Income Taxes
CyrusOne Inc. elected to be taxed as a REIT under the Code, commencing with our taxable year ended December 31, 2013. To remain qualified as a REIT, we are required to distribute at least 90% of our taxable income to our stockholders and meet various other requirements imposed by the Code relating to such matters as operating results, asset holdings, distribution levels and diversity of stock ownership. Provided we continue to qualify for taxation as a REIT, we are generally not subject to corporate level federal income tax on the earnings distributed currently to our stockholders. It is our policy and intent, subject to change, to distribute 100% of our taxable income and therefore no provision is required in the accompanying financial statements for federal income taxes with regards to activities of CyrusOne Inc. and its subsidiary pass-through entities.
We have elected to designate two subsidiaries as taxable REIT subsidiaries (each a TRS). The activities of a TRS may include performing services for our tenants that would otherwise be considered impermissible for REITs. The income of a TRS is subject to federal and state taxes. While CyrusOne Inc. and the operating partnership do not pay federal income taxes, we are still subject to foreign, state, and local income taxes in the locations in which we conduct business. Income tax expense for the years ended December 31, 2017, 2016 and 2015 was $3.0 million, $1.8 million and $1.8 million, respectively.
For certain entities we calculate deferred tax assets and liabilities for temporary differences in the basis between financial statement and income tax assets and liabilities. Deferred income taxes are recalculated annually at rates then in effect. Valuation allowances are recorded to reduce deferred tax assets to amounts that are more likely than not to be realized. The ultimate realization of the deferred tax assets depends upon our ability to generate future taxable income during the periods in which basis differences and other deductions become deductible and prior to the expiration of the net operating loss carryforwards. Deferred tax assets (net of valuation allowance) and liabilities were accrued, as necessary, for the years ended December 31, 2017 and 2016. Historically, we have recorded a full valuation allowance on our foreign net deferred tax assets related to our foreign generated net operating losses due to the uncertainty of their realization. In 2013 and 2014, management determined it was necessary to record a full valuation allowance on all of our domestic and foreign net deferred tax assets due to the uncertainty of their realization. Accordingly, at December 31, 2017 and at December 31, 2016, the net domestic and foreign deferred tax assets were zero.
The Company adopted ASU No. 2015-17, Income Taxes (Topic 740), in the fourth quarter of 2016 and applied it prospectively to all deferred tax assets and liabilities. The adoption had no effect on our consolidated financial statements.
In 2017 and 2016, we paid all our dividends in cash. The following table summarizes the taxability of our common stock dividends per share for the years ended December 31, 2017 and 2016:
|
| | | | | | |
For the year ended December 31, | 2017 | 2016 |
Common Stock dividend per share: | | |
Ordinary income | $ | — |
| $ | 0.20 |
|
Return of capital | 1.64 |
| 1.26 |
|
Total dividend | $ | 1.64 |
| $ | 1.46 |
|
Common stock dividends may be characterized for federal income tax purposes as "ordinary income", "qualified dividend income", "capital gains dividends", non-taxable return of capital, "qualified REIT dividends" (but only for taxable years beginning after December 31, 2017 and before January 1, 2026) or a combination of the foregoing. Common stock dividends that exceed our current and accumulated earnings and profits (calculated for tax purposes) constitute a return of capital rather than a dividend and generally reduce the stockholder's basis in the common stock. To the extent that a dividend exceeds both current and accumulated earnings and profits and the stockholder's basis in the common stock, it will generally be treated as gain from the sale or exchange of that stockholder's common stock. At the beginning of each year, we notify our stockholders of the taxability of the common stock dividends paid during the preceding year.
Tax Cuts and Jobs Act of 2017 (the TCJA)
The TCJA was signed into law on December 22, 2017. The TCJA significantly changed the U.S. federal income tax laws applicable to businesses and their owners, including REITs and their stockholders. Technical corrections or other amendments to the TCJA or administrative guidance interpreting the TCJA may be forthcoming at any time. We cannot predict with certainty the long-term effect of the TCJA or any future law changes on REITs or their stockholders. Below illustrates some of the key changes in the TCJA that may directly impact REITs and their stockholders with respect to an investment in REITs. The changes described below are effective for taxable years beginning after December 31, 2017, unless otherwise noted. Investors should consult with their tax advisors regarding the effect of the TCJA for their particular circumstances.
Income Tax Rates. Under the TCJA, the corporate income tax rate is reduced from a maximum marginal rate of 35% to a flat rate of 21%. Our REIT is not subject to federal income taxes and we do not anticipate that our taxable REIT subsidiaries will materially benefit from this federal tax rate reduction, nor should there be a material impact on our deferred taxes as a result of the rate reduction. The rate of U.S. federal withholding tax on distributions made to non-U.S. shareholders by a REIT that are attributable to gains from the sale or exchange of U.S. real property interests will also be reduced from 35% to 21%.
The TCJA also reduces the highest marginal income tax rate applicable to individuals from 39.6% to 37% (excluding the 3.8% Medicare tax on net investment income) for tax years beginning after December 31, 2017 and before January 1, 2026. Individuals will continue to pay a maximum 20% rate on long term capital gains and qualified dividend income. Generally, dividends payable by REITs do not constitute qualified dividend income. However, the TCJA also allows non-corporate U.S. shareholders to deduct 20% of “qualified REIT dividends” for tax years beginning after December 31, 2017 and before January 1, 2026. A “qualified REIT dividend” is any dividend from a REIT received during the taxable year that is not designated by the REIT as a capital gain dividend or as qualified dividend income.
Limitation on Deductibility of Business Interest. Under the TCJA, in general, the deductibility of interest for a business, other than certain small businesses, is limited to 30% of the business’ adjusted taxable income (which, for purposes of the limitation on the deductibility of business interest, is defined as taxable income computed without regard to certain items of income or deduction, including the deductions for business interest and net operating losses). However, there is an exception to this limitation requirement for a “real property trade or business”, assuming a valid Internal Revenue Service election has been made. A “real property trade or business” is any property development, redevelopment, construction, reconstruction, acquisition, conversion, rental, operation, management, leasing, or brokerage trade or business. REITs are considered a real property trade or business and as such, may make an election to be exempt from the interest limitation requirements. If such election is made by a REIT, the REIT would be required to use a less favorable tax depreciation method to depreciate its real property used in a trade or business. We are currently evaluating the feasibility of making this election in 2018 and if made, we do not believe the required change to a less favorable depreciation method will have a material impact on our financials.