Income Taxes
On December 22, 2017, the U.S. government enacted comprehensive tax legislation commonly referred to as the Tax Cuts and Jobs Act (the “Tax Act”). The Tax Act makes broad and complex changes to the U.S. tax code that impacted the Company’s 2017 provision for income taxes, including, but not limited to: (i) requiring a one-time transition tax on certain unrepatriated earnings of foreign subsidiaries that is payable over eight years and (ii) bonus depreciation that will allow for full expensing of qualified property.
The Tax Act also establishes new tax laws that will affect 2018, including, but not limited to: (i) reduction of the U.S. federal corporate tax rate; (ii) elimination of the corporate alternative minimum tax; (iii) the creation of the base erosion anti-abuse tax, a new minimum tax; (iv) a general elimination of U.S. federal income taxes on dividends from foreign subsidiaries; (v) a new provision designed to tax global intangible low-taxed income (“GILTI”), which allows for the possibility of using foreign tax credits (“FTCs”) and a deduction of up to 50 percent to offset the income tax liability (subject to some limitations); (vi) a new limitation on deductible interest expense; (vii) the repeal of the domestic manufacturing deduction; (viii) limitations on the deductibility of certain executive compensation; (ix) limitations on the use of FTCs to reduce the U.S. income tax liability; and (x) limitations on net operating losses generated after December 31, 2017, to 80 percent of taxable income.
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 Tax Act enactment date for companies to complete the accounting under ASC 740. In accordance with SAB 118, a company must reflect the income tax effects of those aspects of the Act for which the accounting under ASC 740 is complete. To the extent that a company’s accounting for certain income tax effects of the Tax Act is incomplete but it is able to determine a reasonable estimate, it must record a provisional estimate in the financial statements. If a company cannot determine a provisional estimate to be included in the financial statements, it should continue to apply ASC 740 on the basis of the provisions of the tax laws that were in effect immediately before the enactment of the Tax Act.
In connection with its initial analysis of the impact of the Tax Act, the Company recorded a provisional net tax expense of $1.9 million in the period ending December 31, 2017, as described in the following table:
|
| | | |
| FISCAL YEAR |
(dollars in thousands) | 2017 |
Transition Tax (provisional) | $ | 100 |
|
Net impact on U.S. deferred tax assets and liabilities (provisional) (1) | 1,600 |
|
Net changes in deferred tax liability associated with anticipated repatriation taxes (provisional) | 200 |
|
| $ | 1,900 |
|
________________
| |
(1) | Includes $4.7 million of expense for a valuation allowance recorded against foreign tax credit carryforwards, $3.9 million of benefit from the impact of the corporate rate reduction on net deferred tax liability balances, and an expense of $0.8 million for the write-off of certain deferred tax assets that will no longer be realized. |
For various reasons that are discussed more fully below, the Company has not completed its accounting for the income tax effects of the Tax Act. The Company has made reasonable estimates of the effects of the Tax Act and recorded the provisional adjustments as shown in the table above.
Reduction of U.S. Federal Corporate Income Tax Rate - The Tax Act reduces the corporate income tax rate to 21 percent, effective January 1, 2018. While the Company is able to make a reasonable estimate of the impact of the reduction in corporate rate on its deferred tax assets and liabilities, it may be affected by other analyses related to the Tax Act, including, but not limited to, its calculation of deemed repatriation of deferred foreign income and the state tax effect of adjustments made to federal temporary differences.
Deemed Repatriation Transition Tax - The Deemed Repatriation Transition Tax (“Transition Tax”) is a tax on previously untaxed accumulated and current earnings and profits (“E&P”) of the Company’s foreign subsidiaries. To determine the amount of the Transition Tax, the Company must determine, in addition to other factors, the amount of post-1986 E&P of the relevant 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 amount. Due to the ability to utilize foreign tax credits in the calculation of the Transition Tax, the obligation primarily related to the estimated state impacts. However, the Company is continuing to gather additional information. Additional guidance from the U.S. Treasury and state taxing authorities on the application of certain provisions of the Tax Act is expected in the future.
Valuation Allowances - The Company must assess whether its valuation allowance analyses or deferred tax assets are affected by various aspects of the Tax Act (e.g., deemed repatriation of deferred foreign income, GILTI inclusions and new categories of FTCs). While the Company did record an additional valuation allowance against foreign tax credit carryforwards, the Company has recorded provisional amounts related to certain portions of the Tax Act and any corresponding determination of the need for a change in a valuation allowance is also provisional.
The Company is continuing to evaluate other provisions of the Tax Act and the application of ASC 740, however, the Company has estimated that these provisions will not have a material impact in the current year.
The following table presents the domestic and foreign components of Income before provision for income taxes:
|
| | | | | | | | | | | |
| FISCAL YEAR |
(dollars in thousands) | 2017 | | 2016 | | 2015 |
Domestic | $ | 119,632 |
| | $ | 70,481 |
| | $ | 146,331 |
|
Foreign | (1,089 | ) | | (13,990 | ) | | 24,523 |
|
| $ | 118,543 |
| | $ | 56,491 |
| | $ | 170,854 |
|
Provision (benefit) for income taxes consisted of the following:
|
| | | | | | | | | | | |
| FISCAL YEAR |
(dollars in thousands) | 2017 | | 2016 | | 2015 |
Current provision: | | | | | |
Federal | $ | 18,384 |
| | $ | 43,071 |
| | $ | 17,952 |
|
State | 8,155 |
| | 28,033 |
| | 5,962 |
|
Foreign | 9,041 |
| | 14,389 |
| | 11,384 |
|
| 35,580 |
| | 85,493 |
| | 35,298 |
|
Deferred (benefit) provision: | | | | | |
Federal | (15,792 | ) | | (53,647 | ) | | 2,514 |
|
State | (3,850 | ) | | (21,316 | ) | | 626 |
|
Foreign | 47 |
| | (386 | ) | | 856 |
|
| (19,595 | ) | | (75,349 | ) | | 3,996 |
|
Provision for income taxes | $ | 15,985 |
| | $ | 10,144 |
| | $ | 39,294 |
|
Effective Income Tax Rate - The reconciliation of income taxes calculated at the United States federal tax statutory rate to the Company’s effective income tax rate is as follows:
|
| | | | | | | | |
| FISCAL YEAR |
| 2017 | | 2016 | | 2015 |
Income taxes at federal statutory rate | 35.0 | % | | 35.0 | % | | 35.0 | % |
State and local income taxes, net of federal benefit | 2.2 |
| | 8.2 |
| | 2.3 |
|
Employment-related credits, net | (25.5 | ) | | (53.5 | ) | | (15.8 | ) |
Domestic manufacturing deduction | (4.3 | ) | | — |
| | — |
|
Excess tax benefits from stock-based compensation arrangements (1) | (2.1 | ) | | — |
| | — |
|
Noncontrolling interests | (1.3 | ) | | (2.8 | ) | | (0.8 | ) |
Net life insurance expense | (0.6 | ) | | (2.7 | ) | | (0.3 | ) |
Refranchising of Outback Steakhouse South Korea | — |
| | 27.4 |
| | — |
|
Valuation allowance on deferred income tax assets | 3.1 |
| | 6.1 |
| | 1.7 |
|
Nondeductible compensation | 3.1 |
| | 2.5 |
| | 0.8 |
|
Cumulative effect of the Tax Act | 1.6 |
| | — |
| | — |
|
Foreign rate differential | 1.6 |
| | 0.8 |
| | 0.6 |
|
Tax settlements and related adjustments | 0.2 |
| | (0.2 | ) | | (0.1 | ) |
Other, net | 0.5 |
| | (2.8 | ) | | (0.4 | ) |
Total | 13.5 | % | | 18.0 | % | | 23.0 | % |
____________________
| |
(1) | During 2017, excess tax benefits from share-based award activity are reflected as a reduction to the provision for income taxes as a result of the adoption of ASU No. 2016-09. |
The net decrease in the effective income tax rate in 2017 as compared to 2016 was primarily due to impairment and additional tax liabilities recorded in connection with the refranchising of Outback Steakhouse South Korea in 2016. The remaining decrease was primarily due to a domestic manufacturing deduction and excess tax benefits from equity-based compensation arrangements recorded in 2017. These decreases were mostly offset by employment-related credits being a lower percentage of net income in 2017 relative to 2016 and the impact of the Tax Act.
The net decrease in the effective income tax rate in 2016 as compared to 2015 was primarily due to benefits from employment-related credits being a higher percentage of net income in 2016 and a change in the amount and mix of income and losses across the Company’s domestic and international subsidiaries, partially offset by the refranchising of Outback Steakhouse South Korea.
Deferred Tax Assets and Liabilities - The income tax effects of temporary differences that give rise to significant portions of deferred income tax assets and liabilities are as follows:
|
| | | | | | | |
(dollars in thousands) | DECEMBER 31,
2017 | | DECEMBER 25,
2016 |
Deferred income tax assets: | | | |
Deferred rent | $ | 40,504 |
| | $ | 57,783 |
|
Insurance reserves | 15,788 |
| | 23,906 |
|
Unearned revenue | 15,020 |
| | 19,566 |
|
Deferred compensation | 38,273 |
| | 62,389 |
|
Net operating loss carryforwards | 8,003 |
| | 6,036 |
|
Federal tax credit carryforwards | 75,661 |
| | 58,963 |
|
Partner deposits and accrued partner obligations | 4,326 |
| | 8,245 |
|
Other, net | 15,342 |
| | 8,309 |
|
Gross deferred income tax assets | 212,917 |
| | 245,197 |
|
Less: valuation allowance | (15,925 | ) | | (7,220 | ) |
Net deferred income tax assets | 196,992 |
| | 237,977 |
|
Deferred income tax liabilities: | | | |
Less: property, fixtures and equipment basis differences | (18,814 | ) | | (37,847 | ) |
Less: intangible asset basis differences | (116,425 | ) | | (155,053 | ) |
Less: deferred gain on extinguishment of debt | (7,180 | ) | | (23,022 | ) |
Net deferred income tax assets | $ | 54,573 |
| | $ | 22,055 |
|
Undistributed Earnings - The Company previously considered the earnings in its non-U.S. subsidiaries to be indefinitely reinvested and, accordingly, recorded no deferred income taxes. Given the Tax Act’s significant changes and potential opportunities to repatriate cash free of U.S. federal tax, the Company is in the process of evaluating its current permanent reinvestment assertions. This evaluation includes the repatriation of historical earnings (2017 and prior) that have been previously taxed under the Tax Act.
The Company had aggregate undistributed E&P from foreign subsidiaries of approximately $136.0 million, which is considered previously taxed income (“PTI”) subsequent to the Tax Act. The Company recorded $0.1 million in provisional Transition Tax in connection with this E&P. Due to the ability to utilize foreign tax credits in the calculation of the Transition Tax, the obligation primarily related to the estimated state impacts. Additionally, the Company has recorded a provisional deferred tax liability of $0.2 million as of December 31, 2017 for certain state income taxes on the future repatriation of PTI. The Company currently considers the remaining financial statement carrying amounts over the tax basis of investments in its foreign subsidiaries to be indefinitely reinvested, and have not recorded a provisional deferred tax liability. The determination of any unrecorded provisional deferred tax liability on this amount is not practicable due to the uncertainty of how these investments would be recovered.
Tax Carryforwards - The amount and expiration dates of tax loss carryforwards and credit carryforwards as of December 31, 2017 are as follows:
|
| | | | | | | |
(dollars in thousands) | EXPIRATION DATE | | AMOUNT |
United States federal tax credit carryforwards | 2026 | - | 2037 | | $ | 90,092 |
|
Foreign loss carryforwards | 2018 | - | Indefinite | | $ | 29,581 |
|
Unrecognized Tax Benefits - As of December 31, 2017 and December 25, 2016, the liability for unrecognized tax benefits was $23.7 million and $19.6 million, respectively. Of the total amount of unrecognized tax benefits, including accrued interest and penalties, $24.0 million and $18.9 million, respectively, if recognized, would impact the Company’s effective tax rate.
The following table summarizes the activity related to the Company’s unrecognized tax benefits:
|
| | | | | | | | | | | |
| FISCAL YEAR |
(dollars in thousands) | 2017 | | 2016 | | 2015 |
Balance as of beginning of year | $ | 19,583 |
| | $ | 19,430 |
| | $ | 17,563 |
|
Additions for tax positions taken during a prior period | 4,149 |
| | 476 |
| | 3,022 |
|
Reductions for tax positions taken during a prior period | (1,009 | ) | | (430 | ) | | (848 | ) |
Additions for tax positions taken during the current period | 1,822 |
| | 2,472 |
| | 2,305 |
|
Settlements with taxing authorities | — |
| | (391 | ) | | (1,078 | ) |
Lapses in the applicable statutes of limitations | (945 | ) | | (2,230 | ) | | (540 | ) |
Translation adjustments | 63 |
| | 256 |
| | (994 | ) |
Balance as of end of year | $ | 23,663 |
| | $ | 19,583 |
| | $ | 19,430 |
|
The Company had approximately $1.8 million and $1.2 million accrued for the payment of interest and penalties as of December 31, 2017 and December 25, 2016, respectively. The Company recognized immaterial interest and penalties related to uncertain tax positions in the Provision for income taxes, for all periods presented.
In many cases, the Company’s uncertain tax positions are related to tax years that remain subject to examination by relevant taxable authorities. Based on the outcome of these examinations, or a result of the expiration of the statute of limitations for specific jurisdictions, it is reasonably possible that the related recorded unrecognized tax benefits for tax positions taken on previously filed tax returns will change by approximately $3.0 million to $4.0 million within the next twelve months.
Open Tax Years - Following is a summary of the open audit years by jurisdiction:
|
| | | |
| OPEN AUDIT YEARS |
United States federal | 2007 | - | 2016 |
United States states | 2001 | - | 2016 |
Foreign | 2009 | - | 2016 |
The Company was previously under examination by tax authorities in South Korea for the 2008 to 2012 tax years. In connection with the examination, the Company was assessed and paid $6.7 million of tax obligations. The Company is currently seeking relief from double taxation through competent authority.