INCOME TAXES
For the prior taxable years, the Company has filed a consolidated federal income tax return, which includes all of its wholly owned subsidiaries. For its taxable year ended December 31, 2017, the Company intends to file its tax return as a REIT, which it will accomplish by filing the 2017 Form 1120-REIT with the Internal Revenue Service on or before October 15, 2018. The Company’s TRSs will file separately as a C corporation. The Company also files individual separate income tax returns in various states. The Company completed the necessary preparatory work and obtained the necessary approvals such that the Company believes it has been organized and operates in a manner that enables it to qualify, and continue to qualify, as a REIT for federal income tax purposes. As a result, the income tax provision for the year ended December 31, 2017 includes a $223 million deferred tax benefit from the de-recognition of the deferred tax assets and liabilities associated with the entities included in the REIT.
As a REIT, the Company will generally be allowed a deduction for dividends that it pays, and therefore, will not be subject to United States federal corporate income tax on its taxable income that is currently distributed to shareholders. The Company may be subject to certain state gross income and franchise taxes, as well as taxes on any undistributed income and federal and state corporate taxes on any income earned by its TRSs. In addition, the Company could be subject to corporate income taxes related to assets held by the REIT that are sold during the 5-year period following the date of conversion, to the extent such sold assets had a built-in gain as of January 1, 2017. The Company does not intend to dispose of any REIT assets after the REIT conversion within the 5-year period, unless various tax planning strategies, including Internal Revenue Code Section 1031 like-kind exchanges or other deferred tax structures are available, to mitigate the built-in gain tax liability of conversion.
Distributions with respect to the Company’s common stock can be characterized for federal income tax purposes as ordinary income, capital gains, unrecaptured section 1250 gains, return of capital, or a combination thereof. Taxable distributions paid for the years ended December 31, 2017, 2016 and 2015 were classified as ordinary income.
The income tax expense (benefit) on income from continuing operations for each of the three years in the period ended December 31, consisted of the following (in millions):
|
| | | | | | | | | | | |
| 2017 | | 2016 | | 2015 |
Current: | | | | | |
Federal | $ | (2.6 | ) | | $ | 2.9 |
| | $ | 13.4 |
|
State | (0.5 | ) | | 0.9 |
| | 1.6 |
|
Current | $ | (3.1 | ) | | $ | 3.8 |
| | $ | 15.0 |
|
Deferred: | | | | | |
Federal | $ | (200.7 | ) | | $ | (1.4 | ) | | $ | 18.5 |
|
State | (14.4 | ) | | 0.2 |
| | 2.8 |
|
Deferred | $ | (215.1 | ) | | $ | (1.2 | ) | | $ | 21.3 |
|
Income tax expense (benefit) | $ | (218.2 | ) | | $ | 2.6 |
| | $ | 36.3 |
|
Income tax expense (benefit) for 2017, 2016 and 2015 differs from amounts computed by applying the statutory federal rate to income from continuing operations before income taxes for the following reasons (in millions):
|
| | | | | | | | | | | |
| 2017 | | 2016 | | 2015 |
Computed federal income tax expense | $ | 3.3 |
| | $ | 12.3 |
| | $ | 34.0 |
|
State income taxes | 0.1 |
| | 0.6 |
| | 4.4 |
|
Valuation allowance - state tax credit | 6.9 |
| | — |
| | — |
|
REIT rate differential | (2.2 | ) | | — |
| | — |
|
Nondeductible transaction costs | — |
| | 2.4 |
| | — |
|
Tax credits, including solar | (0.3 | ) | | (8.7 | ) | | — |
|
Return to provision | (1.1 | ) | | 0.1 |
| | (0.7 | ) |
Amended return | (0.1 | ) | | (0.2 | ) | | 0.1 |
|
Share-based compensation | (4.0 | ) | | (1.5 | ) | | — |
|
Noncontrolling interest | (0.7 | ) | | (0.7 | ) | | (0.5 | ) |
Rate change effect related to REIT conversion | (223.0 | ) | | — |
| | — |
|
Rate change effect related to Tax Cuts and Jobs Act of 2017 | 3.0 |
| | — |
| | — |
|
Other—net | (0.1 | ) | | (1.7 | ) | | (1.0 | ) |
Income tax expense (benefit) | $ | (218.2 | ) | | $ | 2.6 |
| | $ | 36.3 |
|
The Company's effective tax rate was lower for the year ended 2017 compared to the same period in 2016 primarily due to the deferred tax benefit generated from the de-recognition of deferred tax assets and liabilities associated with the entities included in the REIT.
The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities at December 31 of each year are as follows (in millions):
|
| | | | | | | |
| 2017 | | 2016 |
Deferred tax assets: | | | |
Employee benefits | $ | 9.1 |
| | $ | 35.8 |
|
Capitalized costs | 10.7 |
| | 23.0 |
|
Joint ventures and other investments | 2.8 |
| | 1.3 |
|
Impairment and amortization | 0.7 |
| | 11.4 |
|
Solar investment benefits | 16.6 |
| | 15.0 |
|
Insurance and other reserves | 2.9 |
| | 6.0 |
|
Net operating losses | 7.7 |
| | — |
|
Other | 1.4 |
| | 3.5 |
|
Total deferred tax assets | $ | 51.9 |
| | $ | 96.0 |
|
Valuation allowance | (6.9 | ) | | — |
|
Total net deferred tax assets | $ | 45.0 |
| | $ | 96.0 |
|
| | | |
Deferred tax liabilities: | | | |
Property (including tax-deferred gains on real estate transactions) | $ | 25.7 |
| | $ | 260.3 |
|
Straight-line rental income and advanced rent | — |
| | 8.4 |
|
Other | 2.8 |
| | 9.3 |
|
Total deferred tax liabilities | $ | 28.5 |
| | $ | 278.0 |
|
| | | |
Net deferred tax assets (liabilities) | $ | 16.5 |
| | $ | (182.0 | ) |
Federal tax credit carryforwards as of December 31, 2017 totaled $8.7 million and will expire in 2036. State tax credit carryforwards as of December 31, 2017 totaled $6.9 million and may be carried forward indefinitely under state law. As of December 31, 2017 the Company had federal and state net operating loss carryforwards of $6.2 million and $1.5 million, respectively, both expiring in 2037.
A valuation allowance must be provided if it is more likely than not that some portion of all of the deferred tax assets will not be realized, based upon consideration of all positive and negative evidence. Sources of evidence include, among other things, a history of pretax earnings or losses, expectations of future results, tax planning opportunities and appropriate tax law.
Since the Company converted to a REIT for the year ended December 31, 2017, realization of the benefit from state tax credits is not more likely than not. Therefore, a full valuation allowance of $6.9 million was established against the state tax credits until such time as the Company determines it is able to benefit from the credits due to certain dispositions of C corporation assets that the Company received in the initial REIT conversion.
The Company’s income taxes receivable has been increased by the tax benefits from share-based compensation. The Company receives an income tax benefit for exercised stock options calculated as the difference between the fair market value of the stock issued at the time of exercise and the option exercise price, tax-effected. The Company also receives an income tax benefit for restricted stock units when they vest, measured as the fair market value of the stock issued at the time of vesting, tax effected. The net tax benefits from share-based transactions totaled $5.3 million and $1.9 million for 2017 and 2016, respectively.
In 2016, the Company invested $15.4 million in Waihonu Equity Holdings, LLC ("Waihonu"), an entity that operates two photovoltaic facilities with a combined capacity of 6.5 megawatts in Mililani, Oahu. The Company accounts for its investment in Waihonu under the equity method. The investment return from the Company's investment in Waihonu is principally composed of non-refundable federal and refundable state tax credits. The federal tax credits are accounted for using the flow through method, which reduces the provision for income taxes in the year that the federal tax credits first become available. During 2016, the Company recognized income tax benefits of approximately $8.7 million related to the non-refundable tax credits, $2.9 million related to the refundable state tax credits in Income Tax Receivable, as well as a corresponding reduction to the carrying amount of its investment in Waihonu, recorded in Investments in Affiliates in the accompanying consolidated balance sheets.
For the year ended December 31, 2017, the Company recorded reductions to the carrying value of its Waihonu and KIUC Renewable Solutions Two ("KRS II") investments of $2.4 million and $0.2 million, respectively, in Reduction in Solar Investments, net in the accompanying consolidated statements of operations. For the year ended December 31, 2016, the Company recorded reductions to the carrying value of its Waihonu and KRS II investments of $8.7 million and $1.1 million, respectively, in Reduction in Solar Investments, net in the accompanying consolidated statements of operations.
The Company recognizes accrued interest and penalties on income taxes as a component of income tax expense. As of December 31, 2017, accrued interest and penalties were not material. As of December 31, 2017, the Company has not identified any material unrecognized tax positions.
The Company is subject to taxation by the United States and various state and local jurisdictions. As of December 31, 2017, tax years 2016, 2015, 2014 and 2013 are open to audit by the tax authorities. The federal audit of the 2012 tax return for the Company on a standalone basis and the 2012 tax return for which the Company was included in the consolidated tax group with Matson has concluded. The Department of Taxation also completed its audit of the 2015 Hawai`i state income tax return for the Company. There were no material adjustments to the income statement resulting from the completion of these audits. The IRS is currently auditing tax years 2013 and 2014. In February 2018, the Company was notified that the IRS will be auditing tax years 2016 and 2015 and the Department of Taxation will be auditing tax year 2016. The Company believes that the result of these open audits will not have a material adverse effect on its results of operations, financial condition or liquidity.
On December 22, 2017, The Tax Cuts and Jobs Act of 2017 (the "Act") was signed into law. The Act made significant changes, including lowering the U.S. corporate tax rate from 35% to 21% effective January 1, 2018. As of December 31, 2017 the Company has completed its accounting for the tax effects of the Act and recorded a tax expense of $3.0 million due to a remeasurement of its deferred tax assets and liabilities.