Income taxes
The Company provides for income taxes based upon amounts reported in the financial statements and the provisions of currently enacted tax laws. The Company is registered in Bermuda and is subject to Bermuda law with respect to taxation. Under current Bermuda law, the Company is not taxed on any Bermuda income or capital gains and has received an undertaking from the Bermuda Minister of Finance that, in the event of any Bermuda income or capital gains taxes being imposed, the Company will be exempt from such taxes until March 31, 2035.
The Company has subsidiaries and branches with operations in several jurisdictions outside Bermuda, including but not limited to the U.K., U.S., Switzerland and Canada that are subject to relevant taxes in those jurisdictions. Within Note 25, “Segment information,” gross premiums written are allocated to the territory of coverage exposure and therefore do not correlate to pre-tax income generated in any of the territories identified.
The Company’s (loss) income before income taxes for the years ended December 31, 2017, 2016 and 2015 was generated in the following domestic and foreign jurisdictions:
|
| | | | | | | | | | | |
| Years Ended December 31, |
| 2017 | | 2016 | | 2015 |
Domestic | | | | | |
Bermuda | $ | (419,890 | ) | | $ | 447,257 |
| | $ | 470,454 |
|
Foreign | | | | | |
U.K. | 11,368 |
| | 4,308 |
| | 13,621 |
|
U.S. | (61,914 | ) | | 4,038 |
| | (4,176 | ) |
Switzerland | 8,989 |
| | (1,084 | ) | | 2,276 |
|
Canada | 1,251 |
| | 2,599 |
| | 493 |
|
Other | 30,785 |
| | 33,736 |
| | (2,074 | ) |
Total (loss) income before income taxes | $ | (429,411 | ) | | $ | 490,854 |
| | $ | 480,594 |
|
Income tax (benefit) expense is composed of both current and deferred tax attributable to U.S. and Non-U.S. jurisdictions as follows:
|
| | | | | | | | | | | |
| Years Ended December 31, |
| 2017 | | 2016 | | 2015 |
Current income tax (benefit) expense | | | | | |
U.S. | $ | (629 | ) | | $ | 2,042 |
| | $ | 739 |
|
Non-U.S. | (298 | ) | | 711 |
| | 6,028 |
|
Total current income tax (benefit) expense | $ | (927 | ) | | $ | 2,753 |
| | $ | 6,767 |
|
| | | | | |
Deferred income tax (benefit) expense | | | | | |
U.S. | $ | (4,295 | ) | | $ | (3,487 | ) | | $ | 1,360 |
|
Non-U.S. | (2,358 | ) | | (18,995 | ) | | (1,751 | ) |
Total deferred income tax benefit | $ | (6,653 | ) | | $ | (22,482 | ) | | $ | (391 | ) |
| | | | | |
Total income tax (benefit) expense | | | | | |
U.S. | $ | (4,924 | ) | | $ | (1,445 | ) | | $ | 2,099 |
|
Non-U.S. | (2,656 | ) | | (18,284 | ) | | 4,277 |
|
Total income tax (benefit) expense | $ | (7,580 | ) | | $ | (19,729 | ) | | $ | 6,376 |
|
The table below is a reconciliation of the actual income tax (benefit) expense for the years ended December 31, 2017, 2016 and 2015 to the amount computed by applying the effective tax rate of 0% under Bermuda law to income before taxes:
|
| | | | | | | | | | | |
| Years Ended December 31, |
| 2017 | | 2016 | | 2015 |
Expected tax expense at Bermuda statutory rate of 0% | $ | — |
| | $ | — |
| | $ | — |
|
Foreign tax rate differential | (9,795 | ) | | 11,394 |
| | 6,462 |
|
Changes in valuation allowance | (7,997 | ) | | (36,990 | ) | | 9,830 |
|
Tax exempt income and expenses not deductible | (1,034 | ) | | (757 | ) | | 1,299 |
|
Impact of enacted changes in tax rates | 13,008 |
| | 8,931 |
| | 69 |
|
Prior years tax adjustments | (1,892 | ) | | (5,199 | ) | | (12,272 | ) |
Other | 130 |
| | 2,892 |
| | 988 |
|
Actual income tax (benefit) expense | $ | (7,580 | ) | | $ | (19,729 | ) | | $ | 6,376 |
|
Deferred tax assets and liabilities primarily represent the tax effect of temporary differences between the carrying value of assets and liabilities for financial statement purposes and such values as measured by tax laws and regulations in countries in which the operations are taxable. Deferred tax assets may also represent the tax effect of tax losses carried forward.
In assessing whether a deferred tax asset can be recovered and assessing the need for a valuation allowance, the Company considers all positive and negative evidence to determine whether it is more likely than not that the tax benefit of part or all of a deferred tax asset will be realized. The Company’s framework for assessing the recoverability of deferred tax assets primarily considers taxable income in prior carryback years when permitted by law, future reversal of existing taxable temporary differences, available tax planning strategies and the expected occurrence of future taxable income. The weighting of the positive and negative evidence is commensurate with the extent to which they can be objectively verified.
Significant components of the Company’s deferred tax assets and liabilities as at December 31, 2017 and 2016 were as follows:
|
| | | | | | | |
| December 31, 2017 | | December 31, 2016 |
Deferred income tax assets related to: | | | |
Tax losses carried forward | $ | 115,579 |
| | $ | 116,416 |
|
Deferred compensation | 4,924 |
| | 6,915 |
|
Deferred interest expense | 1,226 |
| | 2,039 |
|
Tax credits carried forward | 5,755 |
| | 5,469 |
|
Discounting of loss reserves | 5,137 |
| | 9,938 |
|
Unearned premiums reserve | 8,622 |
| | 6,647 |
|
Pension | 2,511 |
| | 5,943 |
|
Lloyd’s underwriting loss deductible in future periods | — |
| | 581 |
|
Other | 6,463 |
| | 4,943 |
|
Total gross deferred income tax assets | 150,217 |
| | 158,891 |
|
Less: Valuation allowances | (86,272 | ) | | (98,065 | ) |
Total net deferred income tax assets | $ | 63,945 |
| | $ | 60,826 |
|
| | | |
Deferred income tax liabilities related to: | | | |
Deferred acquisition costs | 5,962 |
| | 4,633 |
|
Intangibles | 4,230 |
| | 7,583 |
|
Unrealized appreciation on investments | 1,477 |
| | 3,179 |
|
Properties and fixed assets | 2,387 |
| | 2,593 |
|
Other | 2,022 |
| | 2,640 |
|
Total deferred income tax liabilities | 16,078 |
| | 20,628 |
|
Net deferred tax asset | $ | 47,867 |
| | $ | 40,198 |
|
As part of the 2017 Tax Act, the U.S. statutory rate was reduced from 35% to 21%. Accordingly, the Company has re-measured U.S. deferred tax assets and liabilities based on the rate they are expected to reverse at in the future. As a result of the re-measurement, the Company’s U.S. net deferred tax asset was reduced in 2017 by $12,934.
Additionally, the 2017 Tax Act prescribed a new method of discounting loss reserves for U.S. tax purposes which requires companies to calculate a revised tax loss reserve adjustment for periods prior to 2018 and then recognize this change in taxable income ratably over an eight year period. This would result in an increase to the deferred tax asset related to loss reserves and an equal increase to the deferred tax liability for the future taxable income, resulting in no impact to the net deferred tax asset as reported above. The new methodology will calculate the discount using a different index for the calculation than it had in the past. Specifically, it will use a lagging 60 month average of the “High Quality Corporate Bond Yield Curve.” The legislation did not specify however, the maturity segment to use, and left the development of the precise methodology and calculation of the factors to the regulatory process. The U.S. Treasury is expected to publish the discount rates for the new method in time for the filing due date of the 2017 tax return on October 15, 2018. Since the U.S. Treasury has not yet published the rates and any estimation of them could result in a materially different adjustment than what the ultimate adjustment will be, the Company has chosen to not include a provisional amount for the deferred tax asset and liability in regards to the change in discounting methodology because the Company does not believe we have adequate information to provide a reasonable estimate. The Company will update its disclosure once the necessary information is available.
The movement in the deferred tax asset on tax losses carried forward and related valuation allowance from December 31, 2016 to December 31, 2017 can be explained as follows:
|
| | | | | | | | |
| | Deferred Tax Asset on Tax Losses Carried Forward | | Valuation Allowance |
Balance, beginning of year | | $ | 116,416 |
| | $ | (98,065 | ) |
Movement due to creation of tax losses carried forward | | 14,327 |
| | (2,242 | ) |
Movement due to use of tax losses carried forward | | (8,765 | ) | | 2,456 |
|
Movement due to provision to return adjustments | | 1,521 |
| | (1,521 | ) |
Movement due to changes in enacted tax rates | | (7,319 | ) | | 3,195 |
|
Movement due to change in assessment of deferred tax asset recoverability | | — |
| | 9,304 |
|
Forfeiture of tax losses carried forward | | (2,576 | ) | | 2,576 |
|
Foreign exchange | | 1,975 |
| | (1,975 | ) |
Balance, end of year | | $ | 115,579 |
| | $ | (86,272 | ) |
The above movement of $14,327 represents the tax benefit on current year tax losses that can be carried forward in the U.K. ($1,837) and the U.S. ($12,490). The related change in valuation allowance of $2,242 reflects the tax expense for certain U.S. tax losses carried forward where a valuation allowance was provided. The movement of $8,765 reflects the impact from the use of tax losses carried forward in Luxembourg ($6,309), Switzerland ($1,888) and Singapore ($568). The related movement in valuation allowance of $2,456 represents the tax benefit from the use of tax losses carried forward where a full valuation allowance was previously provided (Switzerland: $1,888 and Singapore: $568). The movement of $1,521 represents prior year adjustments reflecting tax losses carried forward as per tax returns filed. The change in deferred tax asset of $7,319 and related valuation allowance of $3,195 reflects the impact of enacted changes in income tax rate, primarily in the U.S. The movement in valuation allowance of $9,304 is due to the partial release of valuation allowances which had previously been applied against deferred tax assets related to carried forward Swiss and Luxembourg tax losses acquired as part of the Flagstone acquisition.
As at December 31, 2017, the Company believes, after review of all available positive and negative evidence that it is more likely than not to have sufficient future taxable income to realize a portion of these deferred tax assets. As such, the Company has recorded a partial release from the previously held valuation allowance resulting in a current year tax benefit. The tax effect from forfeiture of tax losses carried forward of $2,576 results from the net reduction of Swiss tax losses association with the application of non-taxable income of Validus Re Swiss’ Bermuda Branch in accordance with Swiss law. The movement of $1,975 represents the foreign exchange effect on the deferred tax asset and related valuation allowance for tax losses carried forward in local currency in Switzerland.
As at December 31, 2017, the Company had net operating and capital losses carried forward, inclusive of cumulative currency translation adjustments, as follows:
|
| | | | | | | | | | | | | | | | | | | | | | | | |
| | Luxembourg | | Switzerland | | United States | | United Kingdom | | Singapore | | Total |
2018-2020 | | $ | — |
| | $ | 145,669 |
| | $ | — |
| | $ | — |
| | $ | — |
| | $ | 145,669 |
|
2029-2038 | | — |
| | — |
| | 22,827 |
| | — |
| | — |
| | 22,827 |
|
No expiration date | | 276,819 |
| | — |
| | 29,281 |
| | 9,543 |
| | 2,323 |
| | 317,966 |
|
Total | | 276,819 |
| | 145,669 |
| | 52,108 |
| | 9,543 |
| | 2,323 |
| | 486,462 |
|
| | | | | | | | | | | | |
Gross deferred tax asset | | 72,001 |
| | 30,590 |
| | 10,943 |
| | 1,813 |
| | 232 |
| | 115,579 |
|
Valuation allowance | | (53,899 | ) | | (27,347 | ) | | (4,794 | ) | | — |
| | (232 | ) | | (86,272 | ) |
Net deferred tax asset | | $ | 18,102 |
| | $ | 3,243 |
| | $ | 6,149 |
| | $ | 1,813 |
| | $ | — |
| | $ | 29,307 |
|
Prior to the enactment of the 2017 Tax Act, the U.S. allowed for net operating losses to be carried back two years and forward 20 years. For years beginning after December 31, 2017, net operating losses on non-insurance companies in the U.S. may no longer be carried back but will be allowed to be carried forward indefinitely. The 2017 Tax Act did not change the treatment of net operating losses for insurance companies. The new legislation does not provide for how to apply these rules where a company files a consolidated tax return which includes both insurance and non-insurance companies. As such, the $22,827 figure above relates to U.S. net operating losses of Validus Re Switzerland which is taxed as an insurance company. The $29,281 figure relates to net operating losses of the Validus U.S. consolidated group of which $7,768 relates to insurance companies within the consolidated group. The Company believes these will have no expiration date when the legislative guidance becomes available.
As of December 31, 2017, there are U.S. alternative minimum tax credit carryforwards of $5,755 which do not expire.
The valuation allowance as at December 31, 2017 of $86,272 (2016: $98,065) relates to tax losses carried forward in Luxembourg, Switzerland, Singapore and the U.S. The Company believes it is necessary to maintain a full valuation allowance against the deferred tax assets related to tax losses carried forward in Singapore and the U.S., outside the U.S. consolidated group, after review of all available positive and negative evidence, including uncertainty regarding the ability of the concerned operations to generate future taxable income to utilize the losses carried forward and realize the deferred tax assets. The weighting of the positive and negative evidence is commensurate with the extent to which they can be objectively verified.
As mentioned above, partial releases of $9,304 (Luxembourg: $6,061 and Switzerland: $3,243) of the valuation allowance previously held against a deferred tax asset related to tax losses carried forward was recorded as of December 31, 2017. The Company believes, after review of all positive and negative evidence, it is now more likely than not to have sufficient future taxable income to realize a portion of these deferred tax assets.
The U.S. consolidated group generated tax losses of $29,281 in 2017. As discussed above, absent further legislative guidance, the Company has attributed all of these losses to the non-insurance company members of the group. Accordingly, these losses will be carried forward indefinitely. As of December 31, 2017, the Company believes it is more likely than not that the U.S. consolidated group will have sufficient future taxable income to utilize these losses within a reasonable period of time.
The Company will continue to monitor all available positive and negative evidence, including its expectations for future taxable income in the relevant jurisdictions, in relation to the recoverability of its existing deferred tax balances. If the Company’s positive evidence continues to develop favorably in the foreseeable future, it is possible that further releases of the valuation allowances related to deferred tax asset balances will occur.
Recognition of the benefit of a given tax position is based upon whether a company determines that it is more likely than not that a tax position will be sustained upon examination based upon the technical merits of the position. In evaluating the more-likely-than-not recognition threshold, the Company must presume the tax position will be subject to examination by a tax authority with full knowledge of all relevant information. If the recognition threshold is met, then the tax position is measured at the largest amount of benefit that is more than 50% likely of being realized upon ultimate settlement. As at December 31, 2017 and 2016, the Company had no accrued liabilities for tax, interest and penalties relating to uncertain tax positions. Interest and penalties related to uncertain tax positions would be recognized in income tax expense.
The Company has undistributed earnings in several foreign subsidiaries. If such earnings were to be distributed, as dividends or otherwise, they may be subject to income and withholding taxes. As a general rule, the Company intends to only distribute earnings that can be distributed in a tax free manner with the exception of a few smaller subsidiaries where the Company has accrued a withholding tax for such future distributions. In the United States, the Company intends to indefinitely reinvest any earnings such that no accrual of potential withholding tax was made. Were the Company to change its assertion that it would not indefinitely reinvest earnings in its U.S. subsidiaries, the Company estimates it would need to accrue $878 of withholding tax payable on future distributions.
The Company has open examinations by tax authorities in the U.S. (2013-2016) and Switzerland (2014-2015). The Company believes that these examinations will be concluded within the next 12 months and currently does not expect any material adjustments as a result of these audits.
The Company has open tax years that are potentially subject to examination by local tax authorities in the following major tax jurisdictions: the U.K. (2016-2017), the U.S. (2016-2017), Switzerland (2013-2017) and Canada (2014-2017).