Income Taxes
On December 22, 2017, the U.S. government enacted the Tax Cuts and Jobs Act (the “Tax Act”). The Tax Act includes significant changes to the U.S. corporate income tax system including: a federal corporate rate reduction from 35% to 21%; limitations on the deductibility of interest expense and executive compensation; creation of the base erosion anti-abuse tax (“BEAT”), a new minimum tax; and the transition of U.S. international taxation from a worldwide tax system to a modified territorial tax system. The change to a modified territorial tax system resulted in a one-time U.S. tax liability on those earnings which have not previously been repatriated to the U.S. (the “Transition Tax”), with future distributions not subject to U.S. federal income tax when repatriated. A majority of the provisions in the Tax Act are effective January 1, 2018.
In response to the Tax Act, the SEC staff issued guidance on accounting for the tax effects of the Tax Act. The guidance provides a one-year measurement period for companies to complete the accounting. We reflected the income tax effects of those aspects of the Tax Act for which the accounting is complete. To the extent our accounting for certain income tax effects of the Tax Act is incomplete but we are able to determine a reasonable estimate, we recorded a provisional estimate in the financial statements. If a company cannot determine a provisional estimate to be included in the financial statements, it should continue to apply the provisions of the tax laws that were in effect immediately before the enactment of the Tax Act.
In connection with our initial analysis of the impact of the Tax Act, we have recorded a provisional estimate of discrete net tax expense of $180 million for the period ended December 31, 2017. This discrete expense consists of provisional estimates of $1,468 million net expense for the Transition Tax payable in installments over eight years, $1,295 million net benefit for the decrease in our deferred tax liability on unremitted foreign earnings, and $7 million net expense for remeasurement of our deferred tax assets/liabilities for the corporate rate reduction and changes in our valuation allowance.
We have not completed our accounting for the income tax effects of certain elements of the Tax Act. The Tax Act creates a new requirement that certain income such as Global Intangible Low-Taxed Income (“GILTI”) earned by a controlled foreign corporation (“CFC”) must be included in the gross income of the CFC U.S. shareholder. Because of the complexity of the new GILTI and BEAT tax rules, we are continuing to evaluate these provisions of the Tax Act and whether taxes due on future U.S. inclusions related to GILTI or BEAT should be recorded as a current-period expense when incurred, or factored into a company’s measurement of its deferred taxes. As a result, we have not included an estimate of the tax expense or benefit related to these items for the period ended December 31, 2017.
For periods ended on or prior to July 17, 2015, we were a member of the eBay consolidated group and our U.S. taxable income was included in the consolidated U.S. federal income tax return of eBay as well as in returns filed by eBay with certain state and local taxing jurisdictions. Our foreign income tax returns are filed on a separate company basis. For periods ended on or prior to July 17, 2015, our income tax liability has been computed and presented herein under the “separate return method” as if PayPal were a separate tax paying entity, as modified by the benefits-for-loss approach. Accordingly, our operating losses and other tax attributes are characterized as utilized when those attributes have been utilized by other members of the eBay consolidated group; however, the benefits-for-loss approach does not impact our tax expense. Federal and unitary state income taxes incurred for periods ended on or prior to July 17, 2015 are remitted to eBay pursuant to a tax sharing agreement between the companies.
In connection with the distribution, eBay and PayPal entered into various agreements that govern the relationship between the parties going forward, including a tax matters agreement. The tax matters agreement was entered into on the distribution date. Under the tax matters agreement, eBay is generally responsible for all additional taxes (and will be entitled to all related refunds of taxes) imposed on eBay and its subsidiaries (including subsidiaries that were transferred to PayPal pursuant to the separation) arising after the distribution date with respect to the taxable periods (or portions thereof) ended on or prior to July 17, 2015, except for those taxes for which PayPal has reflected an unrecognized tax benefit in its financial statements on the distribution date.
The components of income (loss) before income taxes are as follows:
|
| | | | | | | | | | | |
| Year Ended December 31, |
| 2017 | | 2016 | | 2015 |
| (In millions) |
United States | $ | (593 | ) | | $ | (342 | ) | | $ | (253 | ) |
International | 2,793 |
| | 1,973 |
| | 1,741 |
|
Income before income taxes | $ | 2,200 |
| | $ | 1,631 |
| | $ | 1,488 |
|
The income tax expense is composed of the following:
|
| | | | | | | | | | | |
| Year Ended December 31, |
| 2017 | | 2016 | | 2015 |
| (In millions) |
Current: | | | | | |
Federal | $ | 1,522 |
| | $ | 44 |
| | $ | 34 |
|
State and local | 36 |
| | 19 |
| | (5 | ) |
Foreign | 146 |
| | 115 |
| | 104 |
|
| $ | 1,704 |
| | $ | 178 |
| | $ | 133 |
|
Deferred: | | | | | |
Federal | $ | (1,304 | ) | | $ | 90 |
| | $ | 126 |
|
State and local | (3 | ) | | (35 | ) | | 1 |
|
Foreign | 8 |
| | (3 | ) | | — |
|
| (1,299 | ) | | 52 |
| | 127 |
|
Income tax expense | $ | 405 |
| | $ | 230 |
| | $ | 260 |
|
The following is a reconciliation of the difference between the effective income tax rate and the federal statutory rate.
|
| | | | | | | | |
| Year Ended December 31, |
| 2017 | | 2016 | | 2015 |
Federal statutory rate | 35.0 | % | | 35.0 | % | | 35.0 | % |
State taxes, net of federal benefit | 0.8 | % | | (1.0 | )% | | (0.3 | )% |
Foreign income taxed at different rates | (25.7 | )% | | (23.2 | )% | | (20.9 | )% |
Stock-based compensation expense | (0.8 | )% | | 1.6 | % | | 1.5 | % |
Tax credits | (1.4 | )% | | (1.0 | )% | | (0.7 | )% |
Change in valuation allowances | 1.4 | % | | 0.5 | % | | 0.3 | % |
U.S. tax reform (the Tax Act) | 8.2 | % | | — | % | | — | % |
Other | 0.9 | % | | 2.2 | % | | 2.6 | % |
Effective income tax rate | 18.4 | % | | 14.1 | % | | 17.5 | % |
The difference between the effective income tax rate and the federal statutory rate of 35.0% to income before income taxes is primarily the result of foreign income taxed at different rates and, for the year ended December 31, 2017, the effects of the Tax Act discussed above.
Deferred tax assets and liabilities are recognized for the future tax consequences of differences between the carrying amounts of assets and liabilities and their respective tax basis using enacted tax rates in effect for the year in which the differences are expected to reverse. Significant deferred tax assets and liabilities consist of the following:
|
| | | | | | | |
| As of December 31, |
| 2017 | | 2016 |
| (In millions) |
Deferred tax assets: | | | |
Net operating loss and credit carryforwards | $ | 134 |
| | $ | 84 |
|
Accruals and allowances | 118 |
| | 187 |
|
Partnership investment | 7 |
| | 15 |
|
Stock-based compensation | 124 |
| | 99 |
|
Net unrealized (gains) losses | 10 |
| | 14 |
|
Total deferred tax assets | 393 |
| | 399 |
|
Valuation allowance | (74 | ) | | (24 | ) |
Net deferred tax assets | $ | 319 |
| | $ | 375 |
|
Deferred tax liabilities: | | | |
Unremitted foreign earnings | $ | (39 | ) | | $ | (1,246 | ) |
Fixed assets and other intangibles | (145 | ) | | (226 | ) |
Acquired intangibles | (49 | ) | | (95 | ) |
Net unrealized losses (gains) | — |
| | (2 | ) |
Total deferred tax liabilities | (233 | ) | | (1,569 | ) |
Net deferred tax assets (liabilities) | $ | 86 |
| | $ | (1,194 | ) |
The following table shows the deferred tax assets and liabilities within our consolidated balance sheet. |
| | | | | | | | | |
| | | As of December 31, |
| | | 2017 | | 2016 |
| Balance Sheet Location | | (In millions) |
Total deferred tax assets (non-current) | Other assets | | $ | 95 |
| | $ | 21 |
|
Total deferred tax liabilities (non-current) | Long-term liabilities | | (9 | ) | | (1,215 | ) |
Total net deferred tax assets (liabilities) | | | $ | 86 |
| | $ | (1,194 | ) |
As of December 31, 2017, our federal, state and foreign net operating loss carryforwards for income tax purposes were approximately $64 million, $332 million, and $177 million, respectively. The federal and state net operating loss carryforwards are subject to various limitations under Section 382 of the Code. If not utilized, the federal net operating loss carryforwards will begin to expire in 2019, and the state net operating loss carryforwards will begin to expire in 2018. Approximately $26 million of the foreign net operating loss carryforwards will expire in 2034 and a majority of the remainder has no expiration date and may be carried forward indefinitely. As of December 31, 2017, our federal and state tax credit carryforwards for income tax purposes were approximately $25 million and $101 million, respectively. The federal tax credits will begin to expire in 2032. Most of the state tax credits may be carried forward indefinitely.
In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that all or some portion of the deferred tax assets will not be realized. During the years ended December 31, 2017, and 2016, we increased our valuation allowance by $50 million and $11 million, respectively. At December 31, 2017 and 2016, we maintained a valuation allowance with respect to certain of our deferred tax assets relating to operating losses in certain states and foreign jurisdictions and tax credits in certain states that we believe are not likely to be realized.
Immediately prior to enactment of the Tax Act on December 22, 2017, we had $10.0 billion of undistributed foreign earnings. We had accrued $1,334 million of deferred U.S. income and foreign withholding taxes on the portion of these earnings that were not intended to be indefinitely reinvested in our international operations. Upon passage of the Tax Act, all $10.0 billion of undistributed foreign earnings became subject to U.S. federal tax at a reduced rate payable over an 8-year period. As a result, we reversed $1,295 million of deferred U.S. income and foreign withholding taxes and recorded a long-term U.S. tax payable of $1,468 million. Due to the change in U.S. federal tax law, management has decided not to indefinitely reinvest any of our unremitted foreign earnings as of December 31, 2017. We have accrued $39 million of deferred U.S. state and foreign withholding taxes on the $10.0 billion of undistributed foreign earnings. This is a provisional estimate pending further legislative action from the states regarding conformity with the Tax Act.
We benefit from tax rulings concluded in several different jurisdictions, most significantly Singapore and Luxembourg. These rulings result in significantly lower rates of taxation on certain classes of income and require various thresholds of investment and employment in those jurisdictions. We review our compliance on an annual basis to ensure we continue to meet our obligations under these tax rulings. These rulings resulted in tax savings of approximately $443 million, $310 million and $285 million in 2017, 2016 and 2015, respectively. The benefit of these tax rulings on our net income per share (diluted) was approximately $0.36, $0.25 and $0.23 in 2017, 2016 and 2015, respectively. These tax rulings are currently in effect and expire over periods ranging from 2020 to 2021.
The following table reflects changes in unrecognized tax benefits for the periods presented below:
|
| | | | | | | | | | | |
| Year Ended December 31, |
| 2017 | | 2016 | | 2015 |
| (In millions) |
Gross amounts of unrecognized tax benefits as of the beginning of the period | $ | 312 |
| | $ | 267 |
| | $ | 165 |
|
Increases related to prior period tax positions | 61 |
| | 14 |
| | 39 |
|
Decreases related to prior period tax positions | (23 | ) | | (18 | ) | | (4 | ) |
Increases related to current period tax positions | 112 |
| | 51 |
| | 68 |
|
Settlements | (35 | ) | | (1 | ) | | (1 | ) |
Statute of limitation expirations | (3 | ) | | (1 | ) | | — |
|
Gross amounts of unrecognized tax benefits as of the end of the period | $ | 424 |
| | $ | 312 |
| | $ | 267 |
|
If the remaining balance of unrecognized tax benefits were realized in a future period, it would result in a tax benefit of $406 million.
During all years presented, we recognized interest and penalties related to uncertain tax positions in income tax expense. In 2017 we recognized net interest and penalties of $13 million in income tax expense. The amount of interest and penalties accrued as of December 31, 2017 and 2016 was approximately $75 million and $67 million, respectively.
We are subject to taxation in the U.S. and various state and foreign jurisdictions. We are currently under examination by certain tax authorities for the 2003 to 2015 tax years. The material jurisdictions in which we are subject to examination by tax authorities for tax years after 2002 primarily include the U.S. (Federal and California), France, Germany, India, Israel, Italy, and Singapore. We believe that adequate amounts have been reserved for any adjustments that may ultimately result from these examinations. During 2017, a number of audits were closed/settled including one with Israel and another with the United Kingdom.
Although the timing of the resolution of these audits is uncertain, we do not expect the total amount of unrecognized tax benefits as of December 31, 2017 will materially change in the next 12 months. However, given the number of years remaining subject to examination and the number of matters being examined, we are unable to estimate the full range of possible adjustments to the balance of gross unrecognized tax benefits.