Note 18 — Income Taxes

Successor Income Taxes

On the Emergence Date, the Predecessor Company engaged in several internal restructuring transactions that: (i) assigned all of Predecessor’s assets (directly or indirectly) to EGC, and (ii) separated EXXI Ltd, Energy XXI (US Holdings) Limited (Bermuda), Energy XXI, Inc., and Energy XXI USA from EGC. This had the effect, among other things, of isolating the original parent-level equity ownership and certain intercompany loans (the “Intercompany Loans”) from EGC. Then, pursuant to the Plan, the prepetition notes other than the 4.14% promissory note of $5.5 million, the Prepetition Revolving Credit Facility and 100% of the EGC stock owned by Energy XXI USA, Inc., were cancelled. Additionally, new EGC shares and warrants were issued to former creditors as set out in the Plan. Absent an exception, a debtor recognizes Cancellation of Indebtedness Income (“CODI”) upon discharge of its outstanding indebtedness for an amount of consideration that is less than its adjusted issue price. The Internal Revenue Code of 1986, as amended (the “Tax Code”) provides that a debtor in a bankruptcy case (such as the Chapter 11 Cases) may exclude CODI from taxable income but must reduce certain of its tax attributes by the amount of any CODI realized as a result of the Plan (the “Tax Attribute Reduction Rules”). The amount of CODI realized by a taxpayer is the adjusted issue price of any indebtedness discharged less the sum of (i) the amount of cash paid, (ii) the issue price of any new indebtedness issued and (iii) the fair market value of any other consideration, including equity, issued.

As a result of fresh start accounting, significant historic deferred tax assets and liabilities were reduced, including the liability for accrued outbound 30% withholding tax on the Intercompany Loans from the Predecessor’s Bermuda parent, as these obligations were extinguished in the Plan and are not obligations of the Successor entities. With the NOL carryover being reduced by the Tax Attribute Reduction Rules, the principal deferred tax assets and liabilities of the Successor after fresh-start accounting relate to our oil and gas properties. The remaining tax bases of our oil and natural gas properties are greater than their respective book carrying values as determined in fresh-start accounting and after reflecting 2017 activity such that we have recorded a deferred tax asset for those properties. These adjustments reflect the change in estimate from prior filings resulting from recently filed pre-emergence income tax returns for the Predecessor. We have recorded a deferred tax asset for the asset retirement obligation (which has no tax basis and will be tax deductible or result in additional tax basis in assets when settled) and other items that exceed the deferred tax liability for oil and natural gas properties. As such, we recorded an after-tax valuation allowance of $168 million at December 31, 2016, which results in no net deferred tax asset or liability appearing on our statement of financial position. This increase in net tax basis reflects the change in estimate from prior filings resulting from recently filed pre-emergence income tax returns for the Predecessor. We recorded this valuation allowance at this date after an evaluation of all available evidence (including our recent history of Predecessor losses) that led to a conclusion that based upon the more-likely-than-not standard of the accounting literature, these deferred tax assets were unrecoverable. After filing of our initial Form 10-K for the year ended December 31, 2016, tax returns for the Predecessor reflecting the effect of the Tax Attribute Reduction rules were filed resulting in total additional tax basis of $633 million. This amount is made up of an increase in the amount of $663 million related to the change in total CODI excluded (as detailed in the table below), less $30 million related to other changes in estimates of tax attributes resulting from the filings of these tax returns that is unrelated to the Tax Attribute Reduction Rules. These changes were primarily due to: changes in estimate of the amount of the CODI realized and excluded from taxable income and an additional NOL being generated by the Predecessor (including entities not a part of the Successor tax group) that absorbed the CODI exclusion net of other adjustments unrelated to the change in estimate of the CODI exclusion. This change in estimate of the effects of CODI coupled with a decrease in tax return-to-provision adjustment in those tax returns resulted in us increasing our valuation allowance by $224 million (after-tax) in the year ended December 31, 2017. The changes in our tax attributes resulting from the excluded CODI as a result of the tax attribute reduction rules is set out in the following table.

Tax Code Sections 382 and 383 provide an annual limitation with respect to the ability of a corporation to utilize its tax attributes, including as the tax basis in certain assets (net unrealized built-in-losses), against future U.S. taxable income in the event of a change in ownership. The Company’s emergence from the Chapter 11 Cases was considered a change in ownership for purposes of Tax Code Section 382. The limitation under the Tax Code is based on the value of the loss corporation as of the Convenience Date, which reflects value after giving effect to the Plan’s steps. However, this and prior ownership changes and resulting annual limitation will have limited, if any, effect on the Company’s NOLs since all of the NOLs were extinguished by the Tax Attribute Reduction Rules. No cash income taxes were paid during the year ended December 31, 2017, and, based upon current commodity pricing and planned development activity, no cash income taxes have been paid or are expected to be paid or owed for the tax year ending December 31, 2017.

We have estimated our effective income tax rate for the year to be zero, as we are forecasting a pre-tax loss at this time. We do not believe that our net deferred tax assets are realizable in the future on a more-likely-than-not basis at this time.

A post-Emergence Date pre-tax NOL of approximately $339 million resulting from our post-Emergence Date losses represents our only NOL carryforwards. This post-Emergence Date NOL is not subject to limitation in future usage by the ownership changes rules of Tax Code section 382 or the Tax Attribute Reduction Rules resulting from the Plan, but this NOL cannot be carried back to pre-Emergence Date years to create a cash income tax refund.  If, however, the Company were to experience post-Emergence Date changes in stock ownership of greater than 50% within any three-year look back period, this post-Emergence Date NOL would be subject to Tax Code section 382 limitations based upon stock value and other factors at such time. 

Predecessor Income Taxes

The Predecessor Company was a Bermuda company and was generally not subject to income tax in Bermuda. It historically operated through its various subsidiaries in the United States, and, accordingly, U.S. income taxes were provided based upon those U.S. operations and U.S. withholding tax on interest owed to its Bermuda parent on intercompany indebtedness. Pursuant to the Restructuring Support Agreement discussed in Note 3– “Chapter 11 Proceedings” the Predecessor filed bankruptcy and dissolution petitions in the United States and Bermuda, respectively, on the Petition Date. These filings generally had no immediate effect on the Predecessor’s income tax year or income tax reporting requirements.

The Predecessor’s Bermuda companies recorded income tax expense reflecting 30% U.S. withholding tax on any interest (and interest equivalents) accrued on indebtedness of the U.S. companies held by them through the Petition Date. During the year ended June 30, 2016, and for the six-month period ended December 30, 2016, no cash withholding tax payments were made on interest expense or management fees accrued to the Bermuda entities.

During fiscal year 2015, changes in expectations regarding future taxable income, consistent with net losses recorded during the current fiscal year (that are heavily influenced by oil and gas property impairments), caused management to record a net increase in the valuation allowance of $356.8 million resulting in a balance of $379.3 million at June 30, 2015. Due to continuing losses, management recorded an additional valuation allowance of $650 million resulting in a balance of $1,029.3 million at June 30, 2016. This increase to the valuation allowance against net deferred tax assets due to management’s judgment that the existing U.S. federal NOL carryforwards are not, on a more-likely-than-not basis, likely recoverable in future years.

Our (loss) income before income taxes attributable to U.S. and non-U.S. operations are as follows (in thousands):

 

The components of our income tax benefit are as follows (in thousands):

 

The following is a reconciliation of statutory income tax expense to our income tax benefit (in thousands):

 

For the year ended December 31, 2017, we recorded no income tax expense or benefit. We incurred an additional net operating loss during this period that was reduced by non-deductible restructuring costs, consistent with prior periods. We additionally recognized the return to provision adjustment in CODI from the six-month period ended December 31, 2016 due to the filing of both the year ended June 30, 2016 tax return and the six-month period ended December 30, 2016 tax return. This has no effect on earnings but caused an upward adjustment on our valuation allowance. The most significant difference in the effective tax rate for the Predecessor’s year ended June 30, 2016 that differs from prior year’s activity (apart from changes in the valuation allowance) relates to the non-deductibility of certain bankruptcy restructuring related expenses.

Deferred income taxes primarily represent the net tax effect of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. The components of deferred taxes are detailed in the table below (in thousands):

 

At December 31, 2017, current year activity resulted in an NOL carryover of $339 million, which will expire in 2037 if unused.  At December 30, 2016, immediately prior to the Emergence Date, the Predecessor had US federal NOL carryforwards of approximately $681 million which were completely eliminated by the Tax Attribution Reduction Rules.  We do not have significant state NOL carryforwards from pre-Emergence Date years. 

Recognizing the late enactment of the Tax Cuts and Jobs Act of 2017 and complexity of accurately accounting for its impact, the SEC in SAB 118 provided guidance that allows registrants to provide a reasonable estimate of the impact of the Tax Cuts and Jobs Act of 2017 in their financial statements and adjust the reported impact in a measurement period not to exceed one year.  While we believe we have recorded the predominate effects of the Tax Cuts and Jobs Act of 2017 in provisional accounting the fourth quarter of 2017 (related to the corporate tax rate decrease from 35% to 21%), we continue to assess the impact of the Tax Cuts and Jobs Act of 2017 on our business in order to complete our analysis.  Any adjustment to the provisional amounts recorded during the year ended December 31, 2017 will be reported in the reporting period in which any such adjustments are determined in the period in which the adjustments are made.

Neither the Predecessor nor the Successor has recorded reserves for uncertain tax positions.

The Predecessor filed initial tax returns for the tax year ended June 30, 2006 as well as the returns for the tax years ended June 30, 2007 through 2015. The statute of limitations for examination of NOLs and other similar attribute carryforwards does not begin to run until the year the attribute is utilized. In some instances, state statutes of limitations are longer than those under U.S. federal tax law. On January 12, 2015, the U.S. Internal Revenue Service formally notified management that they had completed their examination of the U.S. federal income tax return for the year ended June 30, 2013, and that no changes were proposed to the tax reported (zero) or any tax attribute carried forward.