The components of income tax expense from continuing operations for the years ended December 31 are as follows (in millions):
|
| | | | | | | | | | | |
| 2017 | | 2016 | | 2015 |
Current: | |
| | |
| | |
|
Federal | $ | 30.0 |
| | $ | 17.3 |
| | $ | 40.8 |
|
State | 5.9 |
| | 2.6 |
| | 7.4 |
|
Foreign | 3.6 |
| | 1.4 |
| | 1.3 |
|
Total current | 39.5 |
| | 21.3 |
| | 49.5 |
|
Deferred: | |
| | |
| | |
|
Federal | 102.7 |
| | 19.6 |
| | (4.5 | ) |
State | (9.3 | ) | | (0.2 | ) | | (4.5 | ) |
Foreign | (0.1 | ) | | 0.1 |
| | 6.1 |
|
Total deferred | 93.3 |
| | 19.5 |
| | (2.9 | ) |
Total tax expense | $ | 132.8 |
| | $ | 40.8 |
| | $ | 46.6 |
|
Included in gain (loss) on disposal of discontinued operations is income tax expense of $(0.1) million, $4.0 million and $0.5 million in the years ended December 31, 2017, 2016 and 2015, respectively.
The provision for income taxes in 2017, 2016 and 2015 included benefits of $1.2 million, $4.7 million and $4.0 million, respectively, related to the utilization of net operating loss carryforwards.
The reconciliation of the difference between the Company’s U.S. Federal statutory income tax rate and the effective income tax rate for continuing operations for the years ended December 31 is as follows:
|
| | | | | | | | |
| 2017 | | 2016 | | 2015 |
Tax at U.S. federal statutory income tax rate | 35.0 | % | | 35.0 | % | | 35.0 | % |
State income taxes, net of federal benefit | 1.7 | % | | 3.0 | % | | 3.0 | % |
Non-deductible expenses | 0.2 | % | | — | % | | — | % |
DTA Deed liability revaluation adjustment | (12.8 | )% | | — | % | | — | % |
Interest expense | (10.2 | )% | | (12.1 | )% | | (9.3 | )% |
Dividends from foreign subsidiaries | — | % | | — | % | | 0.3 | % |
Adjustment to liabilities for uncertain tax positions | (1.2 | )% | | 0.9 | % | | (0.4 | )% |
Change in valuation allowance | 1.1 | % | | (0.6 | )% | | (3.4 | )% |
Effect of foreign operations | (4.0 | )% | | (0.7 | )% | | (1.0 | )% |
Effect of changes in tax law | 86.4 | % | | — | % | | (0.5 | )% |
Effect of income from non-controlling interest | (1.3 | )% | | — | % | | — | % |
Other | (1.4 | )% | | (0.2 | )% | | (0.5 | )% |
Effective income tax rate for continuing operations | 93.5 | % | | 25.3 | % | | 23.2 | % |
On November 16, 2017, the U.K. Finance (No.2) Bill 2017 (the “Finance Bill”) received Royal Assent and enacted amendments to the hybrid mismatch rules which are effective from July 13, 2017. Accordingly, the Company has recognized incremental U.K. taxes of $2.7 million in 2017 due to reduced benefits from its intercompany financing arrangements as of the effective date.
During 2017, the Company recorded an additional $3.1 million valuation allowance against its state net operating loss carryforwards as management concluded it is unlikely the tax benefits will be realized largely due to Pennsylvania legislation enacted during 2017 which limits the Company’s annual usage of net operating losses within the state.
During 2015 and 2016, the Company released $2.0 million and $0.9 million of its valuation allowance relating to state net operating loss carryforwards as management has concluded that the tax benefits will be realized due to increases of income apportioned to the applicable states.
During 2015, the Company released $4.5 million of its valuation allowance relating to foreign tax credit carryforwards, as management has concluded that the tax benefits will be realized primarily due to forecasted taxable income resulting from the utilization of substantially all the Company’s remaining federal net operating loss carryforwards. As of December 31, 2017 the Company has fully realized its deferred tax asset for foreign tax credit carryforwards.
In general, it is the practice and intention of the Company to reinvest earnings of its non-U.S. subsidiaries in those operations. Management has no intention of repatriating earnings of its non-U.S. subsidiaries in the foreseeable future. At December 31, 2017, the Company has not recorded any deferred tax liabilities relating to additional taxes such as foreign withholding and state taxes which could arise on the repatriation of unremitted earnings of its non-U.S. subsidiaries.
U.S. Tax Reform
On December 22, 2017, the Tax Cuts and Jobs Act (the “Tax Act”) was signed into law and is effective January 1, 2018. The Tax Act enacted various measures of domestic corporate tax reform that were impactful to the Company including reduction of the federal statutory corporate tax rate from 35% to 21%, limitations on the deductibility of interest expense and introduced several measures of international tax reform including the one-time tax on mandatory deemed repatriation of non-U.S. earnings.
In accordance with ASC 740-10-45-15, the Company has recognized the effect of the tax law in the period of enactment. As a result of the enactment of the Tax Act, the Company has recognized a one-time tax charge of approximately $122.7 million during 2017, which has increased the Company’s overall effective tax rate for the period, predominately related to the Company’s revaluation of its deferred tax assets to the reduced federal statutory corporate tax rate of 21%.
The amounts owed by the Company to OM plc at December 31, 2017 under the Deferred Tax Asset Deed were reduced by $51.8 million due to enactment of the Tax Act. The revaluation of the deed has been reflected as a component of income from continuing operations before taxes.
Status of the Company’s Assessment
Passage of the Tax Act represents the first major tax reform to the U.S. federal corporate income tax system in over thirty years. The newly introduced domestic and international provisions require the gathering and aggregation of new information and performance of complex computations not routinely performed by the Company in the past.
Due to the rapid development of U.S. tax reform in the fourth quarter of 2017, substantial regulatory and interpretive guidance from the U.S. Department of Treasury and other applicable taxing authorities has not been released yet, although it is expected to be forthcoming.
The SEC issued Staff Accounting Bulletin No. 118, Income Tax Accounting Implications of the Tax Cuts and Jobs Act (“SAB 118”) to assist companies by addressing some of the uncertainty in applying ASC 740 with respect to 2017 financial statements. Under SAB 118, the Company is permitted to provide provisional amounts for recording the tax effects of the enacted tax law during a specified measurement period, ending one year after the enactment date.
Accordingly, the Company has provided provisional estimates on the effect of the Tax Act in its 2017 financial statements to the extent the necessary information is not available, prepared, or analyzed to accurately complete the tax accounting.
The Company determined reasonable estimates based on currently available information and published guidance, however the Company’s accounting for the effect of the Tax Act remains incomplete under SAB 118 with respect to the following:
Section 965 toll charge tax liability: The Company has determined a preliminary estimate of its Section 965 toll charge tax liability on the mandatory deemed repatriation of post-1986 undistributed foreign earnings of its non-U.S. subsidiaries. As of December 31, 2017, the Company has accrued income tax liabilities of $1.5 million relating to the toll charge. Starting in 2018, the liability will be paid over an eight-year period and will not accrue interest. The Company has made a reasonable estimate based on currently available information, however the accounting is incomplete and subject to finalization of estimates and amounts related to earnings and profits of its foreign subsidiaries and the filing of 2017 tax returns. U.S. Treasury regulations, administrative interpretations of the Tax Act may require further adjustments to the preliminary estimate.
The Company will continue to evaluate the Tax Act during the measurement period and record adjustments to provisional amounts in the period in which they are completed as information becomes available and further clarifying, interpretive guidance on the application of the tax law is released.
Deferred tax assets and liabilities reflect the expected future tax consequences of temporary differences between the book carrying amounts and tax bases of the Company’s assets and liabilities.
The significant components of deferred tax assets and deferred tax liabilities for the years ended December 31 are as follows (in millions):
|
| | | | | | | |
| 2017 | | 2016 |
Deferred tax assets: | |
| | |
|
Interest expense | $ | 80.9 |
| | $ | 150.5 |
|
Federal net operating loss | 1.8 |
| | 3.7 |
|
State net operating loss carry forwards | 8.6 |
| | 7.6 |
|
Investment in partnerships | 140.3 |
| | 140.1 |
|
Foreign tax credit carry forwards | — |
| | 9.1 |
|
Intangible assets | 0.9 |
| | 1.4 |
|
Employee compensation | 8.9 |
| | 16.5 |
|
Other | 2.6 |
| | 5.6 |
|
Cash flow hedge | 5.1 |
| | 5.9 |
|
Investments | 0.1 |
| | — |
|
Total deferred tax assets | 249.2 |
| | 340.4 |
|
Valuation allowance | (8.6 | ) | | (5.5 | ) |
Deferred tax assets, net of valuation allowance | 240.6 |
| | 334.9 |
|
Deferred tax liabilities: | |
| | |
|
Investments | — |
| | 2.2 |
|
Net deferred tax asset | $ | 240.6 |
| | $ | 332.7 |
|
Due to the enactment of the Tax Act, The Company has revalued its deferred tax assets and related liabilities as of the enactment date of December 22, 2017, resulting in a write-down of $121.1 million.
At December 31, 2017, the Company has tax attributes that carry forward for varying periods. The Company’s federal net operating loss carryforward of $8.5 million originated during 2004 and 2006 and will expire over a seven to nine-year period. State net operating losses of $160.8 million expire over a four to twelve-year period. The Company has recorded a valuation allowance in connection with state net operating loss carryforwards for which the Company believes it is more-likely-than-not that the tax benefits will not be recognized. In evaluating the Company’s ability to recover its deferred tax assets, the Company considers all available positive and negative evidence including the existence of cumulative income in the most recent fiscal years, changes in the business in which the Company operates, and the Company’s ability to forecast future taxable income. The weight given to the evidence is commensurate with the extent to which it can be objectively verified. The more negative evidence that exists, the more positive evidence that is necessary and the more difficult it is to support a conclusion that a valuation allowance is not needed. The Company has three years of cumulative earnings as of December 31, 2017, 2016, and 2015. As of December 31, 2017, management believes it is more likely than not that the balance of the deferred tax asset will be realized based on forecasted taxable income.
A reconciliation of the change in gross unrecognized tax benefits for the years ended December 31 is as follows (in millions):
|
| | | | | | | | | | | |
| 2017 | | 2016 | | 2015 |
Balance as of January 1 | $ | 91.3 |
| | $ | 93.5 |
| | $ | 93.9 |
|
Additions based on current year tax positions | 0.9 |
| | — |
| | — |
|
Reductions related to lapses of statutes of limitations | (3.5 | ) | | (2.2 | ) | | (0.4 | ) |
Balance as of December 31 | $ | 88.7 |
| | $ | 91.3 |
| | $ | 93.5 |
|
The Company’s liability for uncertain tax positions includes unrecognized benefits of $96.9 million and $96.4 million at December 31, 2017 and 2016, respectively, that if recognized would affect the effective tax rate on income from continuing operations.
The Company recognized $2.5 million, $3.6 million, and $1.4 million in interest and penalties in its income tax provision for the years ended December 31, 2017, 2016, and 2015, respectively. The Company recognizes accrued interest and penalties relating to unrecognized tax benefits as income tax expense. The Company’s liability for uncertain tax benefits at December 31, 2017, 2016, and 2015 includes accrued interest and penalties of $8.6 million, $6.1 million and $2.8 million, respectively.
The Company believes that it is reasonably possible that a decrease of up to $46.0 million in unrecognized tax benefits may be necessary within the next twelve months, as the result of a lapse of statute of limitations.
The Company is periodically under examination by various taxing authorities. Examinations are inherently uncertain, may result in payment of additional taxes or the recognition of tax benefits and may be in process for extended periods of time. At December 31, 2017, there were no open examinations in process.
The Company and its subsidiaries file tax returns in U.K., U.S. federal, state, local and other foreign jurisdictions. As of December 31, 2017, the Company is generally no longer subject to income tax examinations by U.K., U.S. federal, state, local, or foreign tax authorities for calendar years prior to 2007.