12. Income Taxes
The Company, CenStar and Verde Energy USA, Inc. (Verde Corp) are each subject to U.S. federal income tax as corporations. CenStar and Verde Corp will file consolidated tax returns in jurisdictions that allow combined reporting. Spark HoldCo and its subsidiaries, with the exception of CenStar and Verde Corp, 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, the Company is subject to U.S. federal income taxation on its allocable share of Spark HoldCo's net U.S. taxable income.
The Company reports federal and state income taxes for its share of the partnership income attributable to its ownership in Spark HoldCo and for the income taxes attributable to CenStar, a C-corporation, which is owned by Spark HoldCo. The income tax liability for the partnership does not accrue to the partnership, but rather the investors are responsible for the income taxes based upon the investor's share of the partnership's income. Net income attributable to the non-controlling interest in CenStar includes the provision for income taxes.
The Company accounts for income taxes using the assets and liabilities method. Deferred tax assets and liabilities are recognized for future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and the tax bases of the assets and liabilities. The Company applies existing tax law and the tax rate that the Company expects to apply to taxable income in the years in which those differences are expected to be recovered or settled in calculating the deferred tax assets and liabilities. Effects of changes in tax rates on deferred tax assets and liabilities are recognized in income in the period of the tax rate enactment. A valuation allowance is recorded when it is not more likely than not that some or all of the benefit from the deferred tax asset will be realized.
On December 22, 2017, the President signed the Tax Cuts and Jobs Act (“U.S. Tax Reform”), which enacts a wide range of changes to the U.S. Corporate income tax system. The impact of U.S. Tax Reform primarily represents our estimates of revaluing our U.S. deferred tax assets and liabilities based on the rates at which they are expected to be recognized in the future. For U.S. federal purposes the corporate statutory income tax rate was reduced from 35% to 21%, effective for the 2018 tax year. Based on our historical financial performance, at December 31, 2017 we have a significant net deferred tax asset position that we have remeasured at the lower corporate rate of 21% and recognized a tax expense to adjust net deferred tax assets to the reduced value.
The provision for income taxes included the following components:
|
| | | | | | | | | | | | |
(in thousands) | | 2017 | | 2016 | | 2015 |
Current: | | | | | | |
Federal | | $ | 6,992 |
| | $ | 5,361 |
| | $ | 268 |
|
State | | 1,952 |
| | 1,683 |
| | (277 | ) |
Total Current | | 8,944 |
| | 7,044 |
| | (9 | ) |
| | | | | | |
Deferred: | | | | | | |
Federal | | 26,583 |
| | 2,944 |
| | 1,820 |
|
State | | 2,001 |
| | 438 |
| | 163 |
|
Total Deferred | | 28,584 |
| | 3,382 |
| | 1,983 |
|
Provision for income taxes | | $ | 37,528 |
| | $ | 10,426 |
| | $ | 1,974 |
|
The effective income tax rate was 33.0% and 13.7% for the years ended December 31, 2017 and 2016, respectively. The following table reconciles the income tax benefit included in the consolidated statement of operations with income tax expense that would result from application of the statutory federal tax rate, 35% for the years ended December 31, 2017 and 2016, respectively, to loss before income tax expense (benefit):
|
| | | | | | |
(in thousands) | 2017 | 2016 |
Expected provision at federal statutory rate | $ | 39,833 |
| $ | 26,635 |
|
Increase (decrease) resulting from: | | |
Impact of U.S. Tax Reform | 13,217 |
| — |
|
Non-controlling interest | (19,810 | ) | (17,740 | ) |
State income taxes, net of federal income tax effect | 2,569 |
| 1,346 |
|
Other | 1,719 |
| 185 |
|
Provision for income taxes | $ | 37,528 |
| $ | 10,426 |
|
Total income tax expense for the year ended December 31, 2017 differed from amounts computed by applying the U.S. federal statutory tax rates to pre-tax income primarily due to state taxes and the impact of permanent differences between book and taxable income, most notably the income attributable to non-controlling interest. The effective tax rate includes a rate benefit attributable to the fact that Spark HoldCo operates as a limited liability company treated as a partnership for federal and state income tax purposes and is not subject to federal and state income taxes. Accordingly, the portion of earnings attributable to non-controlling interest is subject to tax when reported as a component of the non-controlling interest’s taxable income. The effective rate in 2017 includes a $13.2 million unfavorable impact resulting from the enactment of U.S. Tax Reform. The primary impact of the change in tax law was the remeasurment of our U.S. federal deferred tax assets and liabilities at the tax rate expected to be applied when the temporary differences are settled at a rate of 21%.
The Company accounts for income taxes using the assets and liabilities method. Deferred tax assets and liabilities are recognized for future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and those assets and liabilities tax bases. The Company applies existing tax law and the tax rate that the Company expects to apply to taxable income in the years in which those differences are expected to be recovered or settled in calculating the deferred tax assets and liabilities. Effects of changes in tax rates on deferred tax assets and liabilities are recognized in income in the period of the tax rate enactment. We remeasured our deferred tax assets and liabilities, excluding those that will be included on our 2017 tax return based on the rates we expect to realize the deferred tax assets and liabilities at in the future. The amount that was recorded related to the remeasurement of our deferred tax balance was $13.2 million of tax expense. A valuation allowance is recorded when it is not more likely than not that some or all of the benefit from the deferred tax asset will be realized.
The components of the Company’s deferred tax assets as of December 31, 2017 and 2016 are as follows:
|
| | | | | | |
(in thousands) | 2017 | 2016 |
Deferred Tax Assets: | | |
Investment in Spark HoldCo | $ | 18,340 |
| $ | 35,359 |
|
Benefit of TRA Liability | 8,175 |
| 19,705 |
|
Federal net operating loss carryforward | 660 |
| 2,076 |
|
State net operating loss carryforward | 166 |
| 366 |
|
Total deferred tax assets | 27,341 |
| 57,506 |
|
| | |
Deferred Tax Liabilities: | | |
Derivative liabilities | (811 | ) | (1,849 | ) |
Intangibles | (2,287 | ) | (1,519 | ) |
Property and equipment | — |
| (10 | ) |
Other | (58 | ) | (19 | ) |
Total deferred tax liabilities | (3,156 | ) | (3,397 | ) |
Total deferred tax assets/liabilities | $ | 24,185 |
| $ | 54,109 |
|
On the IPO date, the Company recorded a net deferred tax asset of $15.6 million related to the step up in tax basis resulting from the purchase by the Company of Spark HoldCo units from NuDevco. In addition, the Company had a long-term liability of $20.7 million to record the effect of the Tax Receivable Agreement liability and a corresponding long-term deferred tax asset of $7.9 million. As of December 31, 2017 and 2016, the Company had a total liability of $32.3 million and $49.9 million, respectively, for the effect of the Tax Receivable Agreement liability. The Company adjusted the Tax Receivable Agreement liability at December 31, 2017 to include the 2016 tax returns filed. The adjustment resulted in an increase to the liability of $4.7 million, of which $1.8 million increased the deferred tax asset and $2.9 million decreased equity. On December 22, 2017, the President signed the Tax Cuts and Jobs Act (“U.S. Tax Reform”), which enacts a wide range of changes to the U.S. Corporate income tax system including a reduction in the U.S. corporate tax rate to 21% effective in 2018. The revised corporate income tax rate reduces the amount of net cash savings to be realized in future periods. Therefore, we have reduced the TRA liability as of December 31, 2017 by $22.3 million to reflect the effect of U.S. Tax Reform and recorded this adjustment through Other Income. The Company had a long-term deferred tax asset of approximately $8.2 million related to the Tax Receivable Agreement liability at December 31, 2017. See Note 14 "Transactions with Affiliates" for further discussion.
The Company has a federal net operating loss carry forward totaling $3.8 million expiring in 2037 and a state net operating loss of $4.1 million expiring through 2037. No valuation allowance has been recorded as management believes that there will be sufficient future taxable income to fully utilize deferred tax assets.
The Company periodically assesses whether it is more likely than not that it will generate sufficient taxable income to realize its deferred income tax assets. In making this determination, the Company considers all available positive and negative evidence and makes certain assumptions. The Company considers, among other things, its deferred tax liabilities, the overall business environment, its historical earnings and losses, current industry trends, and its outlook for future years. The Company believes it is more likely than not that the deferred tax assets will be utilized.
On February 3, 2016, Retailco exchanged 2,000,000 of its Spark HoldCo units (together with a corresponding number of shares of Class B common stock) for shares of Class A common stock. The exchange resulted in a step up in tax basis, which gave rise to a deferred tax asset of approximately $8.0 million on the exchange date. In addition, the Company recorded an additional long-term liability as a result of the exchange of approximately $10.3 million pursuant to the Tax Receivable Agreement and a corresponding long-term deferred tax asset of approximately $3.9 million. The initial estimate for the deferred tax asset, net of the liability, under the Tax Receivable Agreement was recorded within additional paid-in capital on our consolidated balance sheet at December 31, 2017.
On April 1, 2016, Retailco exchanged 3,450,000 of its Spark HoldCo units (together with a corresponding number of shares of Class B common stock) for shares of Class A common stock. The exchange resulted in a step up in tax basis, which gave rise to a deferred tax asset of approximately $7.6 million on the exchange date. In addition, the Company recorded an additional long-term liability as a result of the exchange of approximately $10.3 million pursuant to the Tax Receivable Agreement and a corresponding long-term deferred tax asset of approximately $3.9 million. The initial estimate for the deferred tax asset, net of the liability, under the Tax Receivable Agreement was recorded within additional paid-in capital on our consolidated balance sheet at December 31, 2017.
On June 8, 2016, Retailco exchanged 1,000,000 of its Spark HoldCo units (together with a corresponding number of shares of Class B common stock) for shares of Class A common stock. The exchange resulted in a step up in tax basis, which gave rise to a deferred tax asset of approximately $5.3 million on the exchange date. In addition, the Company recorded an additional long-term liability as a result of the exchange of approximately $6.9 million pursuant to the Tax Receivable Agreement and a corresponding long-term deferred tax asset of approximately $2.6 million. The initial estimate for the deferred tax asset, net of the liability, under the Tax Receivable Agreement was recorded within additional paid-in capital on our consolidated balance sheet at December 31, 2017.
Separate federal and state income tax returns are filed for Spark Energy, Inc. and Spark HoldCo. CenStar owns all the outstanding stock of Verde Corp and both are taxed as corporations. CenStar and Verde will file a federal consolidated return for 2017 and separate state income tax returns in the states that do not allow combined reporting. The tax years 2013 through 2016 remain open to examination by the major taxing jurisdictions to which the Company is subject to income tax. NuDevco would be responsible for any audit adjustments incurred in connection with transactions occurring up to July 31, 2014 for Spark Energy, Inc. and Spark HoldCo. The last closed audit period of exam was for the 2011 Spark Energy, LLC’s federal tax return and resulted in no adjustments by the IRS. Spark Energy, Inc., Spark HoldCo, ,CenStar, and Verde Corp are not currently under any income tax audits.
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 liability, and for the years ended December 31, 2017, 2016 and 2015, there was no expense recorded for interest and penalties associated with uncertain tax positions or unrecognized tax positions. Additionally, the Company does not have unrecognized tax benefits as of December 31, 2017 and 2016.