Entity information:
Income Taxes
Tax Act
On December 22, 2017, the U.S. government enacted comprehensive tax legislation commonly referred to as the Tax Cuts and Jobs Act (the “Tax Act”) that significantly revises the U.S. tax code generally effective January 1, 2018 by, among other changes, lowering the corporate income tax rate from 35% to 21%, limiting deductibility of interest expense and performance based incentive compensation and implementing a modified territorial tax system. As a Canadian entity, we generally would be classified as a foreign entity (and, therefore, a non-U.S. tax resident) under general rules of U.S. federal income taxation. However, we have subsidiaries subject to U.S. federal income taxation and therefore the Tax Act impacted our consolidated results of operations during 2017, and is expected to continue to impact our consolidated results of operations in future periods. The impacts to our consolidated statement of operations in 2017 consist of the following:
•
The remeasurement of net deferred tax liabilities as of the enactment date.
•
Charges related to certain deductions allowed to be carried forward before the Tax Act, which potentially may not be carried forward and deductible under the Tax Act.
•
A one-time transitional repatriation tax on unremitted foreign earnings (the “Transition Tax”), which may be paid over an eight-year period.
On December 22, 2017, Staff Accounting Bulletin No. 118 (“SAB 118”) was issued to address the application of U.S. GAAP in situations when a registrant does not have the necessary information available, prepared or analyzed (including computations) in reasonable detail to complete the accounting for certain income tax effects of the Tax Act. SAB 118 provides that companies (i) should record the effects of the changes from the Tax Act for which accounting is complete (not provisional), (ii) should record provisional amounts for the effects of the changes from the Tax Act for which accounting is not complete, and for which reasonable estimates can be determined, in the period they are identified, and (iii) should not record provisional amounts if reasonable estimates cannot be made for the effects of the changes from the Tax Act, and should continue to apply guidance based on the tax law in effect prior to the enactment on December 22, 2017. In addition, SAB 118 established a one-year measurement period (through December 22, 2018) where a provisional amount could be subject to adjustment, and requires certain qualitative and quantitative disclosures related to provisional amounts and accounting during the measurement period.
As a result of the reduction in the U.S. corporate tax rate, we remeasured our U.S. net deferred tax liabilities as of the enactment date and recognized a provisional benefit of $419.9 million as a discrete item in the provision for income taxes in 2017, which is a reduction in net deferred tax liabilities and is included in Deferred income taxes, net in the accompanying consolidated balance sheet as of December 31, 2017.
We also recorded $102.6 million of provisional charges related to certain deductions allowed to be carried forward before the Tax Act, which potentially may not be carried forward and deductible under the Tax Act. Of the $102.6 million, $43.0 million is included in Deferred income taxes, net and $59.6 million is included in Other long term liabilities in the accompanying consolidated balance sheet as of December 31, 2017.
We provisionally estimate a Transition Tax of $119.4 million, most of which had been previously accrued with respect to certain undistributed foreign earnings. The $119.4 million provisional Transition Tax is included in Other accrued liabilities in the accompanying consolidated balance sheet as of December 31, 2017. The amount and timing of the Transition Tax payments are currently being evaluated. Under the Tax Act, we have the ability to pay such amount over an eight year period.
Given the complexity of the changes in tax law resulting from the Tax Act, we have not finalized the accounting for the income tax effects of the Tax Act, including any of the provisional amounts describe above. Adjustments to provisional amounts will be recorded as discrete items in the provision for income taxes in the period in which those adjustments become reasonably estimable. Such adjustments may result in the impact of the Tax Act differing from these estimates, possibly materially, during the one-year measurement period due to, among other things, further refinement of our calculations, changes in interpretations and assumptions we have made, interpretations and regulatory changes from the Internal Revenue Service, the SEC, the FASB and various tax jurisdictions, or actions we may take. We will complete our analysis no later than December 22, 2018.
We are in the process of analyzing the effects of the new tax provisions that potentially impact certain foreign income, expenses and credits, such as GILTI (global intangible low-taxed income), BEAT (base-erosion anti-abuse tax), and FDII (foreign-derived intangible income). We have not recorded any impact for GILTI, BEAT or FDII in 2017. The ultimate impact of the Tax Act on our effective tax rate in future periods will depend on interpretations and regulatory changes from the Internal Revenue Service, the SEC, the FASB and various tax jurisdictions, or actions we may take.
Income (loss) before income taxes, classified by source of income (loss), is as follows (in millions):

 
2017
 
2016
 
2015
Canadian
$
1,223.6

 
$
1,050.1

 
$
546.9

Foreign
(121.9
)
 
149.7

 
127.0

Income before income taxes
$
1,101.7

 
$
1,199.8

 
$
673.9


Income tax (benefit) expense attributable to income from continuing operations consists of the following (in millions):

 
2017
 
2016
 
2015
Current:
 
 
 
 
 
Canadian
$
438.1

 
$
78.6

 
$
107.2

U.S. Federal
113.2

 
45.4

 
46.1

U.S. state, net of federal income tax benefit
3.0

 
1.5

 
4.1

Other Foreign
54.5

 
38.3

 
37.1

 
$
608.8

 
$
163.8

 
$
194.5

Deferred:
 
 
 
 
 
Canadian
$
(301.8
)
 
$
49.0

 
$
(48.1
)
U.S. Federal
(473.3
)
 
37.0

 
21.0

U.S. state, net of federal income tax benefit
34.3

 
(6.9
)
 
(7.5
)
Other Foreign
(1.6
)
 
1.0

 
2.3

 
$
(742.4
)
 
$
80.1

 
$
(32.3
)
Income tax (benefit) expense
$
(133.6
)
 
$
243.9

 
$
162.2


The statutory rate reconciles to the effective income tax rate as follows:

 
2017
 
2016
 
2015
Statutory rate
26.5
 %
 
26.5
 %
 
26.5
 %
Costs and taxes related to foreign operations
9.9

 
9.6

 
16.7

Foreign exchange gain (loss)
(7.7
)
 
0.1

 
(1.9
)
Foreign tax rate differential
(1.9
)
 
(1.0
)
 
(5.4
)
Change in valuation allowance
12.0

 
0.2

 
4.7

Change in accrual for tax uncertainties
(0.4
)
 
1.0

 
0.7

Deductible FTC
(1.0
)
 
—

 
—

Intercompany financing
(19.5
)
 
(16.0
)
 
(20.2
)
Impact of Tax Act
(27.4
)
 
—

 
—

Benefit from stock option exercises
(4.9
)
 
—

 
—

Other
2.3

 
(0.1
)
 
3.0

Effective income tax rate
(12.1
)%
 
20.3
 %
 
24.1
 %

Our effective income tax rate was (12.1)% for 2017 and 20.3% for 2016. The change in our effective tax rate in 2017 compared to 2016 is primarily due to the impact of the Tax Act, including the remeasurement of deferred tax liabilities, partially offset by the net impact of Transition Tax and provisional charges, in each case as described above. Our effective income tax rate in 2017 also includes a benefit from stock option exercises as a result of the required adoption of a new share-based compensation accounting standard, as well as differing tax rules applicable to certain subsidiaries outside Canada. These factors were partially offset by a valuation allowance on foreign exchange capital losses. Our effective income tax rate was 24.1% for 2015, primarily due to the impact of the acquisition of Tim Hortons in 2014, including non-deductible transaction related costs, and the mix of income from multiple tax jurisdictions.
Income tax (benefit) expense allocated to continuing operations and amounts separately allocated to other items was (in millions):

 
2017
 
2016
 
2015
Income tax (benefit) expense from continuing operations
$
(133.6
)
 
$
243.9

 
$
162.2

Cash flow hedge in accumulated other comprehensive income (loss)
5.1

 
(1.6
)
 
(21.5
)
Net investment hedge in accumulated other comprehensive income (loss)
(12.8
)
 
12.3

 
111.7

Pension liability in accumulated other comprehensive income (loss)
(2.0
)
 
(1.6
)
 
(7.0
)
Stock option tax benefit in common shares
—

 
(8.6
)
 
(0.5
)
Total
$
(143.3
)
 
$
244.4

 
$
244.9


The significant components of deferred income tax (benefit) expense attributable to income from continuing operations are as follows (in millions):

 
2017
 
2016
 
2015
Deferred income tax (benefit) expense
$
(449.3
)
 
$
77.6

 
$
(51.9
)
Change in valuation allowance
132.7

 
2.1

 
31.8

Change in effective U.S. federal income tax rate
(432.9
)
 
—

 
—

Change in effective U.S. state income tax rate
3.6

 
(2.9
)
 
(7.2
)
Change in effective foreign income tax rate
3.5

 
3.3

 
(5.0
)
Total
$
(742.4
)
 
$
80.1

 
$
(32.3
)

The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities are presented below (in millions):

 
As of December 31,
 
2017
 
2016
Deferred tax assets:
 
 
 
Accounts and notes receivable
$
5.2

 
$
6.7

Accrued employee benefits
48.7

 
67.9

Unfavorable leases
146.1

 
153.8

Liabilities not currently deductible for tax
73.8

 
42.4

Tax loss and credit carryforwards
549.8

 
231.3

Derivatives
135.8

 
—

Other
0.4

 
17.2

Total gross deferred tax assets
959.8

 
519.3

Valuation allowance
(281.5
)
 
(132.9
)
Net deferred tax assets
678.3

 
386.4

Less deferred tax liabilities:
 
 
 
Property and equipment, principally due to differences in depreciation
33.3

 
64.8

Intangible assets
1,790.9

 
1,723.8

Leases
128.6

 
150.9

Statutory impairment
26.4

 
23.5

Derivatives
—

 
25.4

Outside basis difference
67.6

 
102.9

Total gross deferred tax liabilities
2,046.8

 
2,091.3

Net deferred tax liability
$
1,368.5

 
$
1,704.9


The valuation allowance had a net increase of $148.6 million during 2017 primarily due to foreign exchange capital losses. These losses were previously partially offset by deferred tax liabilities related to intercompany loans, which were settled during the current year.
Changes in the valuation allowance are as follows (in millions):

 
2017
 
2016
 
2015
Beginning balance
$
132.9

 
$
124.6

 
$
68.8

Additions due to acquisition
9.4

 
—

 
—

Change in estimates recorded to deferred income tax expense
132.7

 
2.1

 
31.8

Expiration of foreign tax credits and capital losses
—

 
—

 
(3.2
)
Changes from foreign currency exchange rates
5.5

 
(0.7
)
 
(8.2
)
True-ups from changes in losses and credits
0.8

 
6.9

 
35.4

Additions related to other comprehensive income
0.2

 
—

 
—

Ending balance
$
281.5

 
$
132.9

 
$
124.6


The gross amount and expiration dates of operating loss and tax credit carry-forwards as of December 31, 2017 are as follows (in millions):
 
 
Amount
 
Expiration Date
Canadian net operating loss carryforwards
$
1,161.2

 
2032-2037
Canadian capital loss carryforwards
893.0

 
Indefinite
U.S. state net operating loss carryforwards
676.7

 
2018-2037
U.S. capital loss carryforwards
58.2

 
2018
U.S. foreign tax credits
24.5

 
2019-2026
Other foreign net operating loss carryforwards
219.6

 
Indefinite
Other foreign net operating loss carryforwards
9.0

 
2023-2026
Other foreign capital loss carryforward
31.8

 
Indefinite
Foreign credits
1.8

 
2023-2036
Total
$
3,075.8

 
 

In prior periods, we provided deferred taxes on certain undistributed foreign earnings. Under our transition to a modified territorial tax system whereby all previously untaxed undistributed foreign earnings are subject to a transition tax charge at reduced rates and future repatriations of foreign earnings will generally be exempt from U.S. tax, we wrote off the existing deferred tax liability on undistributed foreign earnings and recorded the impact of the new transition tax charge on foreign earnings. We will continue to monitor available evidence and our plans for foreign earnings and expect to continue to provide any applicable deferred taxes based on the tax liability or withholding taxes that would be due upon repatriation of amounts not considered permanently reinvested.
We had $461.0 million of unrecognized tax benefits at December 31, 2017, which if recognized, would favorably affect the effective income tax rate. A reconciliation of the beginning and ending amounts of unrecognized tax benefits is as follows (in millions):
 
 
2017
 
2016
 
2015
Beginning balance
$
240.6

 
$
238.6

 
$
41.6

Additions on tax position related to the current year
186.3

 
2.0

 
0.8

Additions for tax positions of prior years
41.2

 
6.2

 
4.3

Additions for tax positions taken in conjunction with acquisition of Tim Hortons
1.8

 
—

 
202.5

Reductions for tax positions of prior year
(0.2
)
 
(1.0
)
 
(2.8
)
Reductions for settlement
(1.7
)
 
(4.6
)
 
(7.4
)
Reductions due to statute expiration
(7.0
)
 
(0.6
)
 
(0.4
)
Ending balance
$
461.0

 
$
240.6

 
$
238.6


During the twelve months beginning January 1, 2018, it is reasonably possible we will reduce unrecognized tax benefits by approximately $24.3 million, primarily as a result of the expiration of certain statutes of limitations and the resolution of audits.
We recognize interest and penalties related to unrecognized tax benefits in income tax expense. The total amount of accrued interest and penalties was $36.9 million and $27.3 million at December 31, 2017 and 2016, respectively. Potential interest and penalties associated with uncertain tax positions recognized was $9.6 million during 2017, $11.2 million during 2016 and $3.3 million during 2015. To the extent interest and penalties are not assessed with respect to uncertain tax positions, amounts accrued will be reduced and reflected as a reduction of the overall income tax provision.
We file income tax returns with Canada and its provinces and territories. Generally we are subject to routine examinations by the Canada Revenue Agency (“CRA”). The CRA is conducting examinations of the 2010 through 2014 taxation years. Additionally, income tax returns filed with various provincial jurisdictions are generally open to examination for periods of three to five years subsequent to the filing of the respective return.
We also file income tax returns, including returns for our subsidiaries, with U.S. federal, U.S. state, and foreign jurisdictions. Generally we are subject to routine examination by taxing authorities in the U.S. jurisdictions, as well as foreign tax jurisdictions. None of the foreign jurisdictions should be individually material. The examination phase of our U.S. federal income tax returns for fiscal 2009, 2010, the period July 1, 2010 through October 18, 2010 and the period October 19, 2010 through December 31, 2010 was completed during 2015. Various tax positions related to those years are currently under appeals. During 2017, the U.S. Internal Revenue Service commenced the audit of the fiscal year 2014 U.S. federal income tax returns for our U.S. companies. We have various U.S. state and foreign income tax returns in the process of examination. From time to time, these audits result in proposed assessments where the ultimate resolution may result in owing additional taxes. We believe that our tax positions comply with applicable tax law and that we have adequately provided for these matters.