Income Taxes
Effective April 27, 2006 (inception), and concurrent with the completion of the acquisition of the Sensors & Controls business ("S&C") of Texas Instruments Incorporated ("TI") (the "2006 Acquisition"), we commenced filing tax returns in the Netherlands as a stand-alone entity. Several of our Dutch resident subsidiaries are taxable entities in the Netherlands and file tax returns under Dutch fiscal unity (i.e., consolidation). Prior to April 30, 2008, we filed one consolidated tax return in the U.S. On April 30, 2008, our U.S. subsidiaries executed a separation and distribution agreement that divided our U.S. businesses, resulting in two separate U.S. consolidated federal income tax returns. On January 1, 2016, our U.S. subsidiaries resumed filing one consolidated tax return. Our remaining subsidiaries will file income tax returns in the countries in which they are incorporated and/or operate, including the Netherlands, Japan, China, Germany, Belgium, Bulgaria, South Korea, Malaysia, the U.K., France, and Mexico. The 2006 Acquisition purchase accounting and the related debt and equity capitalization of the various subsidiaries of the consolidated company, and the realignment of the functions performed and risks assumed by the various subsidiaries, are of significant consequence to the determination of future book and taxable income of the respective subsidiaries and Sensata as a whole.
Effects of the Tax Cuts and Jobs Act
On December 22, 2017 President Donald Trump signed into U.S. law the Tax Cuts and Jobs Act of 2017 (“Tax Reform”). ASC Topic 740, Accounting for Income Taxes, requires companies to recognize the effect of tax law changes in the period of enactment even though the effective date for most provisions is for tax years beginning after December 31, 2017, or in the case of certain other provisions of the law, January 1, 2018.
Given the significance of the legislation, the U.S. Securities and Exchange Commission (the "SEC") staff issued Staff Accounting Bulletin ("SAB") No. 118 (SAB 118), which allows registrants to record provisional amounts during a one year “measurement period” similar to that used when accounting for business combinations. However, the measurement period is deemed to have ended earlier when the registrant has obtained, prepared, and analyzed the information necessary to finalize its accounting. During the measurement period, impacts of the law are expected to be recorded at the time a reasonable estimate for all or a portion of the effects can be made, and provisional amounts can be recognized and adjusted as information becomes available, prepared, or analyzed.
SAB 118 summarizes a three-step process to be applied at each reporting period to account for and qualitatively disclose: (1) the effects of the change in tax law for which accounting is complete; (2) provisional amounts (or adjustments to provisional amounts) for the effects of the tax law where accounting is not complete, but that a reasonable estimate has been determined; and (3) a reasonable estimate cannot yet be made and therefore taxes are reflected in accordance with law prior to the enactment of the Tax Cuts and Jobs Act.
Amounts recorded where we consider accounting to be complete for the year ended December 31, 2017 principally relate to the reduction in the U.S. corporate income tax rate to 21 percent, which resulted in the recording of an income tax benefit of $73.7 million to remeasure deferred taxes liabilities associated with indefinite-lived intangible assets that are deemed to reverse at the new 21 percent tax rate. Absent this deferred tax liability, we are in a net deferred tax asset position that is offset by a full valuation allowance.
The Tax Reform includes a one-time mandatory repatriation transition tax on the net accumulated earnings and profits of a U.S. taxpayer’s foreign subsidiaries. We have performed an earnings and profits analysis, and as a result of foreign tax credits available to fully offset the anticipated transition tax, there will be no income tax effect in the current period. Therefore, the preliminary accounting for this matter is generally complete.
However, several provisions, including the repatriation provisions, of the Tax Reform have significant impact on our U.S. tax attributes, generally consisting of credits, loss carry-forwards, and deferred interest deductions. Our tax attributes are generally subject to a full valuation allowance in the U.S. and thus, any adjustments to the attributes will not impact the tax provision. Although we have made a reasonable estimate of the gross amounts of the attributes disclosed, a final determination of the Tax Reform’s impact on the attributes and related valuation allowance requirements remain incomplete pending a full analysis of the provisions and their interpretations.
Other significant provisions that are not yet effective but may impact income taxes in future years include: an exemption from U.S. tax on dividends of future foreign earnings, limitation on the current deductibility of net interest expense in excess of 30 percent of adjusted taxable income, a limitation of net operating losses generated after fiscal 2018 to 80 percent of taxable income, an incremental tax (base erosion anti-abuse tax or “BEAT”) on excessive amounts paid to foreign related parties, and a minimum tax on certain foreign earnings in excess of 10 percent of the foreign subsidiaries tangible assets (i.e., global intangible low-taxed income or “GILTI”). We are still evaluating whether to make a policy election to treat the GILTI tax as a period expense or to provide U.S. deferred taxes on foreign temporary differences that are expected to generate GILTI income when they reverse in future years.
Income before taxes
Income/(loss) before taxes for the years ended December 31, 2017, 2016, and 2015 was categorized by jurisdiction as follows:
|
| | | | | | | | | | | |
| U.S. | | Non-U.S. | | Total |
For the year ended December 31, | | | | | |
2017 | $ | (11,425 | ) | | $ | 413,866 |
| | $ | 402,441 |
|
2016 | $ | (43,842 | ) | | $ | 365,287 |
| | $ | 321,445 |
|
2015 | $ | (60,707 | ) | | $ | 266,336 |
| | $ | 205,629 |
|
(Benefit from)/provision for income taxes
(Benefit from)/provision for income taxes for the years ended December 31, 2017, 2016, and 2015 was categorized by jurisdiction as follows:
|
| | | | | | | | | | | | | | | |
| U.S. Federal | | Non-U.S. | | U.S. State | | Total |
For the year ended December 31, | | | | | | | |
2017 | | | | | | | |
Current | $ | — |
| | $ | 50,601 |
| | $ | 240 |
| | $ | 50,841 |
|
Deferred | (56,956 | ) | | (1,104 | ) | | 1,303 |
| | (56,757 | ) |
Total | $ | (56,956 | ) | | $ | 49,497 |
| | $ | 1,543 |
| | $ | (5,916 | ) |
2016 | | | | | | | |
Current | $ | 464 |
| | $ | 49,977 |
| | $ | 226 |
| | $ | 50,667 |
|
Deferred | 10,036 |
| | 2,010 |
| | (3,702 | ) | | 8,344 |
|
Total | $ | 10,500 |
| | $ | 51,987 |
| | $ | (3,476 | ) | | $ | 59,011 |
|
2015: | | | | | | | |
Current | $ | (8,187 | ) | | $ | 45,326 |
| | $ | (197 | ) | | $ | 36,942 |
|
Deferred | (168,855 | ) | | (361 | ) | | (9,793 | ) | | (179,009 | ) |
Total | $ | (177,042 | ) | | $ | 44,965 |
| | $ | (9,990 | ) | | $ | (142,067 | ) |
Effective tax rate reconciliation
The principal reconciling items from income tax computed at the U.S. statutory tax rate for the years ended December 31, 2017, 2016, and 2015 were as follows:
|
| | | | | | | | | | | |
| For the year ended December 31, |
| 2017 | | 2016 | | 2015 |
Tax computed at statutory rate of 35% | $ | 140,854 |
| | $ | 112,506 |
| | $ | 71,970 |
|
Foreign tax rate differential | (111,990 | ) | | (86,339 | ) | | (66,367 | ) |
U.S. Tax Reform Impact | (73,668 | ) | | — |
| | — |
|
Reserve for tax exposure | 38,013 |
| | 11,227 |
| | (2,949 | ) |
Release of valuation allowances | (12,209 | ) | | (1,925 | ) | | (180,001 | ) |
Losses not tax benefited | 8,841 |
| | 32,490 |
| | 56,778 |
|
Patent box | (5,922 | ) | | (10,961 | ) | | (3,714 | ) |
Change in tax law or rates | 3,912 |
| | 2,542 |
| | (10,290 | ) |
Withholding taxes not creditable | 3,896 |
| | 6,014 |
| | 4,346 |
|
Unrealized foreign exchange (gains)/losses, net | 830 |
| | 3,829 |
| | (12,120 | ) |
Other | 1,527 |
| | (10,372 | ) | | 280 |
|
(Benefit from)/provision for income taxes | $ | (5,916 | ) | | $ | 59,011 |
| | $ | (142,067 | ) |
U.S. Tax Reform Impact
As a result of Tax Reform, the U.S. statutory tax rate was lowered from 35 percent to 21 percent, effective on January 1, 2018. We are required to remeasure our U.S. deferred tax assets and liabilities to the new tax rate. We recorded $73.7 million of income tax benefit for the remeasurement of the deferred tax liabilities associated with indefinite-lived intangible assets that will reverse at the new 21 percent rate. Absent this deferred tax liability, the U.S. operation is in a net deferred tax asset position, offset by a full valuation allowance. We reduced our net deferred tax assets excluding the indefinite-lived intangible assets and the corresponding valuation allowance by $120.0 million.
Foreign tax rate differential
We operate in locations outside the U.S., including China, the U.K., the Netherlands, South Korea, Malaysia, Bermuda, and Bulgaria, that have statutory tax rates lower than the historical U.S. statutory rate, resulting in an effective rate benefit. This benefit can change from year to year based upon the jurisdictional mix of earnings. For the years ended December 31, 2017, 2016, and 2015, this benefit was $112.0 million, $86.3 million, and $66.4 million, respectively.
Certain of our subsidiaries are currently eligible, or have been eligible, for tax exemptions or holidays in their respective jurisdictions. From 2016 through 2018, a subsidiary in Changzhou, China was eligible for a reduced tax rate of 15%. The impact of the tax holidays and exemptions on our effective rate is included in the foreign tax rate differential line in the reconciliation of the statutory rate to effective rate.
Patent box
Certain income of our U.K. subsidiaries is eligible for lower tax rates under the “patent box” regime, resulting in certain of our intellectual property income being taxed at a rate lower than the U.K. statutory tax rate. For the years ended December 31, 2017, 2016, and 2015, this benefit was $5.9 million, $11.0 million, and $3.7 million, respectively.
Release of valuation allowances
During the years ended December 31, 2017, 2016, and 2015, we released a portion of our valuation allowance and recognized a deferred tax benefit of $12.2 million, $1.9 million, and $180.0 million, respectively. The deferred tax benefits in fiscal years 2016 and 2015 arose primarily in connection with the 2015 acquisition of CST and the 2014 acquisitions of Wabash, DeltaTech, and Schrader. For each of these acquisitions, deferred tax liabilities were established and related primarily to the step-up of intangible assets for book purposes.
Losses not tax benefited
Losses incurred in certain jurisdictions, predominantly the U.S., are not currently benefited, as it is not more likely than not that the associated deferred tax asset will be realized in foreseeable future. For the years ended December 31, 2017, 2016, and 2015, this resulted in a deferred tax expense of $8.8 million, $32.5 million, and $56.8 million, respectively.
Withholding taxes not creditable
Withholding taxes may apply to intercompany interest, royalty, management fees, and certain payments to third parties. Such taxes are expensed if they cannot be credited against the recipient’s tax liability in its country of residence. Additional consideration also has been given to the withholding taxes associated with the remittance of presently unremitted earnings and the recipient's ability to obtain a tax credit for such taxes. Earnings are not considered to be indefinitely reinvested in the jurisdictions in which they were earned.
In certain jurisdictions we record withholding and other taxes on intercompany payments including dividends. During the years ended December 31, 2017, 2016, and 2015, this amount totaled $3.9 million, $6.0 million, and $4.3 million.
Deferred income tax assets and liabilities
The primary components of deferred income tax assets and liabilities as of December 31, 2017 and 2016 were as follows:
|
| | | | | | | |
| December 31,
2017 | | December 31,
2016 |
Deferred tax assets: | | | |
Inventories and related reserves | $ | 17,287 |
| | $ | 17,616 |
|
Accrued expenses | 25,920 |
| | 32,703 |
|
Property, plant and equipment | 13,396 |
| | 11,297 |
|
Intangible assets | 22,050 |
| | 32,282 |
|
Unrealized Exchange Loss | 12,265 |
| | — |
|
Net operating loss, interest expense, and other carryforwards | 349,244 |
| | 446,946 |
|
Pension liability and other | 8,880 |
| | 10,545 |
|
Share-based compensation | 12,195 |
| | 15,341 |
|
Other | 7,028 |
| | 3,398 |
|
Total deferred tax assets | 468,265 |
| | 570,128 |
|
Valuation allowance | (277,315 | ) | | (299,746 | ) |
Net deferred tax asset | 190,950 |
| | 270,382 |
|
Deferred tax liabilities: | | | |
Property, plant and equipment | (23,222 | ) | | (25,195 | ) |
Intangible assets and goodwill | (428,028 | ) | | (556,089 | ) |
Unrealized exchange gain | (6,031 | ) | | (11,547 | ) |
Tax on undistributed earnings of subsidiaries | (38,894 | ) | | (48,493 | ) |
Other | — |
| | (991 | ) |
Total deferred tax liabilities | (496,175 | ) | | (642,315 | ) |
Net deferred tax liability | $ | (305,225 | ) | | $ | (371,933 | ) |
Valuation allowance and net operating loss carryforwards
Since our inception, we have incurred tax losses in the U.S., resulting in allowable tax net operating loss carryforwards. In measuring the related deferred tax assets, we considered all available evidence, both positive and negative, to determine whether, based on the weight of that evidence, a valuation allowance is needed for all or some portion of the deferred tax assets. Judgment is required in considering the relative impact of negative and positive evidence. The weight given to the potential effect of negative and positive evidence is commensurate with the extent to which it can be objectively verified. The more negative evidence that exists, the more positive evidence is necessary, and the more difficult it is to support a conclusion that a valuation allowance is not needed. Additionally, we utilize the “more likely than not” criteria established in ASC 740 to determine whether the future benefit from the deferred tax assets should be recognized. As a result, we have established a full valuation allowance on the deferred tax assets in jurisdictions that have incurred net operating losses and in which it is more likely than not that such losses will not be utilized in the foreseeable future.
For tax purposes, certain goodwill and indefinite-lived intangible assets are generally amortizable over 6 to 20 years. For book purposes, goodwill and indefinite-lived intangible assets are not amortized, but are tested for impairment annually. The tax amortization of goodwill and indefinite-lived intangible assets will result in a taxable temporary difference, which will not reverse unless the related book goodwill or intangible asset is impaired or written off. This liability may not be used to support deductible temporary differences, such as net operating loss carryforwards, which may expire within a definite period.
The total valuation allowance for the years ended December 31, 2017 and 2016 (decreased)/increased $(22.4) million and $2.8 million, respectively. Subsequently reported tax benefits relating to the valuation allowance for deferred tax assets as of December 31, 2017 will be allocated to income tax benefit recognized in the consolidated statements of operations.
As of December 31, 2017, we have U.S. federal net operating loss carryforwards of $724.9 million and interest expense carryforwards of $472.0 million. U.S. federal net operating loss carryforwards will expire from 2026 to 2037, state net operating loss carryforwards will expire from 2018 to 2037, and the interest carryovers have an unlimited life. It is more likely than not that these net operating losses will not be utilized in the foreseeable future. We also have non-U.S. net operating loss carryforwards of $262.6 million, which will begin to expire in 2018.
We believe a change of ownership within the meaning of Section 382 of the Internal Revenue Code occurred in the fourth quarter of 2012. As a result, our U.S. federal net operating loss utilization will be limited to an amount equal to the market capitalization of our U.S. subsidiaries at the time of the ownership change multiplied by the federal long-term tax exempt rate. A change of ownership under Section 382 of the Internal Revenue Code is defined as a cumulative change of fifty percentage points or more in the ownership positions of certain stockholders owning five percent or more of our common stock over a three year rolling period. We do not believe the resulting limitation will prohibit the utilization of our U.S. federal net operating loss.
Unrecognized tax benefits
A reconciliation of the amount of unrecognized tax benefits is as follows:
|
| | | |
Balance at December 31, 2014 | $ | 22,774 |
|
Increases related to prior year tax positions | 5,467 |
|
Increases related to current year tax positions | 18,382 |
|
Decreases related to settlements with tax authorities | (8,566 | ) |
Balance at December 31, 2015 | 38,057 |
|
Increases related to prior year tax positions | 6,390 |
|
Increases related to current year tax positions | 8,462 |
|
Decreases related to lapse of applicable statute of limitations | (256 | ) |
Decreases related to settlements with tax authorities | (6,755 | ) |
Balance at December 31, 2016 | 45,898 |
|
Increases related to prior year tax positions | 7,968 |
|
Increases related to current year tax positions | 14,585 |
|
Decreases related to lapse of applicable statute of limitations | (1,356 | ) |
Decreases related to settlements with tax authorities | (7,211 | ) |
Balance at December 31, 2017 | $ | 59,884 |
|
During the year ended December 31, 2015, we established a reserve of $16.0 million in connection with a capital restructuring transaction executed during the year.
We record interest and penalties related to unrecognized tax benefits in the consolidated statements of operations and the consolidated balance sheets. The table that follows presents the (income)/expense related to such interest and penalties recognized in the consolidated statements of operations during the years ended December 31, 2017, 2016, and 2015, and the amount of interest and penalties recorded on the consolidated balance sheets as of December 31, 2017 and 2016:
|
| | | | | | | | | | | | | | | | | | | | |
| | Statements of Operations | | Balance Sheets |
| | For the year ended December 31, | | As of December 31, |
(in millions) | | 2017 | | 2016 | | 2015 | | 2017 | | 2016 |
Interest | | $ | 0.2 |
| | $ | 0.1 |
| | $ | 0.1 |
| | $ | 0.7 |
| | $ | 1.0 |
|
Penalties | | $ | (0.1 | ) | | $ | 0.1 |
| | $ | (0.3 | ) | | $ | 0.5 |
| | $ | 1.1 |
|
The liability for unrecognized tax benefits generally relates to the allocation of taxable income to the various jurisdictions where we are subject to tax. At December 31, 2017, we anticipate that the liability for unrecognized tax benefits could decrease by up to $0.2 million within the next twelve months due to the expiration of certain statutes of limitation or the settlement of examinations or issues with tax authorities. The amount of unrecognized tax benefits as of December 31, 2017 and 2016 that will impact our effective tax rate are $5.4 million and $12.0 million, respectively.
Our major tax jurisdictions include the Netherlands, the U.S., Japan, Germany, Mexico, China, South Korea, Belgium, Bulgaria, France, Malaysia, and the U.K. These jurisdictions generally remain open to examination by the relevant tax authority for the tax years 2006 through 2017.
Indemnifications
We have various indemnification provisions in place with Texas Instruments Incorporated ("TI"), Honeywell, William Blair, Tomkins Limited, and Custom Sensors & Technologies Ltd. These provisions provide for the reimbursement by TI, Honeywell, William Blair, Tomkins Limited, and Custom Sensors & Technologies Ltd of future tax liabilities paid by us that relate to the pre-acquisition periods of the acquired businesses including S&C, First Technology Automotive, Airpax, Schrader, and CST, respectively.