Income Taxes
U.S. TAX REFORM
The legislation commonly referred to as The Tax Cuts and Jobs Act (the "TCJA") was enacted on December 22, 2017. The TCJA reduced the U.S. federal statutory tax rate from 35% to 21% effective January 1, 2018, made changes to the international tax rules, repealed the domestic manufacturing deduction effective January 1, 2018, and allowed for full expensing of certain capital purchases from September 28, 2017 through December 31, 2022.
The Company recorded an income tax benefit of $297 million in the fourth quarter as a result of the TCJA, which was comprised of the following:
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• | An income tax benefit of $328 million primarily due to reducing its net U.S. deferred tax liabilities for the 14% decrease in the U.S. federal statutory tax rate. |
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• | Income tax expense of $31 million due to the establishment of a valuation allowance for all unused foreign tax credit carryforwards as of December 31, 2017 as the Company no longer believes that any benefit will be realized from these foreign tax credit carryforwards due to U.S. Tax Reform changes including the elimination of tax on foreign dividends. |
On December 22, 2017, the SEC staff issued Staff Accounting Bulletin ("SAB") 118, Income Tax Accounting Implications of the Tax Cuts and Jobs Act ("SAB 118"), which provides guidance on accounting for the impact of the TCJA, in effect allowing an entity to use a methodology similar to the measurement period in a business combination. Pursuant to the disclosure provisions of SAB 118, as of December 31, 2017 the Company has not completed its accounting for the tax effects of the TCJA. The Company has recorded a reasonable estimate of the impact from the TCJA, but is still analyzing the TCJA and refining our calculations. Additionally, future guidance from the IRS, SEC, or the FASB could result in changes to our accounting for the tax effects of the TCJA.
Income before provision for income taxes and equity in earnings of unconsolidated subsidiaries was as follows:
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| | | | | | | | | | | |
| For the Year Ended December 31, |
(in millions) | 2017 | | 2016 | | 2015 |
U.S. | $ | 1,085 |
| | $ | 1,169 |
| | $ | 1,070 |
|
Non-U.S. | 88 |
| | 114 |
| | 114 |
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Total | $ | 1,173 |
| | $ | 1,283 |
| | $ | 1,184 |
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The provision for income taxes has the following components:
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| | | | | | | | | | | |
| For the Year Ended December 31, |
(in millions) | 2017 | | 2016 | | 2015 |
Current: | |
| | |
| | |
|
Federal | $ | 240 |
| | $ | 311 |
| | $ | 307 |
|
State | 37 |
| | 50 |
| | 52 |
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Non-U.S. | 19 |
| | 44 |
| | 32 |
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Total current provision | 296 |
| | 405 |
| | 391 |
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Deferred: | | | | | |
Federal(1) | (218 | ) | | 18 |
| | 21 |
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State | 14 |
| | 8 |
| | 7 |
|
Non-U.S. | 3 |
| | 3 |
| | 1 |
|
Total deferred provision | (201 | ) | | 29 |
| | 29 |
|
Total provision for income taxes | $ | 95 |
| | $ | 434 |
| | $ | 420 |
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____________________________
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(1) | For the year ended December 31, 2017, the deferred federal provision for income taxes was impacted by the TCJA. |
The following is a reconciliation of the provision for income taxes computed at the U.S. federal statutory tax rate to the provision for income taxes reported in the Consolidated Statements of Income:
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| | | | | | | | | | | |
| For the Year Ended December 31, |
(in millions) | 2017 | | 2016 | | 2015 |
Statutory federal income tax of 35% | $ | 411 |
| | $ | 449 |
| | $ | 414 |
|
State income taxes, net(1) | 34 |
| | 38 |
| | 39 |
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U.S. federal domestic manufacturing benefit | (27 | ) | | (29 | ) | | (29 | ) |
Impact of non-U.S. operations | (11 | ) | | (8 | ) | | (7 | ) |
Impact of the TCJA | (297 | ) | | — |
| | — |
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Other(2)(3) | (15 | ) | | (16 | ) | | 3 |
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Total provision for income taxes | $ | 95 |
| | $ | 434 |
| | $ | 420 |
|
Effective tax rate | 8.1 | % | | 33.8 | % | | 35.5 | % |
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(1) | For the year ended December 31, 2017, the provision for income taxes included an income tax benefit of $5 million due primarily to an agreement for an improved filing group with a state tax authority. |
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(2) | For the year ended December 31, 2017, the provision for income taxes included an income tax benefit of $19 million due to the adoption of ASU 2016-09. Refer to Notes 1 and 2 for additional information on the impact of the adoption of ASU 2016-09 on the Company's consolidated financial statements. |
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(3) | For the year ended December 31, 2016, the provision for income taxes included an income tax benefit of $17 million driven primarily by a restructuring of the ownership of our Canadian business. |
Deferred tax assets (liabilities) were comprised of the following as of December 31, 2017 and 2016:
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| | | | | | | |
| December 31, | | December 31, |
(in millions) | 2017 | | 2016 |
Deferred income tax assets: | |
| | |
|
Deferred revenue | $ | 282 |
| | $ | 449 |
|
Accrued liabilities | 50 |
| | 67 |
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Net operating loss and credit carryforwards | 39 |
| | 37 |
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Compensation | 29 |
| | 51 |
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Pension and PRMB | 4 |
| | 14 |
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Other | 20 |
| | 28 |
|
| 424 |
| | 646 |
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Deferred income tax liabilities: | | | |
Intangible assets and goodwill | (793 | ) | | (1,174 | ) |
Fixed assets | (123 | ) | | (189 | ) |
Other | (19 | ) | | (19 | ) |
| (935 | ) | | (1,382 | ) |
Valuation allowance(1) | (41 | ) | | (14 | ) |
Net deferred income tax liability(2) | $ | (552 | ) | | $ | (750 | ) |
____________________________
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(1) | As of December 31, 2017, the Company's valuation allowance was comprised of $5 million related to a foreign operation which was established as part of the separation transaction and $36 million of foreign tax credits as the Company does not believe that the benefits will be realized in future years as a result of the TCJA, as discussed above. |
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(2) | As of December 31, 2017, the Company's net deferred income tax liability was impacted by the TCJA. |
As of December 31, 2017, the Company had $39 million in tax effected credit carryforwards and net operating loss carryforwards. Of the Company's $36 million of foreign tax credit carryforwards, $18 million were generated in 2011 and will expire in 2020. The remaining state net operating loss and credit carryforwards will expire in periods beyond the next five years.
The Company previously recorded no deferred income taxes on undistributed earnings from non-U.S. subsidiaries because DPS considered the earnings to be indefinitely reinvested or because the Company’s outside tax basis exceeded book basis. The international tax rules of the TCJA resulted in the recognition of all previously unrecognized and current year earnings and profits determined under U.S. income tax principles ("E&P") of $233 million, the tax effect of which was entirely offset by foreign tax credits. Prior to the TCJA, the Company had undistributed U.S. GAAP earnings in non-U.S. subsidiaries of approximately $198 million and $204 million, and undistributed E&P in non-U.S. subsidiaries of approximately $233 million and $195 million, both as of December 31, 2017 and 2016, respectively.
An actual repatriation from our non-U.S. subsidiaries could still be subject to additional foreign withholding taxes. The Company has analyzed our global working capital and cash requirements and continues to be indefinitely reinvested in its undistributed earnings except for amounts in excess of its working capital and cash requirements. The Company has recorded potential tax liabilities attributable to a repatriation and have determined that the provisional estimate for withholding taxes was not significant as of December 31, 2017.
The Company files income tax returns for U.S. federal purposes and in various state jurisdictions. The Company also files income tax returns in various foreign jurisdictions, principally Canada and Mexico. The U.S. and most state income tax returns for years prior to 2014 are closed to examination by applicable tax authorities. Mexican income tax returns are generally open for tax years 2008 and forward and Canadian income tax returns are open for audit for tax years 2010 and forward. The Canada Revenue authority (the "CRA") has completed its audit of the 2010 tax year, and the Company is currently pursuing U.S. Competent Authority relief through the IRS related to an adjustment proposed by the CRA.
The following is a reconciliation of the changes in the gross balance of unrecognized tax benefits for the years ended December 31, 2017, 2016 and 2015:
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| | | | | | | | | | | |
| December 31, |
(in millions) | 2017 | | 2016 | | 2015 |
Beginning balance | $ | 27 |
| | $ | 19 |
| | $ | 13 |
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Increases related to tax positions taken during the current year | — |
| | — |
| | — |
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Increases related to tax positions taken during the prior year | 2 |
| | 12 |
| | 10 |
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Decreases related to tax positions taken during the prior year | (4 | ) | | — |
| | (1 | ) |
Decreases related to settlements with taxing authorities | (7 | ) | | (1 | ) | | (2 | ) |
Decreases related to lapse of applicable statute of limitations | (1 | ) | | (3 | ) | | (1 | ) |
Ending balance | $ | 17 |
| | $ | 27 |
| | $ | 19 |
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The total amount of unrecognized tax benefits that, if recognized, would reduce the effective tax rate is $14 million after considering the federal impact of state income taxes. During the next twelve months, the Company does not expect a significant change to its unrecognized tax benefits.
The Company accrues interest and penalties on its uncertain tax positions as a component of its provision for income taxes. The Company recognized a $3 million benefit and $1 million of expense related to interest and penalties for uncertain tax positions for the years ended December 31, 2017 and 2015, respectively. The Company recognized no interest and penalties for uncertain tax positions for the year ended December 31, 2016. The Company had a total of $2 million and $5 million accrued for interest and penalties for its uncertain tax positions reported as part of other non-current liabilities as of December 31, 2017 and 2016, respectively.