Income Taxes
The components of pre-tax income, generally based on the jurisdiction of the legal entity, were as follows (in millions):
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| | | | | | | | | | | |
| Year Ended December 31, |
| 2017 | | 2016 | | 2015 |
Domestic | $ | (238.8 | ) | | $ | (546.4 | ) | | $ | (27.0 | ) |
Foreign | 586.3 |
| | 888.1 |
| | 968.8 |
|
| $ | 347.5 |
| | $ | 341.7 |
| | $ | 941.8 |
|
For the years ended December 31, 2017, 2016 and 2015, 169%, 260% and 103% of the Company's pre-tax income was derived from foreign sources, respectively. The increase in domestic pre-tax income for the year ended December 31, 2017 compared to the prior year was primarily due to expenses recorded in 2016 as a result of the Joint Settlement Agreements, described further in Note 5, partially offset by the domestic portion of the goodwill impairment charge related to the Company's Business Solutions reporting unit, the NYDFS Consent Order accrual, as also discussed in Note 5, and an increase in business transformation expenses.
In December 2017, the Tax Act was enacted into United States law. Certain of the Tax Act's impacts have been provisionally estimated and will likely be adjusted in future periods as the Company completes its accounting for these matters in accordance with a recent staff accounting bulletin issued by the SEC. For those areas of the Tax Act where the Company does not have the necessary information available, prepared, or analyzed in reasonable detail to complete its accounting, the Company has recorded estimates which may need to be adjusted in subsequent periods, and those subsequent adjustments will be recorded in the Company's provision for income taxes if the estimates change as the Company completes the accounting for those matters during 2018. While management believes it has made reasonable estimates for the numerous complex provisions in the law, tax expense is provisional for the following items:
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• | With respect to the United States taxation of certain previously undistributed earnings of foreign subsidiaries, the determination of the amount of earnings, the amount of assets which are to be included as cash and other specified assets, and which are therefore subject to the higher effective tax rate specified in the Tax Act, and the related potential foreign tax implications are provisional and subject to further analysis, including the Company's completion of the calculation for the 2017 federal, state, and foreign income tax returns. In addition, the Company is completing this analysis for a significant number of its controlled foreign corporations, as the analysis must be completed for each of the subsidiaries and not consolidated at a higher level. Therefore, the amount of this tax may change until the Company finalizes the calculation. The estimated tax provision amount related to this matter was $916 million in the year ended December 31, 2017. |
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• | The Company recorded a provisional $87 million benefit for the remeasurement of deferred tax assets and liabilities and other tax balances to reflect the lower federal income tax rate, among other effects. The Company is still analyzing certain aspects of the Tax Act and refining the calculations, which could potentially affect the measurement of these balances, and the amount is also subject to the Company's completion of the calculation for the 2017 federal, state, and foreign income tax returns. |
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• | The Company has provisionally estimated the total amount of outside basis differences with respect to its foreign subsidiaries as of December 31, 2017 to be $254 million (after giving effect to the Tax Act), and no deferred income tax effects have been recognized with respect to such outside basis differences. These outside tax basis differences primarily relate to the remaining undistributed foreign earnings not subject to the tax on certain previously undistributed earnings of foreign subsidiaries pursuant to the Tax Act and additional outside basis difference inherent in certain entities. To the extent such outside basis differences are attributable to undistributed earnings not already subject to United States tax, such undistributed earnings continue to be indefinitely reinvested in foreign operations. Upon the future realization of the Company's basis difference, the Company could be subject to United States income taxes, state income taxes and possible withholding taxes payable to various foreign countries. However, determination of this amount of unrecognized deferred tax liability is not practicable because of the complexities associated with its hypothetical calculation. The amount of total outside basis differences and appropriate deferred tax effects are impacted by the application of the Tax Act and will be finalized during 2018. |
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• | Subsequent to the enactment of the Tax Act, the Company must make an accounting policy election to account for the tax effects of global intangible low-tax income either as a component of income tax expense in the period the tax arises, or as a component of deferred taxes on the related investments in foreign subsidiaries. The Company is currently evaluating these provisions of the Tax Act and the related implications and has not finalized its accounting policy election. The Company will finalize its accounting policy election in 2018. |
The Company's income tax expense could also increase or decrease in future periods as the effects of the Tax Act are clarified through federal or state regulations, interpretations, or law changes. For example, the Tax Act is broad and complex, and given its recent enactment, regulations or other interpretive guidance is currently limited. Any change in the interpretation of the Tax Act or other legislative proposals or amendments could have a significant effect on the Company's income tax expense in future periods. Furthermore, the effect of the Tax Act on state income taxes, including how the tax on certain previously undistributed earnings of foreign subsidiaries will be interpreted by the states and how states will apply forward-looking provisions of the Tax Act, are currently unclear and subject to potential changes affecting both the amount of state taxes and the remeasurement of the Company's deferred tax assets and liabilities and other tax balances.
The provision for income taxes was as follows (in millions):
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| | | | | | | | | | | |
| Year Ended December 31, |
| 2017 | | 2016 | | 2015 |
Federal | $ | 848.5 |
| | $ | 43.5 |
| | $ | 33.2 |
|
State and local | 5.4 |
| | 2.9 |
| | (1.0 | ) |
Foreign | 50.7 |
| | 42.1 |
| | 71.8 |
|
| $ | 904.6 |
| | $ | 88.5 |
| | $ | 104.0 |
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No tax benefit was recorded in either 2017 for the $60 million NYDFS Consent Order accrual or in 2016 for the $586 million Compensation Payment resulting from the Joint Settlement Agreements. Domestic taxes have been incurred on certain pre-tax income amounts that were generated by the Company's foreign operations, including a tax on certain previously undistributed earnings of foreign subsidiaries imposed by the Tax Act. In addition, certain portions of the Company's foreign source income are subject to United States federal and state income tax as earned due to the nature of the income, and dividend repatriations of the Company's foreign source income may be subject to state income tax. Accordingly, the percentage obtained by dividing the total federal, state and local tax provision by the domestic pre-tax income, all as shown in the preceding tables, is higher than the statutory tax rates in the United States.
The Company's effective tax rates differed from statutory rates as follows:
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| | | | | | | | |
| Year Ended December 31, |
| 2017 | | 2016 | | 2015 |
Federal statutory rate | 35.0 | % | | 35.0 | % | | 35.0 | % |
State income taxes, net of federal income tax benefits | 1.7 | % | | 1.2 | % | | 0.4 | % |
Foreign rate differential, net of United States tax paid on foreign earnings (1.1%, 24.8% and 3.4%, respectively) | (69.3 | )% | | (50.8 | )% | | (24.6 | )% |
Tax Act impact | 251.5 | % | | — | % | | — | % |
Joint Settlement Agreements impact | — | % | | 62.1 | % | | — | % |
NYDFS Consent Order impact | 6.0 | % | | — | % | | — | % |
Goodwill impairment | 46.7 | % | | — | % | | — | % |
Lapse of statute of limitations | (10.0 | )% | | (11.3 | )% | | (0.8 | )% |
Valuation allowances | 0.8 | % | | (2.8 | )% | | (0.9 | )% |
Other | (2.1 | )% | | (7.5 | )% | | 1.9 | % |
Effective tax rate | 260.3 | % | | 25.9 | % | | 11.0 | % |
The Company's effective tax rate for the year ended December 31, 2017 was significantly impacted by the enactment of the Tax Act into United States law, primarily due to a tax on certain previously undistributed earnings of foreign subsidiaries, partially offset by the remeasurement of the Company's deferred tax assets and liabilities and other tax balances to reflect the lower federal income tax rate, among other effects. The Company's effective tax rate for the year ended December 31, 2017 compared to 2016 was also impacted by the goodwill impairment in the Company's Business Solutions reporting unit, the NYDFS Consent Order accrual recorded in 2017, and the Joint Settlement Agreements recorded during 2016. The increase in the Company's effective tax rate for the year ended December 31, 2016 compared to 2015 was primarily due to the Joint Settlement Agreements and an increase in higher-taxed earnings (excluding the Joint Settlement Agreements) compared to lower-taxed foreign earnings, partially offset by the combined effects of various discrete items, including changes in tax contingency reserves.
The Company's provision for income taxes consisted of the following components (in millions):
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| | | | | | | | | | | |
| Year Ended December 31, |
| 2017 | | 2016 | | 2015 |
Current: | | | | | |
Federal | $ | 774.4 |
| | $ | 186.2 |
| | $ | 59.6 |
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State and local | 1.0 |
| | 13.1 |
| | 5.4 |
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Foreign | 59.7 |
| | 63.4 |
| | 78.9 |
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Total current taxes | 835.1 |
| | 262.7 |
| | 143.9 |
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Deferred: | | | | | |
Federal | 74.1 |
| | (142.7 | ) | | (26.4 | ) |
State and local | 4.4 |
| | (10.2 | ) | | (6.4 | ) |
Foreign | (9.0 | ) | | (21.3 | ) | | (7.1 | ) |
Total deferred taxes | 69.5 |
| | (174.2 | ) | | (39.9 | ) |
| $ | 904.6 |
| | $ | 88.5 |
| | $ | 104.0 |
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Deferred tax assets and liabilities are recognized for the expected tax consequences of temporary differences between the book and tax bases of the Company's assets and liabilities. The following table outlines the principal components of deferred tax items (in millions):
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| | | | | | | |
| December 31, |
| 2017 | | 2016 |
Deferred tax assets related to: | | | |
Reserves, accrued expenses and employee-related items | $ | 44.8 |
| | $ | 279.8 |
|
Tax attribute carryovers | 27.1 |
| | 39.1 |
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Pension obligations | 4.6 |
| | 11.1 |
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Intangibles, property and equipment | 11.9 |
| | 9.7 |
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Other | 10.7 |
| | 14.8 |
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Valuation allowance | (19.9 | ) | | (22.0 | ) |
Total deferred tax assets | 79.2 |
| | 332.5 |
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Deferred tax liabilities related to: | | | |
Intangibles, property and equipment | 239.4 |
| | 394.4 |
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Other | 0.9 |
| | 14.3 |
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Total deferred tax liabilities | 240.3 |
| | 408.7 |
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Net deferred tax liability (a) | $ | 161.1 |
| | $ | 76.2 |
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(a) | As of December 31, 2017 and 2016, deferred tax assets that cannot be fully offset by deferred tax liabilities in the respective tax jurisdictions of $11.9 million and $9.7 million, respectively, are reflected in "Other assets" in the Consolidated Balance Sheets. |
The valuation allowances are primarily the result of uncertainties regarding the Company's ability to recognize tax benefits associated with certain United States foreign tax credit carryforwards and certain foreign and state net operating losses. Such uncertainties include generating sufficient United States foreign tax credit limitation related to passive income and generating sufficient income. Changes in circumstances, or the identification and implementation of relevant tax planning strategies, could make it foreseeable that the Company will recover these deferred tax assets in the future, which could lead to a reversal of these valuation allowances and a reduction in income tax expense.
Uncertain Tax Positions
The Company has established contingency reserves for a variety of material, known tax exposures. As of December 31, 2017, the total amount of tax contingency reserves was $344.0 million, including accrued interest and penalties, net of related items. The Company's tax reserves reflect management's judgment as to the resolution of the issues involved if subject to judicial review or other settlement. While the Company believes its reserves are adequate to cover reasonably expected tax risks, there can be no assurance that, in all instances, an issue raised by a tax authority will be resolved at a financial cost that does not exceed its related reserve. With respect to these reserves, the Company's income tax expense would include (i) any changes in tax reserves arising from material changes during the period in the facts and circumstances (i.e., new information) surrounding a tax issue and (ii) any difference from the Company's tax position as recorded in the financial statements and the final resolution of a tax issue during the period. Such resolution could materially increase or decrease income tax expense in the Company's consolidated financial statements in future periods and could impact operating cash flows.
Unrecognized tax benefits represent the aggregate tax effect of differences between tax return positions and the amounts otherwise recognized in the Company's consolidated financial statements, and are reflected in "Income taxes payable" in the Consolidated Balance Sheets. A reconciliation of the beginning and ending amount of unrecognized tax benefits, excluding interest and penalties, is as follows (in millions):
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| | | | | | | |
| 2017 | | 2016 |
Balance as of January 1, | $ | 352.0 |
| | $ | 105.6 |
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Increase related to current period tax positions (a) | 9.0 |
| | 223.6 |
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Increase related to prior period tax positions | — |
| | 71.7 |
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Decrease related to prior period tax positions | (19.8 | ) | | (14.9 | ) |
Decrease due to lapse of applicable statute of limitations | (14.0 | ) | | (33.1 | ) |
Increase/(decrease) due to effects of foreign currency exchange rates | 1.8 |
| | (0.9 | ) |
Balance as of December 31, | $ | 329.0 |
| | $ | 352.0 |
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(a) | Includes recurring accruals for issues which initially arose in previous periods. |
The total amount of unrecognized tax benefits that, if recognized, would affect the effective tax rate was $319.6 million and $343.3 million as of December 31, 2017 and 2016, respectively, excluding interest and penalties.
The Company recognizes interest and penalties with respect to unrecognized tax benefits in "Provision for income taxes" in its Consolidated Statements of Income/(Loss), and records the associated liability in "Income taxes payable" in its Consolidated Balance Sheets. The Company recognized $2.2 million, $(0.2) million and $1.9 million in interest and penalties during the years ended December 31, 2017, 2016 and 2015, respectively. The Company has accrued $25.4 million and $22.5 million for the payment of interest and penalties as of December 31, 2017 and 2016, respectively.
The unrecognized tax benefits accrual as of December 31, 2017 consists of federal, state and foreign tax matters. It is reasonably possible that the Company's total unrecognized tax benefits will decrease by approximately $19 million during the next 12 months in connection with various matters which may be resolved.
The Company and its subsidiaries file tax returns for the United States, for multiple states and localities, and for various non-United States jurisdictions, and the Company has identified the United States as its major tax jurisdiction, as the income tax imposed by any one foreign country is not material to the Company. The United States federal income tax returns of First Data, which include the Company, are eligible to be examined for 2005 and 2006. The Company's United States federal income tax returns since the Spin-off (other than 2010-2013) are also eligible to be examined.
The United States Internal Revenue Service ("IRS") completed its examination of the United States federal consolidated income tax returns of First Data for 2003 and 2004, which included the Company, and issued a Notice of Deficiency in December 2008. In December 2011, the Company reached an agreement with the IRS resolving substantially all of the issues related to the Company's restructuring of its international operations in 2003 ("IRS Agreement"). As a result of the IRS Agreement, the Company expects to make cash payments of approximately $190 million, plus additional accrued interest, of which $94.1 million has been paid as of December 31, 2017. A substantial majority of these payments were made in the year ended December 31, 2012. The Company may pay the remaining amount in 2018. The IRS completed its examination of the United States federal consolidated income tax returns of First Data, which include the Company's 2005 and pre-Spin-off 2006 taxable periods and issued its report on October 31, 2012 ("FDC 30-Day Letter"). Furthermore, the IRS completed its examination of the Company's United States federal consolidated income tax returns for the 2006 post-Spin-off period through 2009 and issued its report also on October 31, 2012 ("WU 30-Day Letter"). Both the FDC 30-Day Letter and the WU 30-Day Letter propose tax adjustments affecting the Company, some of which are agreed and some of which are unagreed. Both First Data and the Company filed their respective protests with the IRS Appeals Division on November 28, 2012 related to the unagreed proposed adjustments. The Company believes its reserves are adequate with respect to both the agreed and unagreed adjustments. During the year ended December 31, 2016, the Company reached an agreement in principle with the IRS concerning its unagreed adjustments and adjusted its reserves accordingly. The Company anticipates concluding the matters related to these years in 2018.
Tax Allocation Agreement with First Data
The Company and First Data each are liable for taxes imposed on their respective businesses both prior to and after the Spin-off. If such taxes have not been appropriately apportioned between First Data and the Company, subsequent adjustments may occur that may impact the Company's financial condition or results of operations.
Also under the tax allocation agreement, with respect to taxes and other liabilities that result from a final determination that is inconsistent with the anticipated tax consequences of the Spin-off (as set forth in the private letter ruling and relevant tax opinion) ("Spin-off Related Taxes"), the Company will be liable to First Data for any such Spin-off Related Taxes attributable solely to actions taken by or with respect to the Company. In addition, the Company will also be liable for half of any Spin-off Related Taxes (i) that would not have been imposed but for the existence of both an action by the Company and an action by First Data or (ii) where the Company and First Data each take actions that, standing alone, would have resulted in the imposition of such Spin-off Related Taxes. The Company may be similarly liable if it breaches certain representations or covenants set forth in the tax allocation agreement. If the Company is required to indemnify First Data for taxes incurred as a result of the Spin-off being taxable to First Data, it likely would have a material adverse effect on the Company's business, financial condition and results of operations. First Data generally will be liable for all Spin-off Related Taxes, other than those described above.