INCOME TAXES
In December 2017, the U.S. enacted the Tax Cuts and Jobs Act (the “Act”) which makes widespread changes to the Internal Revenue Code. The Act, among other things, reduced the U.S. federal corporate tax rate from 35% to 21%, requires companies to pay a transition tax on earnings of certain foreign subsidiaries that were previously not subject to U.S. tax and creates new income taxes on certain foreign sourced earnings.
The SEC issued Staff Accounting Bulletin No. 118 (SAB 118) which provides guidance on accounting for the tax effects of the Act and allows for adjustments to provisional amounts during a measurement period of up to one year. In accordance with SAB 118, the Company has made reasonable estimates related to (1) the remeasurement of U.S. deferred tax balances for the reduction in the tax rate (2) the liability for the transition tax and (3) the taxes accrued relating to the change in permanent reinvestment assertion for unremitted earnings of certain foreign subsidiaries. As a result, the Company recognized a net provisional income tax benefit of $21.0 million associated with these items in 2017.
The components of the provisional amounts recognized as part of the Act is as follows:
|
| | | | |
In millions | | 2017 |
Remeasurement of deferred tax balances | | $ | (300.6 | ) |
Transition tax | | 160.7 |
|
Change in permanent reinvestment assertion | | 118.9 |
|
Income tax benefit, net | | $ | (21.0 | ) |
The Company is continuing to evaluate how the provisions of the Act will be accounted for under ASC 740, “Income Taxes” (ASC 740). The analysis is provisional and is subject to change due to the additional time required to accurately calculate and review the complex tax law. The Company will assess any regulatory guidance that may be issued which could have an impact on the provisional estimates. The Company will continue to gather information and perform additional analysis on these estimates, including, but not limited to, the amount of earnings and profits subject to the transition tax, the calculation of foreign tax credits, the local tax treatment of future distributions of unremitted earnings and in regard to the remeasurement of U.S. deferred taxes, the filing of its 2017 federal and state income tax returns. Any measurement period adjustments will be reported as a component of Provision for income taxes in the reporting period the amounts are determined. The final accounting will be completed no later than one year from the enactment of the Act.
Current and deferred provision for income taxes
Earnings before income taxes for the years ended December 31 were taxed within the following jurisdictions:
|
| | | | | | | | | | | | |
In millions | | 2017 | | 2016 | | 2015 |
United States (1) | | $ | (17.6 | ) | | $ | 419.8 |
| | $ | 451.6 |
|
Non-U.S. | | 1,435.5 |
| | 1,321.5 |
| | 796.3 |
|
Total | | $ | 1,417.9 |
| | $ | 1,741.3 |
| | $ | 1,247.9 |
|
(1) Amount reported in 2017 includes the impact of a premium paid of approximately $520 million related to the early retirement of certain intercompany debt obligations
The components of the Provision for income taxes for the years ended December 31 were as follows:
|
| | | | | | | | | | | | |
In millions | | 2017 | | 2016 | | 2015 |
Current tax expense (benefit): | | | | | | |
United States | | $ | 102.2 |
| | $ | 179.6 |
| | $ | 300.1 |
|
Non-U.S. | | 95.4 |
| | 135.7 |
| | 132.9 |
|
Total: | | 197.6 |
| | 315.3 |
| | 433.0 |
|
Deferred tax expense (benefit): | | | | | | |
United States | | (234.7 | ) | | (6.7 | ) | | 69.0 |
|
Non-U.S. | | 117.3 |
| | (27.1 | ) | | 38.8 |
|
Total: | | (117.4 | ) | | (33.8 | ) | | 107.8 |
|
Total tax expense (benefit): | | | | | | |
United States | | (132.5 | ) | | 172.9 |
| | 369.1 |
|
Non-U.S. | | 212.7 |
| | 108.6 |
| | 171.7 |
|
Total | | $ | 80.2 |
| | $ | 281.5 |
| | $ | 540.8 |
|
The Provision for income taxes differs from the amount of income taxes determined by applying the applicable U.S. statutory income tax rate to pretax income, as a result of the following differences:
|
| | | | | | | | | |
| | Percent of pretax income |
| | 2017 | | 2016 | | 2015 |
Statutory U.S. rate | | 35.0 | % | | 35.0 | % | | 35.0 | % |
Increase (decrease) in rates resulting from: | | | | | | |
Non-U.S. tax rate differential (a) | | (28.8 | ) | | (14.7 | ) | | (17.2 | ) |
Tax on U.S. subsidiaries on non-U.S. earnings | | 0.8 |
| | 0.9 |
| | 1.3 |
|
State and local income taxes (b) | | 1.2 |
| | 1.4 |
| | 1.5 |
|
Valuation allowances (c) | | 2.8 |
| | 0.1 |
| | 1.7 |
|
Change in permanent reinvestment assertion (d), (f) | | 8.4 |
| | — |
| | 3.9 |
|
Transition tax (f) | | 11.3 |
| | — |
| | — |
|
Remeasurement of deferred tax balances (f) | | (21.2 | ) | | — |
| | — |
|
Stock based compensation | | (1.7 | ) | | — |
| | — |
|
Reserves for uncertain tax positions | | (0.9 | ) | | 0.1 |
| | 14.1 |
|
Hussmann gain (e) | | — |
| | (5.7 | ) | | — |
|
Provision to return and other true-up adjustments | | (1.7 | ) | | (0.6 | ) | | 0.7 |
|
Other adjustments | | 0.5 |
| | (0.3 | ) | | 2.3 |
|
Effective tax rate | | 5.7 | % | | 16.2 | % | | 43.3 | % |
| |
(a) | Amount reported in 2017 includes the impact of a premium paid of approximately $520 million related to the early retirement of certain intercompany debt obligations |
| |
(b) | Net of changes in state valuation allowances |
| |
(c) | Primarily federal and non-U.S., excludes state valuation allowances |
| |
(d) | Net of foreign tax credits |
| |
(e) | Gain from sale of Hussmann equity investment |
| |
(f) | Amounts included in 2017 are provisional and relate to the Act |
Tax incentives, in the form of tax holidays, have been granted to the Company in certain jurisdictions to encourage industrial development. The expiration of these tax holidays varies by country. The tax holidays are conditional on the Company meeting certain employment and investment thresholds. The most significant tax holidays relate to the Company’s qualifying locations in China, Puerto Rico, Panama and Singapore. The benefit for the tax holidays for the years ended December 31, 2017, 2016 and 2015 was $19.7 million, $23.3 million and $22.6 million, respectively.
IRS Exam Results
In July 2015, the Company entered into an agreement with the U.S. Internal Revenue Service (IRS) to resolve disputes related to withholding and income taxes for years 2002 through 2011 (the IRS Agreement). The IRS had previously disagreed with the Company’s tax treatment of intercompany debt and distributions and asserted the Company owed income and withholding tax relating to the 2002-2006 period totaling $774 million, not including interest and penalties. The Company also provided a substantial amount of information to the IRS in connection with its audit of the 2007-2011 tax periods. The Company expected the IRS to propose similar adjustments to these periods, although it was not known how the IRS would apply its position to the different facts presented in these years or whether the IRS would take a similar position to intercompany debt instruments not outstanding in prior years.
The resolution reached in July 2015 covered intercompany debt and related issues for the entire period from 2002 through 2011 and includes all aspects of the dispute with the U.S. Tax Court, the Appeals Division and the Examination Division of the IRS. The resolution was subsequently reported to the Congressional Joint Committee on Taxation (JCT), as required, for its review. The JCT concluded its review without objection in December 2015 and the settlement was finalized with the IRS in December 2015.
Pursuant to the agreement with the IRS, the Company agreed to pay withholding tax and interest of $412 million in respect to the 2002-2006 years. The Company owed no additional tax with respect to intercompany debt and related matters for the years 2007-2011. No penalties were applied to any of the tax years 2002 through 2011. The resolution resulted in a net cash outflow in 2015 of approximately $364 million, consisting of $230 million in tax and $134 million of interest, net of a tax benefit of $48 million.
Deferred tax assets and liabilities
A summary of the deferred tax accounts at December 31 are as follows:
|
| | | | | | | | |
In millions | | 2017 | | 2016 |
Deferred tax assets: | | | | |
Inventory and accounts receivable | | $ | 17.4 |
| | $ | 18.2 |
|
Fixed assets and intangibles | | 10.4 |
| | 16.2 |
|
Postemployment and other benefit liabilities | | 396.5 |
| | 652.5 |
|
Product liability | | 95.4 |
| | 151.3 |
|
Other reserves and accruals | | 134.8 |
| | 192.8 |
|
Net operating losses and credit carryforwards | | 589.0 |
| | 528.5 |
|
Other | | 22.7 |
| | 38.6 |
|
Gross deferred tax assets | | 1,266.2 |
| | 1,598.1 |
|
Less: deferred tax valuation allowances | | (344.6 | ) | | (184.5 | ) |
Deferred tax assets net of valuation allowances | | $ | 921.6 |
| | $ | 1,413.6 |
|
Deferred tax liabilities: | | | | |
Inventory and accounts receivable | | $ | (24.1 | ) | | $ | (38.8 | ) |
Fixed assets and intangibles | | (1,237.4 | ) | | (1,949.7 | ) |
Postemployment and other benefit liabilities | | (9.6 | ) | | (7.0 | ) |
Other reserves and accruals | | (1.5 | ) | | (1.9 | ) |
Product liability | | (1.4 | ) | | — |
|
Undistributed earnings | | (137.7 | ) | | (24.0 | ) |
Other | | (11.1 | ) | | (8.4 | ) |
Gross deferred tax liabilities | | (1,422.8 | ) | | (2,029.8 | ) |
Net deferred tax assets (liabilities) | | $ | (501.2 | ) | | $ | (616.2 | ) |
At December 31, 2017, no deferred taxes have been provided for earnings of certain of the Company’s subsidiaries, since these earnings have been, and under current plans will continue to be permanently reinvested in these subsidiaries. These earnings amount to approximately $1.0 billion which if distributed would result in additional taxes, which may be payable upon distribution, of approximately $110.0 million.
At December 31, 2017, the Company had the following operating loss and tax credit carryforwards available to offset taxable income in prior and future years:
|
| | | | | | |
In millions | | Amount | | Expiration Period |
U.S. Federal net operating loss carryforwards | | $ | 680.0 |
| | 2018-2036 |
U.S. Federal credit carryforwards | | 121.5 |
| | 2022-Unlimited |
U.S. State net operating loss carryforwards | | 3,484.2 |
| | 2018-2037 |
U.S. State credit carryforwards | | 34.7 |
| | 2018-Unlimited |
Non-U.S. net operating loss carryforwards | | 752.0 |
| | 2018-Unlimited |
Non-U.S. credit carryforwards | | 8.0 |
| | Unlimited |
The U.S. state net operating loss carryforwards were incurred in various jurisdictions. The non-U.S. net operating loss carryforwards were incurred in various jurisdictions, predominantly in Belgium, Brazil, China, India, Luxembourg, Spain, and the United Kingdom.
Activity associated with the Company’s valuation allowance is as follows:
|
| | | | | | | | | | | | |
In millions | | 2017 | | 2016 | | 2015 |
Beginning balance | | $ | 184.5 |
| | $ | 213.1 |
| | $ | 210.7 |
|
Increase to valuation allowance | | 176.5 |
| | 19.4 |
| | 40.7 |
|
Decrease to valuation allowance | | (19.1 | ) | | (43.5 | ) | | (34.0 | ) |
Accumulated other comprehensive income (loss) | | 2.7 |
| | (4.5 | ) | | (4.3 | ) |
Ending balance | | $ | 344.6 |
| | $ | 184.5 |
| | $ | 213.1 |
|
During 2017, the Company recorded a valuation allowance of approximately $30 million on certain net deferred tax assets in Brazil that were no longer expected to be realized. In addition, the Company recorded a valuation allowance of approximately $100 million related to excess foreign tax credits generated as a result of the Act.
Unrecognized tax benefits
The Company has total unrecognized tax benefits of $120.5 million and $107.1 million as of December 31, 2017, and December 31, 2016, respectively. The amount of unrecognized tax benefits that, if recognized, would affect the continuing operations effective tax rate are $80.4 million as of December 31, 2017. A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows:
|
| | | | | | | | | | | | |
In millions | | 2017 | | 2016 | | 2015 |
Beginning balance | | $ | 107.1 |
| | $ | 174.9 |
| | $ | 343.8 |
|
Additions based on tax positions related to the current year | | 6.2 |
| | 5.9 |
| | 8.7 |
|
Additions based on tax positions related to prior years | | 16.8 |
| | 29.1 |
| | 186.5 |
|
Reductions based on tax positions related to prior years | | (8.6 | ) | | (37.6 | ) | | (102.2 | ) |
Reductions related to settlements with tax authorities | | (4.8 | ) | | (60.9 | ) | | (251.0 | ) |
Reductions related to lapses of statute of limitations | | (1.3 | ) | | (2.8 | ) | | (3.7 | ) |
Translation (gain) loss | | 5.1 |
| | (1.5 | ) | | (7.2 | ) |
Ending balance | | $ | 120.5 |
| | $ | 107.1 |
| | $ | 174.9 |
|
The Company records interest and penalties associated with the uncertain tax positions within its Provision for income taxes. The Company had reserves associated with interest and penalties, net of tax, of $32.5 million and $33.7 million at December 31, 2017 and December 31, 2016, respectively. For the year ended December 31, 2017 and December 31, 2016, the Company recognized $1.9 million and $2.3 million, respectively, in interest and penalties net of tax in continuing operations related to these uncertain tax positions.
In the second quarter of 2015, the Company recorded a tax charge of approximately $227 million to continuing operations related to the increase in the liability for unrecognized tax benefits as a result of the proposed IRS settlement. Pursuant to the agreement with the IRS, the Company reduced its liability for unrecognized tax benefits for all related amounts at December 31, 2015. In addition, the Company recorded a tax benefit of approximately $65 million within continuing operations as a result of the settlement of an audit in a major tax jurisdiction.
The total amount of unrecognized tax benefits relating to the Company's tax positions is subject to change based on future events including, but not limited to, the settlements of ongoing audits and/or the expiration of applicable statutes of limitations. Although the outcomes and timing of such events are highly uncertain, it is reasonably possible that the balance of gross unrecognized tax benefits, excluding interest and penalties, could potentially be reduced by up to approximately $1.0 million during the next 12 months.
The provision for income taxes involves a significant amount of management judgment regarding interpretation of relevant facts and laws in the jurisdictions in which the Company operates. Future changes in applicable laws, projected levels of taxable income and tax planning could change the effective tax rate and tax balances recorded by the Company. In addition, tax authorities periodically review income tax returns filed by the Company and can raise issues regarding its filing positions, timing and amount of income or deductions, and the allocation of income among the jurisdictions in which the Company operates. A significant period of time may elapse between the filing of an income tax return and the ultimate resolution of an issue raised by a revenue authority with respect to that return. In the normal course of business the Company is subject to examination by taxing authorities throughout the world, including such major jurisdictions as Brazil, Canada, China, France, Germany, Ireland, Italy, Mexico, Spain, the Netherlands, the United Kingdom and the United States. These examinations on their own, or any subsequent litigation related to the examinations, may result in additional taxes or penalties against the Company. If the ultimate result of these audits differ from original or adjusted estimates, they could have a material impact on the Company’s tax provision. In general, the examination of the Company’s material tax returns are complete or effectively settled for the years prior to 2008, with certain matters prior to 2008 being resolved through appeals and litigation and also unilateral procedures as provided for under double tax treaties.