lululemon athletica inc.

INCOME TAXES

The Company's domestic and foreign income before income tax expense and current and deferred income taxes from federal, state, and foreign sources are as follows:



	Fiscal Year Ended
	January 28, 2018			January 29, 2017			January 31, 2016
	(In thousands)
Income (loss) before income tax expense
Domestic	$	123,942		$	(30,955	)	$	84,286
Foreign	336,056			453,684			284,209
	$	459,998		$	422,729		$	368,495
Current income tax expense (recovery)
Federal	$	79,724		$	36,245		$	(18,662	)
State	11,573			6,690			3,363
Foreign	109,322			94,581			110,372
	$	200,619		$	137,516		$	95,073
Deferred income tax expense (recovery)
Federal	$	14,443		$	(11,065	)	$	8,719
State	3,988			(1,840		)	425
Foreign	(17,714		)	(5,263		)	(1,769		)
	717			(18,168		)	7,375
Income tax expense	$	201,336		$	119,348		$	102,448

The Company's income tax expense for fiscal 2017, fiscal 2016 and fiscal 2015 include certain discrete tax amounts, as follows:



	Fiscal Year Ended
	January 28, 2018			January 29, 2017			January 31, 2016
	(In thousands)
U.S. tax reform:
One-time transition tax	$	58,896		$	—		$	—
Deferred income tax effects	398			—			—
Tax recovery on ivivva restructuring costs	(12,741		)	—			—
Transfer pricing and repatriation taxes:
Transfer pricing adjustments, net	—			(10,706		)	(4,826		)
Tax on repatriation of foreign earnings	—			(38		)	7,838
Tax adjustment on foreign tax credit calculations	—			—			(10,455		)
Total tax adjustments	$	46,553		$	(10,744	)	$	(7,443	)

U.S. tax reform

The U.S. tax reform enacted on December 22, 2017 and introduces significant changes to the U.S. income tax laws. The U.S. tax reform reduces the U.S. federal income tax rate from 35% to 21%, introduces a shift to a territorial tax system and changes how foreign earnings are subject to U.S. tax, and imposes a mandatory one-time transition tax on the deemed repatriation of accumulated undistributed earnings of foreign subsidiaries. The U.S. tax reform also introduces new taxes on certain foreign-sourced earnings and certain related-party payments, which are referred to as the global intangible low-taxed income tax and the base erosion anti-abuse tax. Accounting for the income tax effects of the U.S. tax reform is complex and requires significant judgement and estimates in the interpretation and calculations of its provisions.

The Company has recognized a provisional amount of $59.3 million in income tax expense in fiscal 2017 in relation to the U.S. tax reform. This includes a provisional current income tax expense of $58.9 million for the mandatory one-time transition tax on the deemed repatriation of accumulated undistributed earnings of foreign subsidiaries, and a provisional deferred income tax expense of $0.4 million to reflect the reduced U.S. tax rate and other effects of the U.S. tax reform.

As the Company completes its analysis of the U.S. tax reform it may make adjustments to the provisional amounts recognized, and will incorporate any additional interpretations or guidance that may be issued. The Company may also identify additional effects not reflected as of January 28, 2018. Any such adjustments may materially impact the provision for income taxes and the effective income tax rate in the period in which the adjustments are made.

The Company expects to complete the accounting for the income tax effects of the U.S. tax reform in fiscal 2018.

One-time transition tax. The U.S. tax reform requires the Company to pay U.S. income taxes on accumulated foreign subsidiary earnings not previously subject to U.S. income tax at a rate of 15.5% on cash and cash equivalents and 8% on the remaining earnings, net of foreign tax credits. The one-time transition tax is payable over eight years. The Company has recognized a provisional amount of $58.9 million in income tax expense. The Company expects to pay the transition tax using its existing cash balances and sources within the U.S.

Further analysis will be required with respect to the method of computation and components of the foreign subsidiaries' earnings and profits, the definition of foreign cash positions, the computation and limitation of the use of foreign tax credits, and the interaction between state and U.S. federal income tax laws on the mandatory deemed repatriation income inclusion for state income tax purposes.

Deferred income tax effects. The U.S. tax reform reduced the U.S. federal income tax rate from 35% to 21%. Accordingly, the Company has remeasured its deferred income tax assets and liabilities to reflect the reduced rate that is expected to apply in future periods when these balances reverse. The Company recognized a provisional deferred income tax expense of $0.4 million to reflect the reduced U.S. tax rate and other effects of the U.S. tax reform.

The U.S. tax reform and the shift to a territorial tax system eliminates U.S. federal income taxes upon any future repatriation of foreign earnings. However, the U.S. tax reform does not eliminate foreign withholding taxes, or certain state income taxes, which may still be payable upon any future repatriation.

As of January 28, 2018, no deferred income tax liabilities have been recognized on any of the undistributed earnings of the Company's foreign subsidiaries as these earnings were indefinitely reinvested outside of the United States. The Company is continuing to evaluate the impact that the U.S. tax reform will have upon the taxes which may become payable upon repatriation, its reinvestment plans, and the most efficient means of deploying its capital resources globally. As this analysis has not yet been completed, it is possible that amounts determined to be indefinitely reinvested outside of the U.S. may ultimately be repatriated, resulting in additional tax liabilities being recognized.

The cumulative undistributed earnings of the Company's foreign subsidiaries as of January 28, 2018 were $1.24 billion, including $1.21 billion of accumulated undistributed earnings of a Canadian subsidiary. In the event the Company determines that all or a portion of such foreign earnings will no longer be indefinitely reinvested outside of the United States, Canadian withholding taxes of 5% and U.S. state income taxes could apply to some portion of any distribution made. This is in addition to the one-time transition tax that is payable as a result of the U.S. tax reform. The amount of tax that would be payable upon repatriation is dependent on the elections available to the Company under Canadian withholding tax legislation, the extent to which such withholding tax would be recoverable through U.S. foreign tax credits, and the interaction between state and U.S. federal income tax laws as a result of the U.S. tax reform.

As of January 28, 2018, the Company had cash and cash equivalents of $796.9 million outside of the United States.

Tax recovery on ivivva restructuring costs

As outlined in Note 13 of these consolidated financial statements, the Company restructured its ivivva operations during fiscal 2017. Income tax recoveries of $12.7 million were recorded on total restructuring costs of $47.2 million in fiscal 2017. These income tax recoveries are based on the tax rate of the applicable tax jurisdictions.

Transfer pricing adjustments, net

The Company's tax positions include the Company's intercompany transfer pricing policies and the associated taxable income and deductions arising from intercompany charges between subsidiaries within the consolidated group.

During fiscal 2016, the Company finalized an Advance Pricing Arrangement ("APA") with the IRS and the Canada Revenue Agency ("CRA"). This agreement determines the amount of income which is taxable in each respective jurisdiction.

In the year ended January 31, 2016, the Company received communications from the IRS and CRA which led to the determination that it was more likely than not that the outcome of the APA would result in a decrease in taxable income in the United States and an increase in taxable income in Canada for fiscal 2011 through fiscal 2015. The Company recorded a net income tax recovery of $4.8 million in the year ended January 31, 2016, representing the largest amount of benefit that was considered more likely than not to be realized upon finalization of the APA.

In the year ended January 29, 2017, the APA was finalized and the final terms of the arrangement resulted in an increased amount of income tax recoverable in the United States. This resulted in the recognition of a further net income tax recovery of $10.7 million in the year ended January 29, 2017.

In accordance with the terms of the APA, the adjustments necessary to reflect the reduction in pre-tax income in the United States for fiscal 2011 to fiscal 2015 were recorded by way of a cumulative catchup reduction in pre-tax income in fiscal 2016. This resulted in a decrease in domestic income (loss) before income tax expense of $129.9 million and a corresponding increase in foreign income before income tax expense in the year ended January 29, 2017.

For the years ended January 29, 2017 and January 31, 2016, the Company recorded net interest expenses related to the APA of $1.7 million and $3.5 million, respectively. This represents accrued interest on the Canadian income tax payable related to the APA. The APA resulted in an increase in income tax payable in Canada. These interest costs were recognized in other income (expense), net.

There were no significant adjustments related to the APA in fiscal 2017.

Tax on repatriation of foreign earnings

In the year ended January 31, 2016, as a result of the change in the expected outcome of the APA described above, it was expected that a significant intercompany debt between one of the Company's U.S. subsidiaries and a Canadian subsidiary would arise upon the finalization of the APA. In order to finance the payment of this intercompany debt, it was expected that $156.0 million would be distributed from a Canadian subsidiary to the U.S. parent entity. As a result, these foreign earnings were no longer considered indefinitely reinvested and the Company recorded an incremental income tax expense and deferred income tax liability of $7.8 million to provide for U.S. income and applicable foreign withholding taxes on this expected distribution.

In the year ended January 29, 2017, the APA was finalized and a distribution of $156.0 million was made from a Canadian subsidiary to the U.S. parent entity.

Tax adjustment on foreign tax credit calculations

During the year ended January 31, 2016, the Company finalized the amount of U.S. income tax payable on the dividends of $473.7 million which were distributed in fiscal 2014. The change in the expected outcome of the APA had an impact on the foreign tax credits relating to the dividends paid in fiscal 2014 that had been initially estimated and as a result the Company recognized an income tax recovery of $10.5 million during fiscal 2015.

A summary reconciliation of the effective tax rate is as follows:



	Fiscal Year Ended
	January 28, 2018		January 29, 2017		January 31, 2016
	(Percentages)
Federal income tax at statutory rate	33.9	%	35.0	%	35.0	%
Foreign tax rate differentials	(5.9	)	(7.0	)	(6.9	)
U.S. state taxes	1.5		1.6		0.8
Non-deductible compensation expense	0.9		0.6		0.6
Permanent and other	0.5		0.5		—
U.S. tax reform	12.9		—		—
Transfer pricing adjustments, net	—		(2.5	)	(1.0	)
Tax on repatriation of foreign earnings	—		—		2.1
Tax adjustment on foreign tax credit calculations	—		—		(2.8	)
Effective tax rate	43.8	%	28.2	%	27.8	%

The Company's U.S. federal income tax rate of 33.9% for the year ended January 28, 2018 is a blended rate that includes the rate decrease which became effective on January 1, 2018.

The tax effects of temporary differences that give rise to significant portions of the deferred income tax assets and deferred income tax liabilities as of January 28, 2018 and January 29, 2017 are presented below:



	January 28, 2018			January 29, 2017
	(In thousands)
Deferred income tax assets:
Net operating loss carryforwards	$	37,436		$	16,280
Inventories	4,691			4,811
Deferred lease liabilities	7,956			9,373
Tenant inducements	7,386			8,453
Stock-based compensation	740			2,354
Foreign tax credits	877			6,818
Other	5,309			2,920
Deferred income tax assets	64,395			51,009
Valuation allowance	(1,843		)	(91		)
Deferred income tax assets, net of valuation allowance	$	62,552		$	50,918
Deferred income tax liabilities:
Property and equipment, net	$	(30,429	)	$	(31,153	)
Other	(968		)	(771		)
Deferred income tax liabilities	(31,397		)	(31,924		)
Net deferred income tax assets	$	31,155		$	18,994

Balance sheet classification:
Deferred income tax assets	$	32,491		$	26,256
Deferred income tax liabilities	(1,336		)	(7,262		)
Net deferred income tax assets	$	31,155		$	18,994

As of January 28, 2018, the Company had foreign net operating loss carryforwards of $121.8 million. The majority of the net operating loss carryforwards expire, if unused, between fiscal 2031 and fiscal 2037.

The Company files income tax returns in the U.S., Canada and various foreign, state, and provincial jurisdictions. The 2012 to 2016 tax years remain subject to examination by the U.S. federal and state tax authorities. The 2010 and 2011 tax years are still open for certain state tax authorities. The 2007 to 2016 tax years remain subject to examination by Canadian tax authorities. The 2011 to 2016 tax years remain subject to examination by tax authorities in certain foreign jurisdictions. The Company does not have any significant unrecognized tax benefits arising from uncertain tax positions taken, or expected to be taken, in the Company's tax returns.