242,034 | ) | ||||||
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Total |
$ | (39,786 | ) | $ | (95,796 | ) | $ | (107,063 | ) | |||
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The difference between actual income tax expense and the tax provision computed by applying the statutory federal income tax rate to income before taxes is attributable to the following:
| Year Ended December 31, | ||||||||||||
| 2017 | 2016 | 2015 | ||||||||||
| (In thousands) | ||||||||||||
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Income before income tax expense: |
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U.S. |
$ | (241,178 | ) | $ | (146,037 | ) | $ | (11,158 | ) | |||
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Foreign |
219,738 | (322,262 | ) | (370,190 | ) | |||||||
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| $ | (21,440 | ) | $ | (468,299 | ) | $ | (381,348 | ) | ||||
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Expected income tax benefit at federal statutory rate |
$ | (7,504 | ) | $ | (163,905 | ) | $ | (133,472 | ) | |||
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Effect of tax rate changes |
(74,294 | ) | — | — | ||||||||
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Mandatory repatriation of earnings pursuant to Tax Reform and Jobs Act |
94,194 | — | — | |||||||||
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Effect of foreign operations |
(42,102 | ) | 48,573 | (4,906 | ) | |||||||
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Amortization of deferred charges associated with intercompany rig sales to other tax jurisdictions |
— | — | 38,466 | |||||||||
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Valuation allowance |
(41,492 | ) | 62,400 | — | ||||||||
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Uncertain tax positions, settlements and adjustments relating to prior years |
31,726 | (34,666 | ) | (1,114 | ) | |||||||
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Other |
(314 | ) | (8,198 | ) | (6,037 | ) | ||||||
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Income tax benefit |
$ | (39,786 | ) | $ | (95,796 | ) | $ | (107,063 | ) | |||
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Deferred Income Taxes. Significant components of our deferred income tax assets and liabilities are as follows:
| December 31, | ||||||||
| 2017 | 2016 | |||||||
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Deferred tax assets: |
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Net operating loss carryforwards, or NOLs |
$ | 133,298 | $ | 159,653 | ||||
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Foreign tax credits |
27,623 | 95,145 | ||||||
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Worker’s compensation and other current accruals |
10,330 | 14,824 | ||||||
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Bareboat charter deductions |
— | 23,353 | ||||||
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UK depreciation deduction |
52,800 | 21,222 | ||||||
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Anticipatory deductions and credits |
13,111 | — | ||||||
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Deferred compensation |
3,711 | 4,689 | ||||||
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Foreign contribution taxes |
3,806 | 3,857 | ||||||
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Stock compensation awards |
6,872 | 11,679 | ||||||
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Deferred deductions |
94 | 8,185 | ||||||
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Other |
3,748 | 2,526 | ||||||
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Total deferred tax assets |
255,393 | 345,133 | ||||||
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Valuation allowance |
(169,224 | ) | (210,716 | ) | ||||
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Net deferred tax assets |
86,169 | 134,417 | ||||||
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Deferred tax liabilities: |
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Property, plant and equipment |
(236,038 | ) | (284,480 | ) | ||||
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Mobilization |
(17,192 | ) | (46,274 | ) | ||||
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Other |
(238 | ) | (674 | ) | ||||
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Total deferred tax liabilities |
(253,468 | ) | (331,428 | ) | ||||
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Net deferred tax liability |
$ | (167,299 | ) | $ | (197,011 | ) | ||
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We record a valuation allowance to derecognize a portion of our deferred tax assets, which we do not expect to be ultimately realized. A summary of changes in the valuation allowance is as follows:
| For the Year Ended December 31, | ||||||||||||
| 2017 | 2016 | 2015 | ||||||||||
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Valuation allowance as of January 1 |
$ | 210,716 | $ | 146,647 | $ | 48,036 | ||||||
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Establishment of valuation allowances: |
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Net operating losses |
20,805 | 10,318 | 82,155 | |||||||||
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Foreign tax credits |
2,877 | 62,400 | — | |||||||||
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Other deferred tax assets |
14,213 | 4,823 | 27,928 | |||||||||
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Releases of valuation allowances in various jurisdictions |
(79,387 | ) | (13,472 | ) | (11,472 | ) | ||||||
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Valuation allowance as of December 31 |
$ | 169,224 | $ | 210,716 | $ | 146,647 | ||||||
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Net Operating Loss Carryforwards — As of December 31, 2017, we had recorded a deferred tax asset of $133.3 million for the benefit of NOL carryforwards, $18.1 million related to our U.S. losses and $115.2 million related to our international operations. Approximately $73.5 million of this deferred tax asset relates to NOL carryforwards that have an indefinite life. The remaining $59.8 million relates to NOL carryforwards in several of our foreign subsidiaries, as well as in the United States. Unless utilized, the NOL carryforwards will expire between 2021 and 2037 as follows:
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Year Expiring |
Tax Benefit of NOL Carryforwards (In millions) |
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2021 |
$ | 5.1 | ||
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2022 |
0.2 | |||
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2023 |
0.1 | |||
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2025 |
28.7 | |||
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2027 |
7.6 | |||
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2036 |
17.9 | |||
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2037 |
0.2 | |||
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Total |
$ | 59.8 | ||
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As of December 31, 2017, a valuation allowance for $110.9 million has been recorded for our NOLs for which the deferred tax assets are not likely to be realized.
Foreign Tax Credits. As of December 31, 2017, we had recorded a deferred tax asset of $27.6 million for the benefit of foreign tax credits in the U.S. Unless utilized, our excess foreign tax credits of $27.6 million in the U.S. will expire in 2019 and in the years 2024 to 2027 as follows:
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Year Expiring |
Foreign Tax Credits (In millions) |
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2019 |
$ | 0.8 | ||
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2024 |
3.1 | |||
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2025 |
3.5 | |||
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2026 |
20.0 | |||
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2027 |
0.2 | |||
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Total |
$ | 27.6 | ||
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As of December 31, 2017, a valuation allowance of $26.7 million has been recorded for our foreign tax credits for which the deferred tax assets are not likely to be realized.
Valuation Allowances — Other Deferred Tax Assets. As of December 31, 2017, we recorded valuation allowances for other deferred tax assets of $31.6 million.
Unrecognized Tax Benefits. Our income tax returns are subject to review and examination in the various jurisdictions in which we operate and we are currently contesting various tax assessments. We accrue for income tax contingencies, or uncertain tax positions, that we believe are more likely than not exposures. A reconciliation of the beginning and ending amount of unrecognized tax benefits, gross of tax carryforwards and excluding interest and penalties, is as follows:
| For the Year Ended December 31, | ||||||||||||
| 2017 | 2016 | 2015 | ||||||||||
| (In thousands) | ||||||||||||
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Balance, beginning of period |
$ | (34,970 | ) | $ | (53,952 | ) | $ | (57,116 | ) | |||
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Additions for current year tax positions |
(51,260 | ) | (4,233 | ) | (7,013 | ) | ||||||
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Additions for prior year tax positions |
(2,938 | ) | (1,020 | ) | (82 | ) | ||||||
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Reductions for prior year tax positions |
623 | 19,661 | 2,673 | |||||||||
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Reductions related to statute of limitation expirations |
6,681 | 4,574 | 7,586 | |||||||||
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Balance, end of period |
$ | (81,864 | ) | $ | (34,970 | ) | $ | (53,952 | ) | |||
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The $51.3 million addition to current year tax positions for 2017 is primarily attributable to a provisional liability associated with the use of tax attributes in conjunction with the deemed, mandatory repatriation provision of the Tax Reform Act. The $19.7 million reduction for prior year tax positions in 2016 resulted primarily from the devaluation of the Egyptian Pound.
At December 31, 2017, $2.3 million, $51.3 million and $52.9 million of the net liability for uncertain tax positions were reflected in “Other assets,” “Deferred tax liability” and “Other liabilities,” respectively. At December 31, 2016, $2.1 million, $3.1 million and $35.0 million of the net liability for uncertain tax positions were reflected in “Other assets,” “Deferred tax liability” and “Other liabilities,” respectively. Of the net unrecognized tax benefits at December 31, 2017, 2016 and 2015, all $101.9 million, $36.0 million and $49.4 million, respectively, would affect the effective tax rates if recognized.
At December 31, 2017, the amount of accrued interest and penalties related to uncertain tax positions were $3.1 million and $15.1 million, respectively. At December 31, 2016, the amount of accrued interest and penalties related to uncertain tax positions were $2.7 million and $16.8 million, respectively.
We record interest related to accrued uncertain tax positions in interest expense and recognize penalties associated with uncertain tax positions in tax expense. Interest expense (benefit) recognized during the three years ended December 31, 2017 related to uncertain tax positions was $0.5 million, $(0.1) million and $(4.8) million, respectively. Penalties recognized during the three years ended December 31, 2017 related to uncertain tax positions were $(1.7) million, $(23.2) million and $2.3 million, respectively.
In several of the international locations in which we operate, certain of our wholly-owned subsidiaries enter into agreements with other of our wholly-owned subsidiaries to provide specialized services and equipment in support of our foreign operations. We apply a transfer pricing methodology to determine the amount to be charged for providing the services and equipment. In most cases, there are alternative transfer pricing methodologies that could be applied to these transactions and, if applied, could result in different chargeable amounts. Taxing authorities in the various foreign locations in which we operate could apply one of the alternative transfer pricing methodologies which could result in an increase to our income tax liabilities with respect to tax returns that remain subject to examination.
We expect the statute of limitations for the 2012 tax year to expire in 2018 for one of our subsidiaries operating in Mexico. We anticipate that the related unrecognized tax benefit will decrease by $1.5 million at that time.
Tax Returns and Examinations. We file income tax returns in the U.S. federal jurisdiction, various state jurisdictions and various foreign jurisdictions. Tax years that remain subject to examination by these jurisdictions include the year 2000 and the years 2006 to 2016. We are currently under audit in the United States, Australia, Brazil, Egypt, Mexico, Nicaragua, Norway, Qatar and the United Kingdom. We do not anticipate that any adjustments resulting from the tax audit of any of these years will have a material impact on our consolidated results of operations, financial condition or cash flows.