ESTERLINE TECHNOLOGIES CORP

NOTE 11: Income Taxes

Income tax expense (benefit) from continuing operations for fiscal 2017, 2016 and 2015 consisted of:

In Thousands	2017			2016			2015
	(Restated)			(Restated)			(Restated)

Current
U.S. Federal	$	2,914		$	13,848		$	9,743
State		146			(852	)		493
Foreign		38,179			30,409			21,903
		41,239			43,405			32,139

Deferred
U.S. Federal		2,744			(6,893	)		(7,686	)
State		(157	)		2,060			864
Foreign		(10,801	)		(16,715	)		(8,831	)
		(8,214	)		(21,548	)		(15,653	)
Income tax expense	$	33,025		$	21,857		$	16,486

U.S. and foreign components of earnings from continuing operations before income taxes for fiscal 2017, 2016 and 2015 were:

In Thousands	2017		2016		2015
	(Restated)		(Restated)		(Restated)

U.S.	$	39,119	$	66,036	$	39,624
Foreign		114,275		69,989		72,486
Earnings from continuing operations before income taxes	$	153,394	$	136,025	$	112,110

Primary components of the Company’s deferred tax assets and liabilities at the end of the fiscal 2017 and 2016 resulted from temporary tax differences associated with the following:

In Thousands	2017			2016
	(Restated)			(Restated)

Reserves and liabilities	$	52,632		$	54,370
Loss carryforwards		53,175			51,760
Tax credit carryforwards		39,078			34,836
Employee benefits		12,720			13,853
Retirement benefits		14,907			22,703
Non-qualified stock options		10,937			13,760
Hedging activities		-			3,350
Other		3,940			1,003
Total deferred tax assets		187,389			195,635
Less valuation allowance		(45,601	)		(43,503	)
Total deferred tax assets, net of valuation allowance		141,788			152,132

Depreciation and amortization		(6,503	)		(7,456	)
Intangibles and amortization		(111,196	)		(116,620	)
Deferred costs		(5,668	)		(3,907	)
Hedging activities		(2,450	)		-
Other		(3,156	)		(2,684	)
Total deferred tax liabilities		(128,973	)		(130,667	)
Net deferred tax assets (liabilities)	$	12,815		$	21,465

The Company operates in numerous taxing jurisdictions and is subject to regular examinations by various U.S. federal, state and foreign jurisdictions. Additionally, the Company assumed tax liabilities and the rights to tax refunds in connection with various acquisitions and divestitures of businesses in prior years. The Company’s income tax positions are based on research and interpretations of income tax laws and rulings in each of the jurisdictions in which the Company does business. Due to the subjectivity and complexity of the interpretations of the tax laws and rulings in each jurisdiction, the differences and interplay in the tax laws between those jurisdictions, as well as the inherent uncertainty in estimating the final resolution of complex tax audit matters, the Company’s estimates of income tax liabilities and assets may differ from actual payments, assessments or refunds.

Management believes that it is more likely than not that the Company will realize the benefit of most of its deferred tax assets. Significant factors management considered in determining the probability of the realization of the deferred tax assets include expected future earnings and the reversal of deferred tax liabilities. Accordingly, no valuation allowance has been recorded on the deferred tax assets other than certain tax credits, capital losses and net operating losses. The U.S. federal capital loss carryforward will begin to expire in fiscal 2020 if not utilized. The foreign net operating loss can be carried forward indefinitely. The majority of the tax credit carryforwards can be carried forward indefinitely.

U.S. and various state and foreign income tax returns are open to examination, and presently there are foreign and state income tax returns under examination. Such examinations could result in challenges to tax positions taken, and accordingly, the Company may record adjustments to provisions based on the outcomes of such matters. However, the Company believes that the resolution of these matters, after considering amounts accrued, will not have a material adverse effect on its consolidated financial statements.

The incremental tax benefit received by the Company upon exercise of non-qualified employee stock options was $2.1 million, $0.6 million, and $2.0 million in fiscal 2017, 2016, and 2015, respectively.

A reconciliation of the U.S. federal statutory income tax rate to the effective income tax rate for fiscal 2017, 2016 and 2015 was as follows:

	2017			2016			2015
	(Restated)			(Restated)			(Restated)

U.S. statutory income tax rate		35.0	%		35.0	%		35.0	%
Foreign taxes		-1.5	%		-10.3	%		-11.2	%
Difference in foreign tax rates		-4.2	%		-4.4	%		-5.3	%
Change in foreign tax rates and laws		-2.9	%		0.0	%		0.0	%
Research and development credits		-3.5	%		-5.2	%		-5.3	%
Non-deductible under consent agreement		0.0	%		0.0	%		2.3	%
Domestic manufacturing deduction		-0.3	%		-1.0	%		-0.6	%
Net change in tax reserves		-0.3	%		-0.2	%		-0.2	%
State income taxes		0.5	%		0.2	%		0.1	%
Other, net		-1.3	%		2.0	%		-0.1	%
Effective income tax rate		21.5	%		16.1	%		14.7	%

The increase in the year-over-year effective tax rate for fiscal 2017 is primarily attributable to the foreign tax law change that limits the interest expense deduction. The increase is partially offset by the French tax law change that reduced its corporate income tax rate.

No provision for federal income taxes has been made on accumulated earnings of foreign subsidiaries, since such earnings are considered indefinitely reinvested. The amount of undistributed foreign earnings which are considered to be indefinitely reinvested at September 29, 2017, is approximately $668.4 million. Furthermore, the Company determined it was not practical to estimate the deferred taxes on these earnings. The amount of deferred income taxes is not practical to compute due to the complexity of the Company’s international holding company structure, layers of regulatory requirements that have to be evaluated to determine the amount of allowable dividends, numerous potential repatriation scenarios that could be created to facilitate the repatriation of earnings to the U.S., and the complexity of computing foreign tax credits.

A reconciliation of the amount of unrecognized tax benefits for fiscal 2017, 2016 and 2015 is as follows:

In Thousands	2017			2016			2015
	(Restated)			(Restated)			(Restated)

Unrecognized tax benefits as of the beginning of year	$	7,877		$	11,389		$	14,826
Unrecognized gross benefit change:
Gross increase due to prior period adjustments		1,608			445			672
Gross decrease due to prior period adjustments		-			(475	)		(2,793	)
Gross increase due to current period adjustments		853			1,475			743
Gross decrease due to settlements with taxing authorities		-			(2,068	)		-
Gross decrease due to a lapse of the statute of limitations		(1,490	)		(2,889	)		(2,059	)
Total change in unrecognized gross benefit		971			(3,512	)		(3,437	)
Unrecognized tax benefits as of the end of the year	$	8,848		$	7,877		$	11,389

Unrecognized tax benefits that, if recognized, would impact the effective tax rate	$	4,888		$	6,626		$	10,583

Statement of operations:
Total amount of interest income (expense) included in income tax expense	$	33		$	(308	)	$	(37	)

Recognized in the statement of financial position:
Total amount of accrued interest included in income taxes payable	$	616		$	583		$	891

During the next 12 months it is reasonably possible that approximately $1.4 million of previously unrecognized tax benefits related to operating losses and tax credits could decrease as a result of settlement of examinations and/or the expiration of statutes of limitations. The Company recognizes interest related to unrecognized tax benefits in income tax expense.

The Company is no longer subject to income tax examinations by tax authorities in its major tax jurisdictions as follows:

		Years No Longer
Tax Jurisdiction		Subject to Audit

U.S. Federal		2013 and prior
Belgium		2015 and prior
Canada		2008 and prior
France		2012 and prior
United Kingdom		2014 and prior