INCOME TAXES
The income tax accounts reflected in the Balance Sheets as of December 31, 2014 include income taxes payable and deferred taxes allocated to us at the time of the Spin-Off and our post-Spin-Off activities. Prior to the Spin-Off, our domestic operations were included in the Time Warner domestic consolidated tax returns, and payments to all domestic tax authorities were made by Time Warner on our behalf. We generally filed our own foreign tax returns and made our own foreign tax payments. Time Warner did not maintain a tax sharing agreement with us and generally did not charge us for any tax payments it made. In addition, it did not reimburse us for the utilization of our tax attributes. For periods prior to the Spin-Off, income taxes were computed and reported in the Financial Statements under the separate return method. The separate return method applies the accounting guidance for income taxes to the Financial Statements as if we were a separate taxpayer and an independent enterprise. The calculation of our income taxes involves considerable judgment and requires the use of both estimates and allocations.
Domestic and foreign income (loss) before income taxes were as follows (in millions):
|
| | | | | | | | | | | |
| Year Ended December 31, |
| 2016 |
| | 2015 |
| | 2014 |
|
Domestic | $ | (104 | ) | | $ | (855 | ) | | $ | 122 |
|
Foreign | 23 |
| | (47 | ) | | 1 |
|
Total | $ | (81 | ) | | $ | (902 | ) | | $ | 123 |
|
The significant components of our Income tax provision (benefit) were as follows (in millions):
|
| | | | | | | | | | | |
| Year Ended December 31, |
| 2016 |
| | 2015 |
| | 2014 |
|
Federal | | | | | |
Current | $ | — |
| | $ | (38 | ) | | $ | 44 |
|
Deferred | (30 | ) | | 17 |
| | (21 | ) |
Foreign | | | | | |
Current(a) | 2 |
| | 2 |
| | 2 |
|
Deferred | (1 | ) | | (2 | ) | | (1 | ) |
State and Local | | | | | |
Current | 3 |
| | (3 | ) | | 13 |
|
Deferred | (7 | ) | | 3 |
| | (1 | ) |
Total(b) | $ | (33 | ) | | $ | (21 | ) | | $ | 36 |
|
| |
(a) | Foreign withholding taxes were insignificant for the years ended December 31, 2016 and 2015 and $1 million for the year ended December 31, 2014. |
| |
(b) | Excludes excess tax benefits from equity awards allocated directly to contributed capital which were insignificant in 2016, 2015 and 2014. |
The differences between our actual effective tax rate and the statutory U.S. Federal income tax rate of 35% were as set forth below (in millions):
|
| | | | | | | | | | | |
| Year Ended December 31, |
| 2016 |
| | 2015 |
| | 2014 |
|
Taxes on income at U.S. federal statutory rate | $ | (28 | ) | | $ | (316 | ) | | $ | 43 |
|
State and local taxes, net of federal tax effects | (3 | ) | | (1 | ) | | 9 |
|
Sale of subsidiaries | — |
| | (14 | ) | | (20 | ) |
Goodwill impairment | — |
| | 306 |
| | — |
|
Domestic production activities deduction | — |
| | — |
| | (2 | ) |
Effect of foreign operations | (7 | ) | | 5 |
| | 8 |
|
Tax reserves and interest | 2 |
| | (2 | ) | | (7 | ) |
Non-deductible meals and entertainment | 2 |
| | 2 |
| | 2 |
|
Equity-based compensation | 3 |
| | — |
| | — |
|
Other | (2 | ) | | (1 | ) | | 3 |
|
Total | $ | (33 | ) | | $ | (21 | ) | | $ | 36 |
|
In the fourth quarter of 2015, the United Kingdom enacted changes to its corporation tax rate, reducing it to 19% from April 1, 2017 and 18% from April 1, 2018. While this does not have an impact on our current tax rate, the application of these new rates to existing deferred tax balances resulted in a tax benefit of $2 million recorded in the fourth quarter of 2015. In the third quarter of 2016, the United Kingdom enacted changes to its corporation tax rate, further reducing it to 17% from April 1, 2020. This did not have a material impact to our existing deferred tax balances.
Significant components of our deferred tax assets and liabilities were as follows (in millions):
|
| | | | | | | |
| December 31, |
| 2016 |
| | 2015 |
|
Deferred tax assets | | | |
Tax attribute carryforwards | $ | 31 |
| | $ | 42 |
|
Accruals and reserves | 37 |
| | 29 |
|
Employee compensation | 38 |
| | 22 |
|
Deferred rent | 56 |
| | 83 |
|
Other | 17 |
| | 19 |
|
Valuation allowances | (19 | ) | | (15 | ) |
Total deferred tax assets | $ | 160 |
| | $ | 180 |
|
| | | |
Deferred tax liabilities | | | |
Intangibles and goodwill | $ | 286 |
| | $ | 371 |
|
Depreciation | 65 |
| | 50 |
|
Total deferred tax liabilities | 351 |
| | 421 |
|
Net deferred tax liability | $ | 191 |
| | $ | 241 |
|
We have recorded valuation allowances for certain tax attribute carryforwards and other deferred tax assets due to uncertainty that exists regarding future realizability. The tax attribute carryforwards at December 31, 2016 consist of $1 million of tax credits and $238 million of net operating losses that expire in varying amounts from 2017 to 2035. The tax attribute carryforwards at December 31, 2015 consist of nil of tax credits and $252 million of net operating losses that expire in varying amounts from 2016 through 2035. If, in the future, we believe that it is more likely than not that these deferred tax benefits will be realized, the reversal of the valuation allowances will be recognized in the Statements of Operations.
U.S. income and foreign withholding taxes have not been recorded on permanently reinvested earnings of foreign subsidiaries aggregating approximately $395 million and $407 million at December 31, 2016 and 2015, respectively. Generally, such amounts become subject to U.S. taxation upon the remittance of dividends and under certain other circumstances. Determination of the amount of unrecognized deferred U.S. federal income tax liability with respect to such earnings is not practicable.
Accounting for Uncertainty in Income Taxes
We recognize income tax benefits for tax positions determined more likely than not to be sustained upon examination, based on the technical merits of the positions.
Changes in our uncertain income tax positions, excluding the related accrual for interest and penalties, from January 1 through December 31 are set forth below (in millions):
|
| | | | | | | | | | | |
| Year Ended December 31, |
| 2016 |
| | 2015 |
| | 2014 |
|
Balance, beginning of the period | $ | 35 |
| | $ | 37 |
| | $ | 43 |
|
Additions for prior year tax positions | 3 |
| | — |
| | 2 |
|
Additions for current year tax positions | 1 |
| | 1 |
| | 2 |
|
Reductions for prior year tax positions | (7 | ) | | (3 | ) | | (10 | ) |
Balance, end of the period | $ | 32 |
| | $ | 35 |
| | $ | 37 |
|
Should our position with respect to these uncertain tax positions be upheld, the significant majority of the effect would be recorded in the Statements of Operations as part of the Income tax provision (benefit).
During the fourth quarter of 2014, the Company was notified by Time Warner that it had substantially concluded a Federal tax settlement related to the examination of the Time Warner tax returns for the years 2005 through 2007, which included certain Time Inc. tax matters. Therefore, we recorded a tax benefit of $10 million in the fourth quarter of 2014 related to these matters as they are effectively settled.
During the year ended December 31, 2016, we recorded an increase to interest reserves through the Statements of Operations of approximately $2 million. During the year ended December 31, 2015, we recorded a decrease to interest reserves through the Statements of Operations of approximately $2 million. During the year ended December 31, 2014, we recorded an increase to interest reserves through the Statements of Operations of approximately $2 million. The amount accrued for interest and penalties as of December 31, 2016, 2015 and 2014 was $9 million, $7 million and $9 million, respectively. Our policy is to recognize interest and penalties accrued on uncertain tax positions as part of income tax expense.
Net reserves for uncertain tax positions, including applicable accrued interest, are included within Other noncurrent liabilities on the accompanying Balance Sheets.
In our judgment, uncertainties related to certain tax matters are reasonably possible of being resolved during the next 12 months. The effect of the resolutions of these matters, a portion of which could vary based on the final terms and timing of actual settlements with taxing authorities, is estimated to be a reduction of recorded unrecognized tax benefits ranging from nil to $12 million, which would lower our effective tax rate.
For periods prior to the Spin-Off, Time Warner has filed income tax returns in the United States and various state and local and foreign jurisdictions on our behalf. The Internal Revenue Service (“IRS”) is currently conducting an examination of Time Warner’s U.S. income tax returns for the 2008 through 2010 period.
As of December 31, 2016, our tax years that remain subject to examination by significant jurisdiction are as follows:
|
| |
U.S. Federal | 2008 through the current period |
United Kingdom | 2015 through the current period |
New York State | 2012 through the current period |
New York City | 2012 through the current period |
California | 2014 Post-Spin through the current period |
On October 13, 2016, the Treasury Department and Internal Revenue Service issued final and temporary regulations addressing whether certain instruments between related parties are treated as debt or equity, as well as required documentation. The Company completed its evaluation of the impact of these new regulations and have concluded that they will not have a material impact on our operations or tax positions.
Tax Matters Agreement
We entered into a Tax Matters Agreement with Time Warner that governs the rights, responsibilities and obligations of Time Warner and us after the Spin-Off with respect to all tax matters (including tax liabilities, tax attributes, tax returns and tax contests). As a member of Time Warner’s consolidated U.S. federal income tax group, we have (and will continue to have following the Spin-Off) joint and several liability with Time Warner to the IRS for the consolidated U.S. federal income taxes of the Time Warner group relating to taxable periods in which we were part of the group.
With respect to taxes other than those incurred in connection with the Spin-Off (which are discussed below), the Tax Matters Agreement will provide that we will indemnify Time Warner for (1) any taxes of Time Inc. and its subsidiaries for all periods after the Distribution and (2) any taxes of the Time Warner group for periods prior to the Distribution to the extent attributable to Time Inc. or its subsidiaries. For purposes of the indemnification described in clause (2), however, we will generally be required to indemnify Time Warner only for any such taxes that are paid in connection with a tax return filed after the Distribution or that result from an adjustment made to such taxes after the Distribution. In these cases, our indemnification obligations generally would be computed based on the amount by which the tax liability of the Time Warner group is greater than it would have been absent our inclusion in its tax returns (or absent the applicable adjustment). We and Time Warner will generally have joint control over tax authority audits or other tax proceeding related to Time Inc. specific tax matters.
The Tax Matters Agreement generally provides that we are required to indemnify Time Warner for any tax (and reasonable expenses) resulting from the failure of any step of the Spin-Off to qualify for its intended tax treatment under U.S. federal income tax and U.K. tax laws, where such taxes result from (1) untrue representations and breaches of covenants that we made and agreed to in connection with the Spin-Off (including representations we made in connection with the tax opinion received by Time Warner and covenants containing the restrictions described below that are designed to preserve the tax-free nature of the Distribution), (2) the application of certain provisions of U.S. federal income tax law to the Spin-Off or (3) any other actions that we know or reasonably should expect would give rise to such taxes.
The Tax Matters Agreement imposed certain restrictions on us and our subsidiaries (including restrictions on share issuances, business combinations, sale of assets and similar transactions) that were designed to preserve the tax-free nature of the Distribution. These restrictions applied for the two-year period after the Distribution.