INCOME TAXES
Income before income taxes consists of the following (in thousands):
|
| | | | | | | | | | | |
| Years ended December 31, |
| 2017 | | 2016 | | 2015 |
United States | $ | 116,225 |
| | $ | 132,846 |
| | $ | 134,611 |
|
Foreign | 45,175 |
| | 10,351 |
| | 5,545 |
|
Total | $ | 161,400 |
| | $ | 143,197 |
| | $ | 140,156 |
|
The allocation of income before income taxes may fluctuate year to year due to activity within the Bright Horizons consolidated group. Due to the disposition of our remaining assets in Ireland and the related disposition of our investment in the foreign subsidiary in 2017, the foreign income before income taxes includes a gain of approximately $11.9 million, with a corresponding loss of approximately $15.6 million within the U.S. income before income taxes. This transaction resulted in a consolidated net loss of $3.7 million which is included in other expenses in the consolidated statement of income.
Income tax expense consists of the following (in thousands):
|
| | | | | | | | | | | |
| Years ended December 31, |
| 2017 | | 2016 | | 2015 |
Current tax expense | | | | | |
Federal | $ | 29,733 |
| | $ | 42,691 |
| | $ | 29,236 |
|
State | 4,531 |
| | 10,752 |
| | 8,723 |
|
Foreign | 7,735 |
| | 7,115 |
| | 9,028 |
|
| 41,999 |
| | 60,558 |
| | 46,987 |
|
Deferred tax (benefit) expense | | | | | |
Federal | (36,794 | ) | | (6,463 | ) | | (11,014 | ) |
State | 612 |
| | (2,069 | ) | | 6,776 |
|
Foreign | (1,380 | ) | | (3,589 | ) | | 3,480 |
|
| (37,562 | ) | | (12,121 | ) | | (758 | ) |
Income tax expense | $ | 4,437 |
| | $ | 48,437 |
| | $ | 46,229 |
|
The following is a reconciliation of the U.S. federal statutory rate to the effective rate on pretax income (in thousands):
|
| | | | | | | | | | | |
| Years ended December 31, |
| 2017 | | 2016 | | 2015 |
Federal tax expense computed at statutory rate | $ | 56,490 |
| | $ | 50,119 |
| | $ | 49,055 |
|
State tax expense, net of federal tax | 2,881 |
| | 6,374 |
| | 5,849 |
|
Valuation allowance, net | (1,028 | ) | | (107 | ) | | (185 | ) |
Intercompany interest | (5,074 | ) | | (6,953 | ) | | (6,919 | ) |
Permanent differences and other, net | 1,041 |
| | (389 | ) | | (901 | ) |
Stock-based compensation | (22,757 | ) | | — |
| | — |
|
Change in tax rate | (32,844 | ) | | (96 | ) | | 319 |
|
Transition Tax | 11,027 |
| | — |
| | — |
|
Change to uncertain tax positions, net | 614 |
| | 432 |
| | (333 | ) |
Foreign rate differential | (5,913 | ) | | (943 | ) | | (656 | ) |
Income tax expense | $ | 4,437 |
| | $ | 48,437 |
| | $ | 46,229 |
|
The effective income tax rate for 2017 decreased from prior years primarily due to three items. The first relates to the excess tax benefits associated with the exercise of stock options and vesting of restricted stock which reduced income tax expense by $26.5 million in 2017 due to the adoption of ASU 2016-09: Compensation—Stock Compensation (Topic 718) (“ASU 2016-09”). ASU 2016-09 was adopted prospectively as of January 1, 2017. The excess tax benefits from stock-based compensation were recorded to the balance sheet in prior years.
Second, a net tax benefit of $22.3 million was recorded due to the enactment of the U.S. Tax Cuts and Jobs Act (“Tax Act”), as discussed in more detail below. Third, a tax benefit of approximately $7.0 million was recorded in 2017 related to the disposition of our remaining assets in Ireland, also resulting in the disposition of our investment in a subsidiary for tax purposes.
On December 22, 2017, the U.S. federal government enacted comprehensive tax legislation with the Tax Act that makes broad and complex changes to the U.S. tax code, impacting the year ended December 31, 2017 and future years. For 2017, the Tax Act requires a one-time transition tax on certain unrepatriated earnings of foreign subsidiaries that is payable over eight years and also allows for bonus depreciation that permits full expensing of qualified property. Effective January 1, 2018, the Tax Act reduces the U.S. federal corporate tax rate from 35% to 21%.
The SEC staff issued Staff Accounting Bulletin No. 118 (“SAB 118”), which provides guidance on accounting for the tax effects of the Tax Act. SAB 118 provides a measurement period that should not extend beyond one year from the date of the Tax Act enactment for companies to complete the accounting under Accounting Standards Codification 740—Income Taxes. In accordance with SAB 118, to the extent that a company’s accounting for certain income tax effects of the Tax Act is incomplete, but the company is able to determine a reasonable estimate, it must record a provisional estimate in its financial statements.
The Company’s accounting for certain elements of the Tax Act is incomplete. However, the Company was able to make the following reasonable estimates of certain items and has recorded provisional adjustments as of December 31, 2017 based on these estimates.
The Tax Act reduces the corporate federal tax rate to 21% effective January 1, 2018. As a result, the Company recorded a provisional decrease of $33.3 million to its net deferred tax liability with a corresponding adjustment to deferred tax benefit for the year ended December 31, 2017. While the Company was able to make a reasonable estimate of the impact of the reduction in corporate tax rate, it may be affected by other analyses related to the Tax Act including, the calculation of the deemed repatriation of foreign income and the state tax effect of federal adjustments.
The Deemed Repatriation Transition Tax (“Transition Tax”) is a tax on previously untaxed accumulated and current earnings and profits (“E&P”) of certain foreign subsidiaries. To determine the amount of the Transition Tax, the Company must determine the amount of post-1986 E&P of the relevant foreign subsidiaries, as well as the amount of non-U.S. income taxes paid on such earnings. The Company is able to make a reasonable estimate of the Transition Tax and recorded a provisional tax obligation of $11.0 million. However, the Company is continuing to gather additional information to more precisely compute the amount of Transition Tax.
Significant components of the Company’s net deferred tax liability are as follows (in thousands):
|
| | | | | | | |
| December 31, |
| 2017 | | 2016 |
Deferred tax assets: | | | |
Reserve on assets | $ | 605 |
| | $ | 342 |
|
Net operating loss carryforwards | 304 |
| | 1,347 |
|
Liabilities not yet deductible | 28,951 |
| | 39,401 |
|
Deferred revenue | 2,934 |
| | 3,370 |
|
Stock-based compensation | 8,024 |
| | 13,855 |
|
Depreciation | — |
| | 118 |
|
Other | 2,608 |
| | 1,620 |
|
| 43,426 |
| | 60,053 |
|
Valuation allowance | — |
| | (1,028 | ) |
Total deferred tax assets | 43,426 |
| | 59,025 |
|
Deferred tax liabilities: | | | |
Intangible assets | (97,674 | ) | | (143,806 | ) |
Depreciation | (19,685 | ) | | (26,930 | ) |
Total deferred tax liabilities | (117,359 | ) | | (170,736 | ) |
Net deferred tax liability | $ | (73,933 | ) | | $ | (111,711 | ) |
During 2017, the overall deferred tax liability decreased significantly, primarily due to the Tax Act. The U.S. net deferred tax liability was revalued at the lower rate and reduced by $33.3 million. The other book to tax differences, resulting in a net decrease in the deferred tax liability, were in the treatment of amortization of intangible assets, depreciation and stock-based compensation. At December 31, 2017, the net deferred tax liability of $73.9 million includes deferred tax assets of $0.1 million which are recorded to other assets in the consolidated balance sheet.
The Company has foreign net operating losses of $1.3 million and has recorded an associated deferred tax asset totaling $0.3 million. The net operating losses in certain foreign jurisdictions will begin to expire in 2024, while others can be carried forward indefinitely. During 2017, the valuation allowance of $1.0 million was released, based upon consideration of the cumulative income over the last three years and projected forecast of taxable income of the foreign subsidiary. At December 31, 2017, there are no foreign deferred tax assets that require a valuation allowance.
The Company considers the earnings of certain non-U.S. subsidiaries to be indefinitely invested outside the United States on the basis of estimates that future domestic cash generation will be sufficient to meet future domestic cash needs and our specific plans for reinvestment of those subsidiary earnings. The Company has not recorded a deferred tax liability of approximately $1.1 million related to the state taxes and foreign withholding taxes on approximately $123.0 million of cumulative undistributed earnings of foreign subsidiaries indefinitely invested outside the United States.
Uncertain Tax Positions
The Company follows the authoritative guidance relating to the accounting for uncertainty in income taxes. The Company may recognize the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the consolidated financial statements from such a position should be measured based on the largest benefit that has a greater than fifty percent likelihood of being realized upon ultimate settlement.
A reconciliation of the beginning and ending amounts of unrecognized tax benefits is as follows (in thousands):
|
| | | | | | | | | | | |
| Years ended December 31, |
| 2017 | | 2016 | | 2015 |
Beginning balance | $ | 1,096 |
| | $ | 706 |
| | $ | 713 |
|
Additions for tax positions of prior years | — |
| | — |
| | 353 |
|
Additions for tax positions of current year | 650 |
| | 443 |
| | 353 |
|
Settlements | — |
| | — |
| | (50 | ) |
Reductions for tax positions of prior years | — |
| | (27 | ) | | — |
|
Lapses of statutes of limitations | — |
| | — |
| | (663 | ) |
Effect of foreign currency adjustments | 157 |
| | (26 | ) | | — |
|
Ending balance | $ | 1,903 |
| | $ | 1,096 |
| | $ | 706 |
|
The Company recognizes accrued interest and penalties related to unrecognized tax benefits in income tax expense. The Company’s current provision for income tax expense for the years ended December 31, 2017, 2016 and 2015 included no interest and penalties. There was no liability for total interest and penalties at December 31, 2017 and 2016. During 2017, the Company recorded an unrecognized tax benefit for a foreign subsidiary's tax position.
The total amount of unrecognized tax benefits that if recognized would affect the Company’s effective tax rate is $1.9 million. The Company expects the unrecognized tax benefits to change over the next 12 months if certain tax matters ultimately settle with the applicable taxing jurisdiction during this time frame, or if applicable statutes of limitations lapse. The impact of the amount of such changes to previously recorded uncertain tax positions could range from zero to $1.9 million.
The Company and its domestic subsidiaries are subject to U.S. federal income tax as well as multiple state jurisdictions. U.S. federal income tax returns are typically subject to examination by the Internal Revenue Service (IRS) and the statute of limitations for federal income tax returns is three years. The Company’s filings for 2014 through 2016 are subject to audit based upon the federal statute of limitations.
State income tax returns are generally subject to examination for a period of three to five years after filing of the respective return. The state impact of any federal changes remains subject to examination by various states for a period of up to one year after formal notification to the states. There were no significant settlements of state audits during the year. As of December 31, 2017, there were no income tax audits in process and the tax years from 2013 to 2016 are subject to audit.
The Company is also subject to corporate income tax at its subsidiaries located in the United Kingdom, the Netherlands, India, Canada, Ireland and Puerto Rico. The tax returns for the Company’s subsidiaries located in foreign jurisdictions are subject to examination for periods ranging from one to seven years.