SYNTEL INC

9. Income Taxes

Income before income taxes for the Company’s U.S. and foreign operations for the years ended December 31, 2017, 2016 and 2015 was as follows:


	2017		2016		2015
	(In thousands)
U.S.	$	64,947	$	52,742	$	42,342
Foreign		160,538		220,643		284,859

	$	225,485	$	273,385	$	327,201

Income taxes for the years ended December 31, 2017, 2016 and 2015 consisted of the following:


	2017			2016			2015
	(In thousands)
Current:
Federal	$	20,777		$	65,636		$	14,521
State		4,066			3,192			2,639
City		678			533			439
Foreign		40,011			256,117			61,393

Total current provision		65,532			325,478			78,992

Deferred:
Federal		(915	)		(150	)		(537	)
State		(170	)		(28	)		(99	)
City		(28	)		(5	)		(16	)
Foreign		(5,202	)		5,480			(3,665	)

Total deferred expense(benefit)		(6,315	)		5,297			(4,317	)

Total provision for income taxes	$	59,217		$	330,775		$	74,675

The components of net deferred tax assets as of December 31, 2017 and 2016 are as follows:


	2017			2016
	(In thousands)
Deferred tax assets
Carry-forward losses of subsidiaries		—		$	7
Minimum alternate tax credit of subsidiaries		46,938			35,979
Property, plant and equipment		686			198
Accrued expenses and allowances		13,420			15,055
Valuation allowance		(6,122	)		(9,167	)

Total deferred tax assets		54,922			42,072

Deferred tax liabilities
Provision for branch tax on dividend equivalent in India		(9,972	)		(9,782	)
Provision for tax on unrealized gains in India		(59	)		(33	)
Others		(1,114	)		(258	)

Total deferred tax liabilities		(11,145	)		(10,073	)

Net deferred tax assets	$	43,777		$	31,999

The balance sheet classification of the net deferred tax asset is summarized as follows:


	2017			2016
	(In thousands)
Deferred tax asset, non-current		54,922			42,072
Deferred tax liabilities, non-current		(11,145	)		(10,073	)

	$	43,777		$	31,999

Syntel’s software development centers/units in India are located in Mumbai, Chennai Pune and Gurugram. Software development centers/units enjoy favorable tax provisions due to their registration in Special Economic Zone (SEZ), as Export Oriented Unit (EOU) and as units located in Software Technologies Parks of India (STPI). Units registered with STPI, EOUs and certain units located in SEZ were exempt from payment of corporate income taxes for ten years of operations on the profits generated by these units or March 31, 2011, whichever was earlier. Certain units located in SEZ are eligible for 100% exemption from payment of corporate taxes for the first five years of operation and 50% exemption for the next two years and a further 50% exemption for another three years, subject to fulfillment of certain criteria laid down. New units in SEZ operational after April 1, 2005 are eligible for 100% exemption from payment of corporate taxes for the first five years of operation, 50% exemption for the next five years and a further 50% exemption for another five years, subject to fulfillment of criteria.

The Company’s units located at SEEPZ Mumbai and the STPI/EOU units ceased to enjoy the tax exemption on March 31, 2011. Three SEZ units completed their first five years of 100% exemption as of March 31, 2016. One SEZ unit located at Chennai completed its first five years of 100% exemption as of March 31, 2015. The Company started operations in KPO SEZ units in Airoli, Navi Mumbai in the quarters ended June 30, 2015 and June 30, 2016, respectively. The Company started operations in a SEZ unit in Pune in the quarter ended June 30, 2017.

Syntel’s SEZ in Pune set up under the SEZ Act 2005, commenced operations in 2008. The SEZ for Chennai commenced operations in 2010. Income from operation of the SEZ, as a developer, is exempt from payment of corporate income taxes for ten out of 15 years from the date of SEZ notification.

Provision for Indian Income Tax is made only in respect of business profits generated from these software development units, to the extent they are not covered by the above exemptions and on income from treasury operations and other income.

The benefit of the tax holiday under Indian Income Tax was $28.59 million, $38.97 million and $45.6 million for the years ended December 31, 2017, 2016 and 2015, respectively.

For the year ended December 31, 2017, the Company has recorded one-time additional tax of $8.16 million due to changes to the Internal Revenue Code of 1986 made by the Tax Cuts and Jobs Act,2017.Out of aforesaid $8.16 million $0.9 million for deferred income tax due to change in Federal tax rate and $7.26 million on undistributed foreign income.

During the three months ended September 30, 2016, and after a comprehensive review of anticipated sources and uses of capital both domestically and abroad, as well as other considerations, the Board of Directors determined that it was in the best interests of the Company and its shareholders to declare a special cash dividend of fifteen dollars ($15.00) per share. In conducting this evaluation, the Board of Directors considered, among other factors, the operational and financial objectives of the Company, long-term and short-term capital needs, the Company’s projections on growth and working capital needs, planned uses of U.S. and foreign earnings, the available sources of liquidity in the U.S., and growth plans outside of the U.S. As part of this evaluation, the Company determined that certain amounts which had been previously designated for internal and external expansion and investment at its foreign subsidiaries were no longer required for these purposes. The special cash dividend was funded through a one-time repatriation of approximately $1.03 billion (net of foreign income tax $210 million paid outside of the U.S) of cash held by the Company’s foreign subsidiaries and a portion of borrowings under the new Senior Credit Facility. In connection with the one-time repatriation, the Company recognized a one-time tax expense of approximately $270.6 million (net of foreign tax credits) in the third quarter of 2016. The Company has recorded additional state tax of $0.9 million, attributable to the above repatriation, in the quarter ended March 31, 2017. The Company has reversed $6.26 million relating to the true up of tax provisions including the impact of foreign exchange rates, in the computation of the tax related to the dividend repatriation, upon the finalization of the federal tax return attributable to the above repatriation, in the quarter ended September 30, 2017.

Management regularly evaluates foreign earnings to determine whether future foreign earnings that accumulate will be permanently invested outside the U.S. In conducting this evaluation, management considers, among other factors, the operational and financial objectives of the Company, long-term and short-term capital needs, the Company’s projections on growth and working capital needs, planned uses of U.S. and foreign earnings, the available sources of liquidity in the U.S., and growth plans outside of the U.S. The Company provides dividend distribution taxes on any foreign earnings in excess of these requirements. The December 31, 2017 provision includes the impact of certain foreign earnings that are not permanently invested. If in the future, management were to conclude that any additional portion of foreign earnings will not be permanently reinvested outside the U.S., this would result in an additional provision for income taxes, which could affect the Company’s future effective tax rate. If the Company determines to repatriate all undistributed repatriable earnings of foreign subsidiaries as of December 31, 2017, the Company would have accrued taxes of approximately $30.0 million.

During the years ended December 31, 2017, 2016 and 2015, the effective income tax rate was 26.3%, 121.0% and 22.8%, respectively.

The tax rate for the year ended December 31, 2017 was impacted by one-time additional tax of $0.9 million deferred income tax due to change in federal tax rate and $7.26 million on deferred foreign income due to changes to the Internal Revenue Code of 1986 made by the Tax Cuts and Jobs Act, 2017. The tax rate for the year ended December 31, 2017 was also impacted by one-time favorable adjustments of $6.26 million relating to the true up of tax provisions including the impact of foreign exchange rates, in the computation of the tax related to the dividend repatriation, upon the finalization of the federal tax return and one-time reversal of valuation allowance of $2.92 million and additional charge of $0.9 million (net of federal tax benefits) of state income tax on repatriation. Without the above, the effective tax rate for the year ended December 31, 2017 would have been 26.3%.

The U.S. Government and state tax authorities are expected to continue to issue guidance regarding the Tax Cuts and Jobs Act of 2017, which may result in adjustments to our provisional estimates of deferred tax charge of $0.9 million. The adjustments to net deferred tax liabilities are provisional amounts estimated based on information available as of December 31, 2017. These amounts are subject to change as we obtain information necessary to complete the calculations. We will recognize any changes to the provisional amounts as we refine our estimates of the cumulative temporary differences, including those related to immediate deduction for qualified property, and our interpretations of the application of the Tax Act. We are continuing to analyze certain aspects of the Act and may refine our estimates, which could potentially affect the measurement of our net deferred tax assets or give rise to new deferred tax amounts. The final determination of the remeasurement of our net deferred tax assets and the transition tax will be completed as additional information becomes available, but no later than one year from the enactment date.

The tax rate for the year ended December 31, 2016 was primarily impacted by a one-time repatriation. The Company recognized a one-time tax expense of approximately $270.6 million (net of foreign tax credits) and reversal of unrecognized tax benefits of $3.08 million. Without the above, the effective tax rate for the year ended December 31, 2016 would have been 23.0%.

The tax rate for the year ended December 31, 2015 was impacted by a favorable adjustment of $1.10 million relating to the true up of tax provisions upon the finalization of the India tax computation and $1.20 million relating to the finalization of state tax and local tax matters. The Company has provided tax charges of $0.84 million on account of valuation allowances against the minimum alternative tax. Without the above, the effective tax rate for the year ended December 31, 2015 would have been 23.3%.

The Company records provisions for income taxes based on enacted tax laws and rates in the various taxing jurisdictions in which it operates. In determining the tax provisions, the Company provides for tax uncertainties in income taxes, when it is more likely than not, based on the technical merits, that a tax position would not be sustained upon examination. Such uncertainties, which are recorded in income taxes payable, are based on management’s estimates and accordingly, are subject to revision based on additional information. The provision no longer required for any particular tax year is credited to the current period’s income tax expense. Conversely, in the event of a future tax examination, any additional tax expense not previously provided for will be recognized in the period in which the actual liability is concluded or the management determines that the Company will not prevail on certain tax positions taken in filed returns, based on the “more likely than not” concept.

Syntel Inc. and its subsidiaries file income tax returns in various tax jurisdictions. The Company is no longer subject to U.S. federal tax examinations by tax authorities for years before 2014 and for state tax examinations for years before 2013.

Syntel India, the Company’s India subsidiary, has disputed tax matters for the financial years 1996-97 to 2014-15 pending at various levels of tax authorities. Financial year 2015-16 and onwards are open for regular tax examination by the Indian tax authorities. However, the tax authorities in India are authorized to reopen the already concluded tax assessments for financial years 2010-11 and onwards.

The following table accounts for the differences between the actual effective tax rate and the statutory U.S. Federal income tax rate of 35% for the years ended December 31, 2017, 2016 and 2015:


	2017			2016			2015
Statutory rate		35.0	%		35.0	%		35.0	%
State taxes, net of federal Benefit		1.6	%		1.0	%		0.6	%
City taxes		0.2	%		0.0	%		0.0	%
Foreign effective tax rates different from U.S. Statutory Rate¹		(10.5	%)		(13.0	%)		(12.6	%)
Tax reserves		(2.4	%)		(1.0	%)		(0.0	%)
Prior Year state tax payment		—			—			(0.4	%)
One-time tax due to the 2017 Tax Cuts and Jobs Acts Law		3.7	%		—			—
Valuation Allowance		(1.3	%)		—			0.2	%
Tax related to repatriation		—			99.0	%		—

Effective income tax rate		26.3	%		121.0	%		22.8	%

1	The foreign jurisdiction that materially affects the effective income tax rate is India.

During the years ended December 31, 2017, 2016 and 2015, the effective income tax rates were 26.3%, 121.0% and 22.8%, respectively.

A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows:


	(in millions)
	2017			2016
Balance as at January 1	$	68.51		$	50.24
Additions based on tax positions related to the current year		0.02			22.48
Additions based on tax positions for prior years		6.79			0.0
Reductions for tax positions of prior years		(0.42	)		(3.08	)
Foreign currency translation effect		3.04			(1.13	)

Balance as at December 31	$	77.94		$	68.51
Income taxes paid, see below		(44.03	)		(41.41	)

Amounts, net of income taxes paid	$	33.91		$	27.10

The above table shows the unrecognized tax benefits that, if recognized, would affect the effective tax rate.

The Company has paid income taxes of $44.03 million and $41.41 million against the liabilities for unrecognized tax benefits of $77.94 million and $68.51 million, as at December 31, 2017 and 2016, respectively. The Company has paid the taxes in order to reduce the possible interest and penalties related to these unrecognized tax benefits.

The Company recognized accrued interest and penalties related to unrecognized tax benefits as part of tax expense. During the years ended December 31, 2017 and December 31, 2016, the Company recognized a tax charge and tax reversal towards interest of approximately $0.76 million and $0.15 million, respectively.

The Company had accrued approximately $2.21 million and $1.45 million for interest and penalties as of December 31, 2017 and December 31, 2016, respectively.

The Company’s amount of net unrecognized tax benefits for the tax disputes of $1.71 million could change in the next twelve months as litigation and global tax audits progress. At this time, due to the uncertain nature of this process, it is not reasonably possible to estimate an overall range of possible change.

Syntel has not provided for India Income Tax which are disputed and pending at various level (including potential tax dispute) of $15.91 million for the financial year 1996-97 to December 31, 2017, which is after providing $54.61 million as unrecognized tax benefits under ASC740. Indian tax exposures involve complex issues and may need an extended period to resolve the issues with the Indian income tax authorities. Syntel’s management, after consultation with legal counsel, believes that the resolution of these matters will not have a material adverse effect on the Company’s consolidated financial position or results of operations.

Service Tax Audit

Syntel India regularly files quarterly Service Tax refund applications and claims refunds of Service Tax on input services, which remain unutilized against a no service tax on export of services. As of December 31, 2017, Syntel Indian entities has not provided against Service tax refunds claims of $3.87 million disputed by Service tax Department which are pending at various level.

The Company obtained a tax consultant’s advice on the aforesaid disputes. The consultant is of the view that the tax disputes are contrary to the wording of the service tax notifications and provisions. The Company therefore believes that its claims of service tax refunds should be upheld at the appellate stage and the refunds should be accordingly granted. Based on the consultant’s tax advice, the Company believes that it has a reasonable basis to defend the rejection of the refunds. Accordingly, no provision has been made in the Company’s books.

Local Taxes

As of December 31, 2017 and 2016, the Company had a local tax liability provision of approximately $0.4 million, equal to $0.3 million net of federal tax benefit, relating to local taxes including employer withholding taxes, employer payroll expense taxes, business licenses, and corporate income taxes.

Minimum Alternate Tax (MAT)

Minimum Alternate Tax (“MAT”) is payable on the Book Income, including the income for which deduction is claimed under section 10A and section 10AA of the Indian Income Tax Act. The excess MAT over the normal tax liability is “MAT Credit.” MAT Credit can be carried forward for 15 years (as amended by the Finance Act, 2017, as compared to 10 years, as previously provided) and set-off against future tax liabilities, if normal tax provisions are in excess of taxes payable under MAT. Accordingly, for the three months ended March 31, 2017, the Company has reversed a valuation allowance of $2.92 million against deferred tax assets which was recognized on MAT Credit. The MAT credit as of December 31, 2017 of $44.63 million (net of valuation allowance of $2.62 million) must be utilized before March 31 of the following financial years and will expire as follows


Year of Expiry of MAT Credit
	(In millions)
2022 - 2023		0.15
2023 - 2024		0.65
2024 - 2025		2.08
2025 - 2026		2.96
2026 - 2027		0.74
2027 - 2028		6.22
2028 - 2029		7.37
2029 - 2030		8.09
2030 - 2031		10.40
2031 - 2032		4.93
2032 - 2033		3.66
Total		47.25
Less: Valuation allowance		2.62
Total (net of valuation allowance)		44.63

India Budget Proposal 2018

The Finance Bill 2018 was presented on February 1, 2018. These proposals include an increase in income tax cess to 4%, against the existing 3%. The proposals would increase the effective tax rate to 34.944% from 34.608%.The Indian corporate tax rate would be reduced to 25%, as compared to the existing 30% for companies with annual turnover below INR 2500 million ($39.5 million). The proposal includes no other changes to corporate income tax rates.

If enacted, these proposals, would have a one-time marginal tax benefit to Syntel of $0.1 million. These tax benefits would be accounted in the quarter in which the aforesaid proposal is enacted.