The Company and its eligible subsidiaries file a consolidated federal income tax return. The Company has entered into a separate tax allocation agreement with CNA, a majority-owned subsidiary in which its ownership exceeds 80%. The agreement provides that the Company will: (i) pay to CNA the amount, if any, by which the Company’s consolidated federal income tax is reduced by virtue of inclusion of CNA in the Company’s return or (ii) be paid by CNA an amount, if any, equal to the federal income tax that would have been payable by CNA if it had filed a separate consolidated return. The agreement may be canceled by either of the parties upon thirty days written notice.
For 2015 through 2017, the Internal Revenue Service (“IRS”) has accepted the Company into the Compliance Assurance Process (“CAP”), which is a voluntary program for large corporations. Under CAP, the IRS conducts a real-time audit and works contemporaneously with the Company to resolve any issues prior to the filing of the tax return. The Company believes this approach should reduce tax-related uncertainties, if any. Although the outcome of tax audits is always uncertain, the Company believes that any adjustments resulting from audits will not have a material impact on its results of operations, financial position and cash flows. The Company and/or its subsidiaries also file income tax returns in various state, local and foreign jurisdictions. These returns, with few exceptions, are no longer subject to examination by the various taxing authorities before 2013.
Diamond Offshore, which is not included in the Company’s consolidated federal income tax return, files income tax returns in the U.S. federal and various state and foreign jurisdictions. Tax years that remain subject to examination by these jurisdictions include years 2009 to 2016.
On December 22, 2017, H.R.1, “An Act to Provide for Reconciliation Pursuant to Titles II and V of the Concurrent Resolution on the Budget for Fiscal Year 2018,” previously known as “The Tax Cuts and Jobs Act” was signed into law (the “Tax Act”). The Tax Act amended the Internal Revenue Code in several areas that had a direct and immediate effect on the Company’s results of operations and statement of financial position as of and for the year ended December 31, 2017 including, among other things, a reduction in the U.S. federal corporate income tax rate from 35% to 21% effective January 1, 2018, eliminating the corporate alternative minimum tax (“AMT”) and changing how existing AMT credits can be realized, and a one-time mandatory deemed repatriation of accumulated earnings of foreign subsidiaries as of December 31, 2017, inclusive of the utilization of certain tax attributes offset by a provisional liability for uncertain tax positions related to such attributes. The Tax Act is subject to further clarification by the issuance of future technical guidance by the U.S. Department of Treasury and/or future technical correction legislation.
The Securities and Exchange Commission issued Staff Accounting Bulletin No. 118 (“SAB 118”) which allows companies to report the income tax effects of the Tax 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 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. The Company will continue to monitor developments in this area and adjust its provisional estimates throughout the year in 2018, as and if necessary, as additional guidance and clarification becomes available.
The Company recorded a one-time non-cash provisional $200 million increase to net income (net of noncontrolling interests) for the year ended December 31, 2017 related to the Tax Act. This increase includes a $268 million income tax benefit due to the adjustment of net deferred tax assets and liabilities related to the reduction of the U.S. federal corporate income tax rate from 35% to 21% partially offset by a $78 million charge mostly related to the one-time mandatory repatriation of previously deferred earnings of certain of Diamond Offshore’s non-U.S. subsidiaries, inclusive of the utilization of certain tax attributes offset by a provisional liability for uncertain tax positions related to such attributes. The Company is still in the process of evaluating the estimate as it relates to the tax effect of: (i) the amount of deferred tax assets and liabilities subject to the income tax rate change from 35% to 21%, including the calculation of the mandatory deemed repatriation aspect of the Tax Act and the state tax effect of adjustments made to federal temporary differences, (ii) the ability to more likely than not realize the benefit of deferred tax assets, including net operating losses and foreign tax credits, (iii) the effect of re-computing CNA’s insurance reserves and the transition adjustment from existing law, the effects of which will have no impact on the effective tax rate and (iv) the special accounting method provisions for recognizing income for U.S. federal income tax purposes no later than financial accounting purposes and the transition adjustment from existing law, which will also have no impact on the effective tax rate.
Any adjustments to these provisional amounts will be reported as a component of Income tax (expense) benefit in the reporting period in which such adjustments are determined, which will be no later than the fourth quarter of 2018.
The current and deferred components of income tax expense (benefit) are as follows:
| Year Ended December 31 | 2017 | 2016 | 2015 | |||||||||||||||||||||
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| (In millions) | ||||||||||||||||||||||||
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Income tax expense (benefit): |
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Federal: |
||||||||||||||||||||||||
|
Current |
$ | 157 | $ | 71 | $ | 79 | ||||||||||||||||||
|
Deferred |
(63 | ) | 102 | (234 | ) | |||||||||||||||||||
|
State and city: |
||||||||||||||||||||||||
|
Current |
22 | 13 | 21 | |||||||||||||||||||||
|
Deferred |
17 | 13 | 5 | |||||||||||||||||||||
|
Foreign |
37 | 21 | 86 | |||||||||||||||||||||
|
|
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Total |
$ | 170 | $ | 220 | $ | (43 | ) | |||||||||||||||||
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The components of U.S. and foreign income before income tax and a reconciliation between the federal income tax expense at statutory rates and the actual income tax expense (benefit) is as follows:
| Year Ended December 31 | 2017 | 2016 | 2015 | |||||||||||||||||||||
|
(In millions) |
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Income before income tax: |
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|
U.S. |
$ | 1,322 | $ | 1,207 | $ | 543 | ||||||||||||||||||
|
Foreign |
260 | (271 | ) | (299 | ) | |||||||||||||||||||
|
Total |
$ | 1,582 | $ | 936 | $ | 244 | ||||||||||||||||||
|
Income tax expense at statutory rate |
$ | 554 | $ | 328 | $ | 86 | ||||||||||||||||||
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Increase (decrease) in income tax expense resulting from: |
||||||||||||||||||||||||
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Effect of the Tax Act |
(190 | ) | ||||||||||||||||||||||
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Exempt investment income |
(134 | ) | (126 | ) | (126 | ) | ||||||||||||||||||
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Foreign related tax differential |
(36 | ) | 40 | (18 | ) | |||||||||||||||||||
|
Amortization of deferred charges associated with intercompany |
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rig sales to other tax jurisdictions |
38 | |||||||||||||||||||||||
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Taxes related to domestic affiliate |
1 | (14 | ) | (10 | ) | |||||||||||||||||||
|
Partnership earnings not subject to taxes |
(51 | ) | (52 | ) | (38 | ) | ||||||||||||||||||
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Allowance for foreign tax credits |
7 | 62 | ||||||||||||||||||||||
|
Unrecognized tax positions, settlements and adjustments relating to prior years |
(8 | ) | (42 | ) | 1 | |||||||||||||||||||
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Other (a) |
27 | 24 | 24 | |||||||||||||||||||||
|
Income tax expense (benefit) |
$ | 170 | $ | 220 | $ | (43 | ) | |||||||||||||||||
| (a) |
Includes state and local taxes and other non-deductible expenses. |
The Company currently intends to indefinitely reinvest the earnings of its foreign subsidiaries. Except to the extent of the U.S. tax provided under the Tax Act or other required U.S. tax provision, the Company has not provided tax on any withholding or other tax that may be applicable should a future distribution be made from any unremitted earnings. It is not practical to estimate this potential liability.
A reconciliation of the beginning and ending amount of unrecognized tax benefits, excluding tax carryforwards and interest and penalties, is as follows:
| Year Ended December 31 | 2017 | 2016 | 2015 | |||||||||||||||||||||
| (In millions) | ||||||||||||||||||||||||
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Balance at January 1 |
$ | 35 | $ | 54 | $ | 57 | ||||||||||||||||||
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Additions for tax positions related to the current year |
51 | 4 | 7 | |||||||||||||||||||||
|
Additions for tax positions related to a prior year |
5 | 1 | ||||||||||||||||||||||
|
Reductions for tax positions related to a prior year |
(1 | ) | (20 | ) | (3 | ) | ||||||||||||||||||
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Lapse of statute of limitations |
(6 | ) | (4 | ) | (7 | ) | ||||||||||||||||||
|
Balance at December 31 |
$ | 84 | $ | 35 | $ | 54 | ||||||||||||||||||
In 2016, the $20 million in reductions for tax positions related to a prior year, is primarily from the devaluation of the Egyptian pound. At December 31, 2017, 2016 and 2015, $102 million, $36 million and $49 million of unrecognized tax benefits related to Diamond Offshore would affect the effective tax rate if recognized.
The Company recognizes interest accrued related to: (i) unrecognized tax benefits in Interest expense and (ii) tax refund claims in Other revenues on the Consolidated Statements of Income. The Company recognizes penalties in Income tax expense on the Consolidated Statements of Income. Interest amounts recorded by the Company were insignificant for the years ended December 31, 2017, 2016 and 2015. The Company recorded income tax benefit of $2 million and $23 million for the years ended December 31, 2017 and 2016 and income tax expense of $2 million for the year ended December 31, 2015 related to penalties.
The following table summarizes deferred tax assets and liabilities:
| December 31 | 2017 | 2016 | ||||||||||||||
| (In millions) | ||||||||||||||||
|
Deferred tax assets: |
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Insurance reserves: |
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|
Property and casualty claim and claim adjustment expense reserves |
$ | 74 | $ | 125 | ||||||||||||
|
Unearned premium reserves |
142 | 206 | ||||||||||||||
|
Receivables |
13 | 26 | ||||||||||||||
|
Employee benefits |
243 | 407 | ||||||||||||||
|
Life settlement contracts |
- | 56 | ||||||||||||||
|
Deferred retroactive reinsurance benefit |
68 | 117 | ||||||||||||||
|
Net operating loss carryforwards |
169 | 178 | ||||||||||||||
|
Tax credit carryforwards |
199 | 289 | ||||||||||||||
|
Basis differential in investment in subsidiary |
15 | 17 | ||||||||||||||
|
Other |
211 | 246 | ||||||||||||||
|
Total deferred tax assets |
1,134 | 1,667 | ||||||||||||||
|
Valuation allowance |
(169 | ) | (210 | ) | ||||||||||||
|
Net deferred tax assets |
965 | 1,457 | ||||||||||||||
|
Deferred tax liabilities: |
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|
Deferred acquisition costs |
(77 | ) | (120 | ) | ||||||||||||
|
Net unrealized gains |
(263 | ) | (295 | ) | ||||||||||||
|
Property, plant and equipment |
(765 | ) | (1,019 | ) | ||||||||||||
|
Basis differential in investment in subsidiary |
(364 | ) | (409 | ) | ||||||||||||
|
Other liabilities |
(220 | ) | (235 | ) | ||||||||||||
|
Total deferred tax liabilities |
(1,689 | ) | (2,078 | ) | ||||||||||||
|
Net deferred tax liabilities (a) |
$ | (724 | ) | $ | (621 | ) | ||||||||||
| (a) | Includes $25 and $15 of deferred tax assets reflected in Other assets in the Consolidated Balance Sheets at December 31, 2017 and 2016. |
Federal net operating loss carryforwards of $51 million expire between 2033 and 2037. Net operating loss carryforwards in foreign tax jurisdictions of $42 million expire between 2021 and 2027 and $76 million can be carried forward indefinitely. Federal tax credit carryforwards of $171 million can be utilized to offset future current tax liabilities or will ultimately be refundable no later than 2021. Foreign tax credit carryforwards of $28 million will expire in 2019 and 2024 to 2027.
Although realization of deferred tax assets is not assured, management believes it is more likely than not that the recognized deferred tax assets will be realized through recoupment of ordinary and capital taxes paid in prior carryback years and through future earnings, reversal of existing temporary differences and available tax planning strategies. As of December 31, 2017, Diamond Offshore recorded a valuation allowance of $169 million related to net operating losses of $111 million, foreign tax credits of $27 million, and other deferred tax assets of $31 million.