ARRIS INTERNATIONAL PLC

Note 18. Income Taxes

Income (loss) before income taxes (in thousands):


	Years Ended December 31,
	2017			2016			2015
U.K.	$	(64,177	)	$	(36,300	)	$	(5,321	)
U.S.		(159,951	)		(149,605	)		47,063
Other Foreign		245,331			209,997			65,311

	$	21,203		$	24,092		$	107,053

Income tax expense (benefit) consisted of the following (in thousands):


	Years Ended December 31,
	2017			2016			2015
Current — U.K.	$	667		$	81,822		$	559
U.S.		3,530			47,025			2,141
Other Foreign		25,347			31,552			14,476

		29,544			160,399			17,176

Deferred — U.K.		(22,254	)		(23,177	)		(30	)
U.S.		(49,671	)		(105,735	)		5,119
Other Foreign		(2,540	)		(16,356	)		329

		(74,465	)		(145,268	)		5,418

Income tax expense (benefit)	$	(44,921	)	$	15,131		$	22,594

A reconciliation of the U.K. statutory income tax rate of 19.25% for 2017 and 20.00% for 2016 and the U.S. federal statutory income tax rate of 35.00% for 2015 and the effective income tax rates is as follows:


	Years Ended December 31,
	2017			2016			2015
Statutory income tax rate		19.25	%		20.00	%		35.00	%
Effects of:
State income taxes, net of federal benefit		11.0			(16.6	)		5.2
Acquired deferred tax assets		—			—			5.8
U.S. domestic manufacturing deduction		(0.9	)		(12.0	)		—
Facilitative transaction costs		54.2			22.0			—
Research and development tax credits		(119.7	)		(90.6	)		(25.1	)
Withholding taxes (U.K. entities)		12.4			245.5			—
U.K. stamp duty		—			9.4			—
Subpart F income		—			4.0			4.8
Changes in valuation allowance		35.1			6.0			(26.6	)
Foreign tax credits		29.5			(14.0	)		(20.7	)
Non-deductible officer compensation		4.9			—			5.3
Non-U.S. tax rate differential		—			—			(5.0	)
Non-U.K. tax rate differential		26.1			(50.9	)		—
Benefit of other foreign tax regimes		(170.6	)		(135.4	)		—
Recapture of dual consolidated losses		—			—			1.1
Taiwan gain		—			—			34.3
Change in tax rate		(105.0	)		—			—
Uncertain tax positions		(13.1	)		88.9			(1.7	)
Other, net		5.0			(13.5	)		8.7

		(211.85	)%		62.8	%		21.1	%

On December 22, 2017, the Tax Cuts and Jobs Act of 2017 (the “Act”) was signed into law making significant changes to the Internal Revenue Code. Changes include, but are not limited to, a corporate tax rate decrease from 35% to 21% effective for tax years beginning after December 31, 2017, a one-time transition tax on the mandatory deemed repatriation of cumulative foreign earnings as of December 31, 2017, a new alternative U.S. tax on certain Base Erosion Anti-Avoidance (BEAT) payments from a U.S. company to any foreign related party, a new U.S. tax on certain off-shore earnings referred to as Global Intangible Low-Taxed Income (GILTI), additional limitations on certain executive compensation, and limitations on interest deductions.

The Company was required to recognize the effect of the tax law changes in the period of enactment, such as determining the transition tax, remeasuring its U.S. deferred tax assets and liabilities as well as reassessing the realizability of its deferred tax assets. The Company has calculated its best estimate of the impact of the Act in its year end income tax provision in accordance with its understanding of the Act and guidance available as of the date of this filing and as a result has recorded ($22.5) million as an income tax benefit in the fourth quarter of 2017, the period in which the legislation was enacted. The provisional amount related to the remeasurement of certain deferred tax assets and liabilities based on the rates at which they are expected to reverse in the future was ($22.3) million. The provisional amount related to the one-time transition tax on the mandatory deemed repatriation of foreign earnings was ($0.2) million based on cumulative foreign earnings of $32.4 million.

On December 22, 2017, Staff Accounting Bulletin No. 118 (“SAB 118”) was issued to address the application of U.S. GAAP in situations when a registrant does not have the necessary information available, prepared, or analyzed (including computations) in reasonable detail to complete the accounting for certain income tax effects of the Act. SAB 118 allows us to record these provisional amounts during a measurement period not to extend beyond one year of the enactment date. In accordance with SAB 118, the Company has determined that the ($22.3) million of the deferred tax benefit recorded in connection with the remeasurement of certain deferred tax assets and liabilities and the ($0.2) million of current tax benefit recorded in connection with the transition tax on the mandatory deemed repatriation of foreign earnings was a provisional amount and a reasonable estimate at December 31, 2017. Since the Act was passed late in the fourth quarter of 2017, and ongoing guidance and accounting interpretation are expected over the next 12 months, we consider the accounting for the transition tax, deferred tax re-measurements, and other items to be incomplete due to additional work necessary to (1) do a more detailed analysis of historical foreign earnings as well as potential correlative adjustments; (2) determine re-measurement of any changes to deferred tax assets and liabilities associated with any acquisition accounting adjustments for fair value adjustments made within the acquisition accounting measurement period; (3) assess any forthcoming guidance; and (4) finalize our ongoing analysis of final year-end data and tax positions. Any subsequent adjustment to these amounts will be recorded to tax expense in the quarter of 2018 when the analysis is complete. We expect to complete our analysis within the measurement period in accordance with SAB 118.

Deferred income taxes reflect the net tax effects of temporary differences between carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of ARRIS’ net deferred income tax assets (liabilities) were as follows (in thousands):


	December 31,
	2017			2016
Deferred income tax assets
Inventory costs	$	29,453		$	63,756
Property, plant and equipment		—			2,789
Accrued employee benefits		34,472			41,246
Accrued operating expenses		24,904			42,544
Reserves		16,434			26,731
Investments		8,796			667
Loss carryforwards		91,832			67,645
Research and development and other credits		164,841			118,113
Capitalized research and development		83,224			177,594
Other		17,379			50,171

Total deferred income tax assets		471,335			591,256

Deferred income tax liabilities:
Property, plant and equipment		(571	)		—
Other liabilities		(7,190	)		(6,656	)
Goodwill and intangible assets		(325,283	)		(451,600	)

Total deferred income tax liabilities		(333,044	)		(458,256	)

Net deferred income tax assets		138,291			133,000
Valuation allowance		(91,743	)		(57,772	)

Net deferred income tax assets	$	46,548		$	75,228

Significant attributes of ARRIS’s deferred tax assets related to loss carryforwards and tax credits were as follows: (in thousands):


	2017		2016		Expiration
Net operating loss carryforwards (“NOL”):
U.S. federal⁽¹⁾	$	27,405	$	30,009		2018 - 2037
Georgia		15,948		4,737		2018 - 2037
Pennsylvania		17,687		13,899		2018 - 2037
Other U.S. states		12,236		4,495		2018 - 2037
Non-U.S.		18,556		14,505		Varies ⁽²⁾

Total tax effected loss carryforward	$	91,832	$	67,645

Tax credit carryforwards:
U.S. federal R&D	$	103,581	$	84,711		2018 - 2037
Other U.S. federal		5,742		3,075		2027
California R&D		34,208		13,782		Indefinite
Other U.S. states R&D		21,310		16,545		2018 - 2037

Total credit carryforward	$	164,841	$	118,113

(1)

Gross of tax effect U.S. Federal operating loss carryforwards are $130.5 million for the year ended December 31, 2017 and $85.7 million for the year ended December 31, 2016.

(2)

Canadian NOLs expire within 16 years and all other material foreign NOLs have an indefinite carryforward life.

ARRIS’ ability to use U.S. federal, state, and other foreign net operating loss carryforwards to reduce future taxable income, or to use U.S. federal and state research and development tax credit and other carryforwards to reduce future income tax liabilities, is subject to the ability to generate sufficient taxable income of an appropriate characterization in the appropriate taxing jurisdictions. In some instance the utilization is also subject to restrictions attributable to change of ownership during prior tax years. as defined by appropriate law in the relevant taxing jurisdiction. These limitations, as noted above, prevent the Company from utilizing certain deferred tax assets and were considered in establishing our valuation allowances.

Significant components of ARRIS’s valuation allowance were as follows (in thousands):


	2017			2016
U.S. federal R&D	$	(8,578	)	$	(8,064	)
Other U.S. federal		(4,241	)		(16,792	)
Georgia NOL		(15,008	)		(3,464	)
Pennsylvania NOL		(10,068	)		(6,596	)
Other state NOL		(8,988	)		(3,265	)
California R&D		(18,773	)		—
Other state R&D		(15,606	)		(10,438	)
Non-U.S. NOL		(10,481	)		(9,153	)

Ending balance	$	(91,743	)	$	(57,772	)

A roll-forward analysis of our deferred tax asset valuation allowances is as follows (in thousands):


	For the Period ended December 31,
	2017			2016			2015
Beginning balance	$	57,772		$	87,788		$	118,629
Additions		52,680			17,973			3,312
Reductions		(18,709	)		(47,989	)		(34,153	)

Ending balance	$	91,743		$	57,772		$	87,788

As of December 31, 2017, the Company did not provide additional income taxes or other non-U.K. withholding taxes on approximately $18.6 million of unremitted earnings from its U.S. foreign subsidiaries directly or indirectly owned by U.S. shareholders, as such earnings are intended to be reinvested indefinitely outside of the U.S. Accordingly, should earnings of non-U.K. subsidiaries be distributed in the form of dividends (or otherwise), ARRIS may be subject to additional taxable income (in various jurisdictions) and non-U.K. withholding taxes. Determination of the amount of unrecognized tax liabilities related to these indefinitely reinvested and undistributed non-U.K. earnings is not practicable because of the complexities associated with this hypothetical calculation. Furthermore, the Company does not assert indefinite reinvestment on its earnings of foreign subsidiaries that are not directly or indirectly owned by a U.S. shareholder, and have recorded a deferred tax liability of $2.7 million associated with the unremitted earnings of those subsidiaries.

In accordance with the Tax Cuts and Jobs Act of 2017 and Staff Accounting Bulletin No. 118 (“SAB 118”), the Company provided a provisional estimate for U.S. Federal income taxes of $(0.2) million relating to certain unremitted earnings of non-U.S. subsidiaries owned by U.S. entities. With respect to impacts relating to U.S. state income taxes and non-U.S. withholding taxes, as well as the Company’s determination with respect to its indefinite reinvestment assertion relating to investments in non-U.S. subsidiaries owned by the U.S., we consider our accounting to be incomplete due to forthcoming guidance and our ongoing analysis of final year-end data and tax positions. We expect to complete our analysis with the measurement period in accordance with SAB 118.

Tabular Reconciliation of Unrecognized Tax Benefits (in thousands):


	For the Period ended December 31,
	2017			2016			2015
Beginning balance	$	128,053		$	49,919		$	48,019
Gross increases — tax positions in prior period		6,783			8,068			1,599
Gross decreases — tax positions in prior period		(21,409	)		(5,700	)		(2,185	)
Gross increases — current-period tax positions		24,551			27,774			9,578
Increases from acquired businesses		39,420			60,796			—
Changes related to foreign currency translation adjustment and remeasurement		1,545			(1,087	)		—
Decreases relating to settlements with taxing authorities and other		(686	)		(3,933	)		(6,689	)
Decreases due to lapse of statute of limitations		(4,032	)		(7,784	)		(403	)

Ending balance	$	174,225		$	128,053		$	49,919

The Company and its subsidiaries file income tax returns in the U.S. and U.K. jurisdictions, and various state and other foreign jurisdictions. As of December 31, 2017, the Company and its subsidiaries were under income tax audit in various jurisdictions including the United Kingdom, the United States, Hong Kong and various states and other foreign countries. ARRIS does not anticipate audit adjustments in excess of its current accrual for uncertain tax positions.

Liabilities related to uncertain tax positions inclusive of interest and penalties were $178.2 million and $137.2 million at December 31, 2017 and 2016, respectively. These liabilities at December 31, 2017 and 2016 were reduced by $29.6 million and $28.4 million, respectively, for offsetting benefits from the corresponding effects of potential transfer pricing adjustments, state income taxes and other unrecognized tax benefits. These offsetting benefits are recorded in other non-current assets and noncurrent deferred income taxes. The net result of $148.6 million and $108.7 million at December 31, 2017 and 2016, respectively, if recognized and released, would favorably affect tax expense.

Included in the net result of $148.6 million as of December 31, 2017, is $37.9 million of net acquired uncertain tax positions. This amount is fully indemnified and offset by a corresponding indemnification asset recorded in other non-current assets.

The Company reported approximately $4.0 million and $9.2 million, respectively, of interest and penalty accrual related to the anticipated payment of these potential tax liabilities as of December 31, 2017 and 2016. The Company classifies interest and penalties recognized on the liability for uncertain tax positions as income tax expense.

Based on information currently available, the Company anticipates that over the next twelve-month period, statutes of limitations may close and audit settlements will occur relating to existing unrecognized tax benefits of approximately $15.6 million primarily arising from U.S. federal and state tax related items.