Note 11. Income Taxes

For periods prior to the Separation, income tax expense and deferred tax balances were calculated on a separate tax return basis although the Company’s operations in certain circumstances, particularly the U.S. and Canada, have historically been included in the tax returns filed by the respective RRD entities of which the Company’s business was a part. Beginning October 1, 2016, as a stand-alone entity, the Company files tax returns on its own behalf and its deferred taxes and effective tax rate may differ from those in the historical periods.

The Company maintains an income taxes payable or receivable account in each jurisdiction and with the exception of certain entities outside the U.S. that transferred to the Company at Separation, the Company is deemed to settle current tax balances for the period prior to the Separation with the RRD tax-paying entities in the respective jurisdictions.  These settlements are reflected as changes in net parent company investment in the consolidated and combined balance sheets.  

Income taxes have been based on the following components of earnings from operations before income taxes for the years ended December 31, 2017, 2016 and 2015:

The components of income tax expense (benefit) from operations for the years ended December 31, 2017, 2016 and 2015 were as follows:  

The following table outlines the reconciliation of differences between the U.S. Federal statutory tax rate and the Company’s worldwide effective income tax rate:

The 2017 effective income tax rate is higher as compared to the 2016 effective income tax rate mainly due to impacts of the recent changes to U.S. tax legislation as a result of the enactment of the Tax Cuts and Jobs Act (H.R. 1) (“the Tax Act”) on December 22, 2017. The 2017 effective income tax rate was also impacted by non-deductible expenses incurred by the Company in 2017 which were previously incurred by RRD on behalf of the Company during pre-Separation periods, as well as a one-time favorable change in valuation allowances in 2016 not present in 2017.

On December 22, 2017, 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 of one year from the Tax Act enactment date for companies to complete their accounting. In accordance with SAB 118, a company must reflect the income tax effects of those aspects of the Act for which the accounting 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 its accounting on the basis of the provisions of the tax laws that were in effect immediately before the enactment of the Tax Act.

As a result of the reduction in the U.S. corporate income tax rate from 35% to 21% effective January 1, 2018, the Company has revalued its U.S. deferred tax assets and liabilities as of December 31, 2017. The Company has recorded a reduction in the value of its net U.S. deferred tax asset of approximately $8.2 million, which has been recorded as additional deferred income tax expense in the Company’s consolidated statement of operations for the year ended December 31, 2017 and represents an income tax rate increase of 14.8%. Due to the transition to a territorial tax system under the Tax Act, the Company will be deemed to repatriate its foreign subsidiaries’ untaxed accumulated earnings and pay a mandatory U.S. federal tax (“the transition tax”) of 15.5% on the portion of the earnings that are in cash and cash equivalents and 8% on the portion of earnings that are in non-cash and non-cash equivalent assets. The Company has estimated this tax liability (federal and state) to be approximately $14.2 million which has been recorded as income tax expense in the consolidated statement of operations for the year ended December 31, 2017 and represents an income tax rate increase of 25.3%. In accordance with SAB 118, the impact of the revaluation of deferred tax assets ($8.2 million) and the transition tax ($14.2 million) are recorded in the Company’s financial statements for the year ended December 31, 2017 as provisional amounts as the Company was able to reasonably estimate the impact of these items. As the Company continues to analyze the full effects of the Tax Act on its financial statements, the impact of the Tax Act may differ from these provisional estimates due to, among other things, changes in interpretations and assumptions the Company has made, Department of the U.S. Treasury Internal Revenue Service (“IRS”) guidance and regulations that may be issued and actions the Company may take as a result. Pursuant to SAB 118, the Company will complete the accounting for these items within the twelve month measurement period.

As available under the Tax Act, the Company will make an election to pay the transition tax liability in installments over eight years. Consequently, $13.1 million of this liability has been recorded as noncurrent taxes payable and $1.1 million as current taxes payable in the Company’s consolidated balance sheet as of December 31, 2017.

Along with the change to a territorial tax system, the Tax Act creates the global intangible low-taxed income ("GILTI") provision. The GILTI provision imposes a tax on foreign income in excess of a deemed return on tangible assets of foreign subsidiary corporations. The Company may be subject to the GILTI tax in a given year, but currently does not expect that it should have a material impact to the Company’s tax provision. The determination of whether the Company is subject to the GILTI provision will be an annual analysis of several factors under the provision, including the amount of foreign income generated by the Company’s foreign subsidiaries and whether the Company has income subject to the GILTI tax, which may change from year to year. In January 2018, the Financial Accounting Standards Board (“FASB”) released guidance on the accounting for GILTI tax, which allows an accounting policy election for companies to either account for deferred taxes related to GILTI inclusions or to treat any taxes on GILTI inclusions as period costs. The Company has not yet adopted its accounting policy with respect to GILTI tax; however, will do so within the twelve month measurement period pursuant to SAB 118.

Deferred income taxes

The significant deferred tax assets and liabilities at December 31, 2017 and 2016 were as follows:

The amounts above are included in the Consolidated Balance Sheets as either a net asset or liability on a jurisdiction by jurisdiction basis.

Transactions affecting the valuation allowances on deferred tax assets during the years ended December 31, 2017, 2016 and 2015 were as follows:

As of December 31, 2017, the Company had domestic and foreign net operating loss deferred tax assets of approximately $10.1 million ($14.4 million at December 31, 2016), of which $3.5 million expires between 2018 and 2027. Limitations on the utilization of these deferred tax assets may apply. The Company has provided valuation allowances to reduce the carrying value of certain deferred tax assets, as management has concluded that, based on the weight of available evidence, it is more likely than not that the deferred tax assets will not be fully realized.

Earnings generated by a foreign subsidiary are presumed to ultimately be transferred to the parent company. Therefore, the establishment of deferred taxes may be required with respect to the excess of the investment value for financial reporting over the tax basis of investments in those foreign subsidiaries (also referred to as book-over-tax outside basis differences). A company may overcome this presumption and forgo recording a deferred tax liability in its financial statements if it can assert that management has the intent and ability to indefinitely reinvest the earnings of its foreign subsidiaries. Prior to the year ended December 31, 2017, the Company has not provided deferred U.S., foreign or local income taxes on the book-over-tax outside basis differences of its foreign subsidiaries because such excess has been considered to be indefinitely reinvested in the local country businesses. As a result of the transition tax that the Company will incur pursuant to the Tax Act, the Company now has the ability to repatriate to the U.S. parent the foreign cash associated with the foreign earnings subject to the transition tax, as these earnings have already been subject to U.S. federal taxes. The Company is currently analyzing its global working capital and cash requirements in order to determine the amount of excess cash at its foreign subsidiaries that can be repatriated to the U.S. with minimal additional taxes, but has not yet determined whether the Company plans to change its assertion of indefinite reinvestment on all foreign earnings and other outside basis differences.  As the Company has not completed its analysis in accordance with SAB 118, the Company has not recorded any deferred taxes attributable to the book-over-tax outside basis differences in its foreign subsidiaries.  The Company will record the tax effects of any change in the Company’s assertion in the period that it completes its analysis; however, the Company does not anticipate incurring material foreign and/or local country taxes upon repatriation of foreign subsidiary earnings.

Cash payments for income taxes for U.S. states and foreign jurisdictions were $30.5 million, $5.2 million and $1.9 million in 2017, 2016 and 2015, respectively. In certain jurisdictions, such as the United States and Canada, the Company is deemed to settle tax balances as of October 1, 2016 with RRD within net parent investment. Total amounts settled with RRD were $2.6 million, $37.2 million and $55.1 million for 2017, 2016 and 2015, respectively.  Cash refunds for income taxes were $1.0 million, $0.7 million and $0.1 million in 2017, 2016 and 2015, respectively.  

Uncertain tax positions

Changes in the Company’s unrecognized tax benefits at December 31, 2017, 2016 and 2015 were as follows:

As of December 31, 2017, 2016 and 2015, the Company had $0.3 million, $1.9 million and $1.0 million, respectively, of unrecognized tax benefits. Unrecognized tax benefits of $0.1 million as of December 31, 2017, if recognized, would have decreased income taxes and the corresponding effective income tax rate and increased net earnings. This potential impact on net earnings reflects the reduction of these unrecognized tax benefits, net of certain deferred tax assets and the federal tax benefit of state income tax items.

As of December 31, 2017, no portion of the total amount of unrecognized tax benefits is expected to decrease within twelve months due to the resolution of audits or expirations of statutes of limitations related to U.S. federal, state or international tax positions.

The Company classifies interest expense and any penalties related to income tax uncertainties as a component of income tax expense. The total interest expense/(benefit), net of tax benefits, related to tax uncertainties recognized in the Consolidated and Combined Statements of Operations was ($0.2) million, $0.3 million and $0.2  million for the years ended December 31, 2017, 2016 and 2015, respectively. There were no benefits from the reversal of accrued penalties for the years ended December 31, 2017, 2016 and 2015. There were no accrued interest liabilities related to income tax uncertainties at December 31, 2017. Accrued interest liabilities of $0.3 million related to income tax uncertainties were reported as a component of other noncurrent liabilities in the Consolidated Balance Sheets at December 31, 2016. There were no accrued penalties related to income tax uncertainties for the years ended December 31, 2017 and 2016.

The Company has tax years from 2009 that remain open and subject to examination by certain U.S. state taxing authorities and/or certain foreign tax jurisdictions. During 2017, the Company filed its initial U.S. federal income tax return as a separate company for the stub period October 1, 2016 through December 31, 2016. Other than this stub period, there are no prior years subject to IRS examination.