Income Taxes
Tax Matters Agreement
The Company and ADP entered into a tax matters agreement as part of the spin-off that governs the rights and obligations of both parties after the spin-off with respect to taxes for both pre and post spin-off periods. Under this agreement, ADP is generally required to indemnify the Company for any income taxes attributable to ADP's operations or the Company's operations and for any non-income taxes attributable to ADP's operations, in each case for all pre spin-off periods as well as any taxes arising from transactions effected to consummate the spin-off, and the Company generally is required to indemnify ADP for any non-income taxes attributable to the Company's operations for all pre spin-off periods and for any income taxes attributable to the Company's operations for post spin-off periods.
The Company is generally required to indemnify ADP against any tax resulting from the spin-off (and against any claims made against ADP in respect of any tax imposed on its stockholders), in each case if that tax results from (i) an issuance of a significant amount of the Company's equity securities, a redemption of a significant amount of the Company's equity securities or the Company's involvement in other significant acquisitions of the Company's equity securities (excluding the spin-off), (ii) other actions or failures to act by the Company, or (iii) any of the Company's representations or undertakings referred to in the tax matters agreement being incorrect or violated. ADP will generally be required to indemnify the Company for any tax resulting from the spin-off if that tax results from (a) ADP's issuance of its equity securities, redemption of its equity securities, or involvement in other acquisitions of its equity securities, (b) other actions or failures to act by ADP, or (c) any of ADP's representations or undertakings referred to in the tax matters agreement being incorrect or violated.
The Company recognized receivables from ADP of $1.0 million and $1.1 million as of June 30, 2017 and 2016, respectively, and payables to ADP of $1.2 million and $1.6 million as of June 30, 2017 and 2016, respectively, under the tax matters agreement. In accordance with the tax matters agreement, the Company recognized a net gain of $2.6 million in fiscal 2016 in other income, net in the consolidated statement of operations associated with an indemnification receivable from ADP for pre spin-off tax periods and a net loss of $1.1 million in fiscal 2015 in other income, net in the consolidated and combined statement of operations associated with an indemnification payable to ADP for pre spin-off tax refunds.
Provision for Income Taxes
Prior to the spin-off, the provision for income taxes and the income tax balances were calculated as if the Company filed income tax returns separate from ADP. Subsequent to the spin-off, the provision for income tax and income tax balances represent the Company's income tax liabilities as an independent company.
Earnings before income taxes presented below is based on the geographic location to which such earnings were attributable.
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| | | | | | | | | | | |
| June 30, |
| 2017 | | 2016 | | 2015 |
Earnings before income taxes: | | | | | |
U.S. | $ | 324.9 |
| | $ | 293.1 |
| | $ | 224.7 |
|
Foreign | 110.4 |
| | 76.0 |
| | 75.2 |
|
| $ | 435.3 |
| | $ | 369.1 |
| | $ | 299.9 |
|
The provision (benefit) for income taxes consisted of the following components:
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| | | | | | | | | | | |
| June 30, |
| 2017 | | 2016 | | 2015 |
Current: | | | | | |
Federal | $ | 69.6 |
| | $ | 84.9 |
| | $ | 104.6 |
|
Foreign | 27.5 |
| | 24.5 |
| | 18.3 |
|
State | 14.8 |
| | 16.5 |
| | 16.0 |
|
Total current | 111.9 |
| | 125.9 |
| | 138.9 |
|
Deferred: | | | | | |
Federal | 17.0 |
| | (3.3 | ) | | (19.2 | ) |
Foreign | 2.0 |
| | 1.3 |
| | (2.3 | ) |
State | 1.9 |
| | (1.6 | ) | | (3.8 | ) |
Total deferred | 20.9 |
| | (3.6 | ) | | (25.3 | ) |
Total provision for income taxes | $ | 132.8 |
| | $ | 122.3 |
| | $ | 113.6 |
|
A reconciliation between the Company’s effective tax rate and the U.S. federal statutory rate is as follows:
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| | | | | | | | | | | | | | | | | | | | |
| June 30, |
| 2017 | | % | | 2016 | | % | | 2015 | | % |
Provision for taxes at U.S. statutory rate | $ | 152.4 |
| | 35.0 | % | | $ | 129.2 |
| | 35.0 | % | | $ | 105.0 |
| | 35.0 | % |
Increase (decrease) in provision from: | | | | | | | | | | | |
State taxes, net of federal benefit | 10.8 |
| | 2.5 | % | | 9.7 |
| | 2.6 | % | | 8.8 |
| | 2.9 | % |
Stock compensation - excess tax benefits | (12.0 | ) | | (2.8 | )% | | — |
| | — | % | | — |
| | — | % |
Noncontrolling interest | (2.0 | ) | | (0.5 | )% | | (2.5 | ) | | (0.7 | )% | | (2.8 | ) | | (0.9 | )% |
Foreign tax rate differential | (12.4 | ) | | (2.8 | )% | | (7.8 | ) | | (2.1 | )% | | (4.3 | ) | | (1.4 | )% |
U.S. tax on foreign earnings | 1.1 |
| | 0.3 | % | | 0.8 |
| | 0.2 | % | | — |
| | — | % |
Foreign tax credits | (1.9 | ) | | (0.4 | )% | | (1.5 | ) | | (0.4 | )% | | (1.7 | ) | | (0.6 | )% |
Resolution of tax matters | — |
| | — | % | | — |
| | — | % | | (3.4 | ) | | (1.1 | )% |
Non-deductible separation costs | — |
| | — | % | | — |
| | — | % | | 7.8 |
| | 2.6 | % |
Tax law changes | — |
| | — | % | | — |
| | — | % | | 4.6 |
| | 1.5 | % |
Capital losses | — |
| | — | % | | — |
| | — | % | | (29.2 | ) | | (9.7 | )% |
Valuation allowances | 0.8 |
| | 0.2 | % | | 1.1 |
| | 0.3 | % | | 27.1 |
| | 9.0 | % |
Domestic production activities deduction | (4.2 | ) | | (1.0 | )% | | (6.4 | ) | | (1.7 | )% | | — |
| | — | % |
Pre spin-off tax return adjustments | — |
| | — | % | | (0.4 | ) | | (0.1 | )% | | 0.5 |
| | 0.2 | % |
Other | 0.2 |
| | — | % | | 0.1 |
| | — | % | | 1.2 |
| | 0.4 | % |
Provision for income taxes | $ | 132.8 |
| | 30.5 | % | | $ | 122.3 |
| | 33.1 | % | | $ | 113.6 |
| | 37.9 | % |
During fiscal 2017, the effective tax rate was favorably impacted by excess tax benefits associated with adopting ASU 2016-09 effective July 1, 2016 as described in Note 2.
During fiscal 2015, the Company incurred non-deductible separation costs which unfavorably impacted the effective tax rate.
On December 19, 2014, the Tax Increase Prevention Act of 2014 was signed into law. Among the changes included in the law was a provision allowing for additional first year depreciation for assets placed into service during calendar year 2015, commonly known as "bonus depreciation." The bonus depreciation provision related to pre spin-off tax periods for which ADP was entitled under the tax law and in accordance with the tax matters agreement to claim additional tax depreciation for assets associated with the Company's business. During fiscal 2015, the Company recorded tax expense of $4.6 million to adjust deferred taxes for the additional tax depreciation to be taken by ADP in pre spin-off tax periods.
The balance sheet classification and significant components of deferred income tax assets and liabilities are as follows:
|
| | | | | | | |
| June 30, |
| 2017 | | 2016 |
Classification: | | | |
Long term deferred tax assets (included in other assets) | $ | 22.1 |
| | $ | 23.9 |
|
Long term deferred tax liabilities (included in deferred income taxes) | (65.9 | ) | | (46.9 | ) |
Net deferred tax liabilities | $ | (43.8 | ) | | $ | (23.0 | ) |
| | | |
Components: | | | |
Deferred tax assets: | | | |
Accrued expenses | $ | 13.9 |
| | $ | 15.4 |
|
Compensation and benefits | 46.1 |
| | 57.7 |
|
Deferred revenue | 53.8 |
| | 57.6 |
|
Net operating losses | 10.5 |
| | 13.5 |
|
Capital losses | 28.8 |
| | 28.7 |
|
| 153.1 |
| | 172.9 |
|
Less: valuation allowances | (35.1 | ) | | (34.3 | ) |
Net deferred tax assets | 118.0 |
| | 138.6 |
|
| | | |
Deferred tax liabilities: | | | |
Deferred expenses | 64.9 |
| | 76.6 |
|
Property, plant and equipment and intangible assets | 92.1 |
| | 76.5 |
|
Prepaid expenses | 2.6 |
| | 5.9 |
|
Other | 2.2 |
| | 2.6 |
|
Deferred tax liabilities | 161.8 |
| | 161.6 |
|
Net deferred tax liabilities | $ | (43.8 | ) | | $ | (23.0 | ) |
Undistributed foreign earnings that the Company intends to indefinitely reinvest, and for which no taxes have been provided, aggregated to approximately $57.4 million and $166.4 million as of June 30, 2017 and 2016, respectively. During fiscal 2017, the Company underwent an internal legal entity reorganization resulting in a deemed distribution of foreign earnings for U.S. tax purposes of $172.8 million. The tax provision impact of the deemed distribution, net of foreign tax credits, is immaterial. The remaining foreign earnings are considered indefinitely reinvested since the Company's intent is to use these earnings outside of the U.S. to fund local working capital needs and future foreign investments, including potential acquisitions, and the U.S. can meet its cash needs without repatriation of foreign cash.
During fiscal 2016, the Company concluded that $31.6 million of prior year earnings of certain foreign subsidiaries were no longer considered indefinitely reinvested and recognized income tax expense of $0.8 million for the associated foreign withholding and U.S. income taxes, net of foreign tax credits. The foreign earnings identified for repatriation during the third quarter of fiscal 2016 in order to manage worldwide cash in a tax-efficient manner were repatriated to the U.S. during the fourth quarter of fiscal 2016.
The Company had federal net operating losses of approximately $0.1 million as of June 30, 2017 which expire in 2022. The Company had federal capital losses of $75.4 million which expire in 2020 and state capital losses of $75.4 million which expire in 2020 through 2030. The Company had foreign net operating loss carryforwards of approximately $38.4 million as of June 30, 2017, of which $5.9 million expires in 2018 through 2023 and $32.5 million has an indefinite carryforward period.
Valuation Allowance
The Company recorded valuation allowances of $35.1 million and $34.3 million as of June 30, 2017 and 2016, respectively, because the Company has concluded it is more likely than not that it will be unable to utilize net operating and capital loss carryforwards of certain subsidiaries to offset future taxable earnings. As of each reporting date, the Company’s management considers new evidence, both positive and negative, which could impact management’s view with regard to future realization of deferred tax assets.
During fiscal 2017, the valuation allowance balance was decreased by $1.1 million for a Canadian valuation allowance adjustment based on positive evidence which indicated that the foreign loss carryforward would be utilized prior to expiration. The company concluded the deferred tax asset would be realizable based on a three-year cumulative profit position and forecasts of future year pre-tax income.
During fiscal 2016, the Company determined that sufficient positive evidence did not exist to realize certain foreign deferred tax assets. Based on a three-year cumulative loss position and forecasts of future year pre-tax income, the Company increased the valuation allowance by $1.1 million in relation to these deferred tax assets. The valuation allowance for 2017 and 2016 was also adjusted for current year deferred tax movements and foreign currency translation.
During fiscal 2015, based on achieving three years of cumulative pre-tax income and forecasts of future pre-tax income, management determined that sufficient positive evidence existed to conclude that it is more likely than not that certain non-U.S. tax losses were realizable, and therefore, recorded tax benefits to adjust the valuation allowance by $2.7 million. In addition, tax expense was recorded to increase the deferred tax valuation allowance in fiscal 2015 by $29.2 million for capital losses realized on the internet sales leads business disposition. The Company concluded a full valuation allowance against the capital losses was necessary due to the short carryforward period and limitations on the Company's ability to utilize the losses to offset income. The net impact of the adjustments related to the deferred tax valuation allowance and the capital losses realized on the internet sales leads business disposition are included in the fiscal 2015 effective tax rate reconciliation. The valuation allowance for fiscal 2015 was also impacted by foreign currency translation.
Income tax payments, net of refunds were $120.3 million, $109.4 million, and $120.8 million for fiscal 2017, 2016, and 2015, respectively. The income tax payments exclude payments made by ADP prior to the spin-off on behalf of the Company as these amounts are recorded within group equity in the historical combined financial statements. Income tax payments paid by ADP on behalf of the Company were $20.3 million for fiscal 2015.
Unrecognized Income Tax Benefits
As of June 30, 2017, 2016, and 2015, the Company had unrecognized income tax benefits of $6.4 million, $4.7 million, and $1.9 million, respectively, of which $4.8 million, $3.6 million, and $1.6 million, respectively, would impact the effective tax rate, if recognized. The remainder, if recognized, would principally affect deferred taxes.
A roll-forward of unrecognized tax benefits is as follows:
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| | | | | | | | | | | |
| June 30, |
| 2017 | | 2016 | | 2015 |
Beginning of the year balance | $ | 4.7 |
| | $ | 1.9 |
| | $ | 0.2 |
|
Additions for current year tax positions | 1.0 |
| | 1.9 |
| | 0.6 |
|
Additions for tax positions of prior years | 1.2 |
| | 1.1 |
| | 1.1 |
|
Reductions for tax positions of prior years | — |
| | (0.1 | ) | | — |
|
Settlement with tax authorities | (0.2 | ) | | — |
| | — |
|
Expiration of the statute of limitations | (0.2 | ) | | — |
| | — |
|
Impact of foreign exchange rate fluctuations | (0.1 | ) | | (0.1 | ) | | — |
|
End of year balance | $ | 6.4 |
| | $ | 4.7 |
| | $ | 1.9 |
|
During fiscal 2017, 2016, and 2015, the Company increased its net unrecognized income tax benefits by $1.7 million, $2.8 million, and $1.7 million, respectively, based on information that indicated the extent to which certain tax positions were more likely than not to be sustained. Penalties and interest expense associated with uncertain income tax positions have been recorded in the provision for income taxes on the consolidated and combined statements of operations. Penalties and interest incurred during fiscal 2017, 2016, and 2015 were not significant. As of June 30, 2017 and 2016, the Company had an insignificant amount of accrued penalty and interest associated with uncertain tax positions, which was included within other liabilities on the consolidated balance sheets.
The Company conducts business globally and, as a result, files income tax returns in the U.S. federal jurisdiction and various state, local and foreign jurisdictions. In the normal course of business, the Company is subject to examination by taxing authorities. The tax years currently under examination vary by jurisdiction. The Company is currently under examination by the U.S. Internal Revenue Service ("IRS") for the tax year ending June 30, 2015. The Company regularly considers the likelihood of assessments in each of the jurisdictions resulting from examinations. The Company has established a liability for unrecognized income tax benefits which it believes to be adequate in relation to the potential assessments. Once established, the liability for unrecognized tax benefits is adjusted when there is more information available, when an event occurs necessitating a change, or the statute of limitations for the relevant taxing authority to examine the tax position has expired.
During fiscal 2017, the IRS began an employment tax audit covering calendar years 2014 through 2016. The Company has assessed the estimated liability of a potential assessment and recorded a liability as of June 30, 2017. The Company anticipates the audit and any related assessments to be finalized in fiscal 2018.
Income tax-related examinations currently in progress in which the Company has significant business operations are as follows:
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| | |
Tax Jurisdictions | | Fiscal Years Ended |
U.S. (IRS) | | 6/30/2015 |
New Jersey | | 6/30/2008 thru 6/30/2011 |
Canada | | 6/30/2012 thru 6/30/2014 |
Kuwait | | 6/30/2013 thru 6/30/2015 |
Spain | | 6/30/2011 |
Italy | | 6/30/2015 |
Based on the possible outcomes of the Company's tax audits and expiration of the statute of limitations, it is reasonably possible that the liability for uncertain tax positions will change within the next twelve months. The associated net tax impact on the effective tax rate is estimated to be a $1.7 million tax benefit, with minimal cash payments.
Although the final resolution of the Company's tax disputes is uncertain, based on current information, the resolution of tax matters is not expected to have a material effect on the Company's consolidated financial condition, liquidity, or results of operations. However, an unfavorable resolution could have a material impact on the Company’s consolidated financial condition, liquidity, or results of operations in the periods in which the matters are ultimately resolved.