NOTE 14—INCOME TAXES

Select Inc. is subject to U.S. federal, foreign and state income taxes as a corporation. SES Holdings and its subsidiaries, with the exception of certain corporate subsidiaries, are treated as flow‑through entities for U.S. federal income tax purposes and as such, are generally not subject to U.S. federal income tax at the entity level. Rather, the tax liability with respect to their taxable income is passed through to their members or partners. Accordingly, prior to the reorganization in connection with the Select 144A Offering, the Predecessor only recorded a provision for Texas franchise tax and U.S. federal and state provisions for certain corporate subsidiaries as the Predecessor’s taxable income or loss was includable in the income tax returns of the individual partners and members. However, for periods following the reorganization in connection with the Select 144A Offering, Select Inc. recognizes a tax liability on its allocable share of SES Holdings’ taxable income.

The Company’s effective tax rates for the twelve months ended December 31, 2017, 2016 and 2015 were 2.4%,  0.2% and (0.4)% respectively. The effective tax rates for the twelve months ended December 31, 2017 differ from the statutory rate of 35% due to net income allocated to noncontrolling interests, state income taxes, other permanent differences between book and tax accounting and valuation allowances.

The Company recorded income tax expense (benefit) of $(0.9) million, $(0.5) and $0.3 million for the twelve months ended December 31, 2017, 2016 and 2015, respectively.

The components of the federal and state income tax expense (benefit) are summarized as follows:

 

A reconciliation of the Company’s provision for income taxes as reported and the amount computed by multiplying income before taxes, less noncontrolling interest, by the U.S. federal statutory rate of 35%:

 

For the year ended December 31, 2015, the calculation is not applicable as the Company was not subject to federal income taxes prior to the Select 144A Offering, with the exception of certain corporate subsidiaries.

Deferred taxes result from the temporary differences between financial reporting carrying amounts and the tax basis of existing assets and liabilities. As of December 31, 2017 and 2016, the Company had net deferred tax liabilities of $0.6 million and $0.6 million, respectively, which are recorded in other long‑term liabilities on the consolidated balance sheets. The principal components of the deferred tax assets (liabilities) are summarized as follows:

 

For the year ended December 31, 2017, the Company has recorded an increase in valuation allowance of $68.0 million against certain deferred tax assets, primarily driven by the Rockwater Merger and thus the creation of additional federal, state, and foreign net operating loss carryforwards as well as adjustments to the outside basis of the investment in SES Holdings. The Company has assessed the future potential to realize these deferred tax assets and has concluded it is more likely than not that these deferred tax assets will not be realized based on current economic conditions and expectations of the future. As a result, the Company has not recorded a liability for the effect of any associated Tax Receivable Agreement liabilities as the liability is based on the actual cash tax savings, which are not considered probable as of December 31, 2017. See Note 13—Related Party Transactions for further discussion of the Tax Receivable Agreements.

The Tax Cuts and Jobs Act, which was enacted on December 22, 2017, reduced the corporate income tax rate effective January 1, 2018 from 35% to 21%. At December 31, 2017, the Company has not completed its accounting for the tax effects of enactment of the Tax Cuts and Jobs Act; however, it has made reasonable estimates of the effects on its existing deferred tax balances. The Company has remeasured certain deferred federal tax assets and liabilities based on the rates at which they are expected to reverse in the future, which is generally 21%. The Company also estimated the impact related to the one time transition tax with respect to certain subsidiaries acquired in the Rockwater Merger. The provisional amount recognized related to the remeasurement of the deferred federal tax balance under the provisions of SAB 118, was reduced due to an offsetting adjustment to the valuation allowance at December 31, 2017. The Company is still analyzing certain aspects of the Tax Cuts and Jobs Act, and refining its calculations, which could potentially affect the measurement of those balances or potentially give rise to new deferred tax amounts. The Company’s estimates may also be affected in the future as the Company gains a more thorough understanding of the Tax Cuts and Jobs Act, and how the individual states are implementing this new law.

The Company has a U.S. federal net operating loss carryforward of $137.8 million which begin to expire in 2030; state net operating loss carryforwards of $101.7 million primarily in North Dakota, Pennsylvania, Oklahoma and Colorado which expire in various years, starting in 2020; and foreign loss carryforwards of $14.5 million, which begin to expire in 2035. The tax benefits of deferred tax assets are recorded as an asset to the extent that management assesses the utilization of such assets to be more likely than not. When the future utilization of some portion of deferred tax assets is determined not to be more likely than not, a valuation allowance is provided to reduce the recorded tax benefits from such assets. As of December 31, 2017, management’s assessment as to the realizability of certain deferred tax assets has resulted in the recording of a valuation allowance to reduce deferred tax assets to the amounts that are considered more likely than not to be realized. Management believes there will be sufficient future taxable income based on the reversal of temporary differences to enable utilization or sustainability of those deferred tax assets that do not have a valuation allowance recorded against them.

Accounting for uncertainty in income taxes prescribes a recognition threshold and measurement methodology for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. As of December 31, 2017 and 2016 there was no material liability or expense for the periods then ended recorded for payments of interest and penalties associated with uncertain tax positions or material unrecognized tax positions and the Company’s unrecognized tax benefits were not material.

Separate federal and state income tax returns are filed for Select Inc., SES Holdings and certain consolidated affiliates. The tax years 2014 through 2016 remain open to examination by the major taxing jurisdictions to which the Company is subject to income tax. Select Inc. and SES Holdings are not currently under any income tax audits. Rockwater Energy Solutions, Inc. is currently under federal audit for the tax years 2012-2015.