Income Taxes
On December 22, 2017, the Tax Cuts and Jobs Act (“U.S. Tax Reform”) was enacted by the U.S. federal government. The legislation significantly changed U.S. tax law by, among other things, lowering the federal corporate tax rate from 35.0% to 21.0%, effective January 1, 2018, implementing a territorial tax system, and imposing a one-time toll charge on deemed repatriated earnings of foreign subsidiaries as of December 30, 2017. In addition, there are many new provisions, including changes to bonus depreciation, the deduction for executive compensation and interest expense, a tax on global intangible low-taxed income provisions (“GILTI”), the base erosion anti-abuse tax (“BEAT”), and a deduction for foreign-derived intangible income (“FDII”). The two material items that impacted us in 2017 were the corporate tax rate reduction and the one-time toll charge. While the corporate tax rate reduction is effective January 1, 2018, we accounted for this anticipated rate change in 2017, the period of enactment.
The SEC issued Staff Accounting Bulletin No. 118 (“SAB 118”), which provides us with up to one year to finalize accounting for the impacts of U.S. Tax Reform. When the initial accounting for U.S Tax Reform impacts is incomplete, we may include provisional amounts when reasonable estimates can be made or continue to apply the prior tax law if a reasonable estimate cannot be made. We have estimated the provisional tax impacts related to the toll charge, certain components of the revaluation of deferred tax assets and liabilities, including depreciation and executive compensation, and the change in our indefinite reinvestment assertion. As a result, we recognized a net tax benefit of approximately $7.0 billion, including a reasonable estimate of our deferred income tax benefit of approximately $7.5 billion related to the corporate rate change, which was partially offset by a reasonable estimate of $312 million for the toll charge and approximately $125 million for other tax expenses, including a change in our indefinite reinvestment assertion. We have elected to account for the tax on GILTI as a period cost and thus have not adjusted any of the deferred tax assets and liabilities of our foreign subsidiaries for U.S. Tax Reform. The ultimate impact may differ from these provisional amounts due to gathering additional information to more precisely compute the amount of tax, changes in interpretations and assumptions, additional regulatory guidance that may be issued, and actions we may take. We expect to finalize accounting for the impacts of U.S. Tax Reform when the 2017 U.S. corporate income tax return is filed in 2018.
In connection with U.S. Tax Reform, we have also reassessed our international investment assertions and no longer consider the historic earnings of our foreign subsidiaries as of December 30, 2017 to be indefinitely reinvested. We have made a reasonable estimate of local country withholding taxes that would be owed when our historic earnings are distributed. As a result, we have recorded deferred income taxes of $96 million on approximately $1.2 billion of historic earnings.
Income/(loss) before income taxes and the provision for/(benefit from) income taxes, consisted of the following (in millions):
|
| | | | | | | | | | | |
| December 30,
2017
(52 weeks) | | December 31,
2016
(52 weeks) | | January 3,
2016
(53 weeks) |
Income/(loss) before income taxes: | | | | | |
United States | $ | 3,876 |
| | $ | 3,358 |
| | $ | (13 | ) |
International | 1,654 |
| | 1,665 |
| | 1,026 |
|
Total | $ | 5,530 |
| | $ | 5,023 |
| | $ | 1,013 |
|
| | | | | |
Provision for/(benefit from) income taxes: | | | | | |
Current: | | | | | |
U.S. federal | $ | 757 |
| | $ | 1,095 |
| | $ | 427 |
|
U.S. state and local | (46 | ) | | 76 |
| | 22 |
|
International | 296 |
| | 239 |
| | 234 |
|
| 1,007 |
| | 1,410 |
| | 683 |
|
Deferred: | | | | | |
U.S. federal | (6,570 | ) | | 31 |
| | (173 | ) |
U.S. state and local | 101 |
| | (60 | ) | | (70 | ) |
International | 2 |
| | — |
| | (74 | ) |
| (6,467 | ) | | (29 | ) | | (317 | ) |
Total provision for/(benefit from) income taxes | $ | (5,460 | ) | | $ | 1,381 |
| | $ | 366 |
|
Tax benefits related to the exercise of stock options and other equity instruments recorded directly to additional paid-in capital totaled $30 million in 2016 and $10 million in 2015. In the first quarter of 2017, we prospectively adopted ASU 2016-09. We now record tax benefits related to the exercise of stock options and other equity instruments within our tax provision, rather than within equity. Accordingly, we recognized a tax benefit of $22 million within our 2017 statement of income related to tax benefits upon the exercise of stock options and other equity instruments.
The effective tax rate on income/(loss) before income taxes differed from the U.S. federal statutory tax rate for the following reasons:
|
| | | | | | | | |
| December 30,
2017
(52 weeks) | | December 31,
2016
(52 weeks) | | January 3,
2016
(53 weeks) |
U.S. federal statutory tax rate | 35.0 | % | | 35.0 | % | | 35.0 | % |
Increase/(decrease) resulting from: | | | | | |
Tax on income of foreign subsidiaries | (4.7 | )% | | (3.6 | )% | | (11.8 | )% |
Domestic manufacturing deduction | (1.5 | )% | | (1.9 | )% | | (2.9 | )% |
U.S. state and local income taxes, net of federal tax benefit | 1.1 | % | | 0.8 | % | | (0.6 | )% |
Earnings repatriation | 0.4 | % | | 0.4 | % | | 21.9 | % |
Tax exempt income | (0.7 | )% | | (3.3 | )% | | (10.9 | )% |
Deferred tax effect of statutory tax rate changes | 0.3 | % | | (2.0 | )% | | (10.4 | )% |
Audit settlements and changes in uncertain tax positions | (0.1 | )% | | 1.8 | % | | 6.2 | % |
Venezuela nondeductible devaluation loss | — | % | | 0.2 | % | | 9.9 | % |
Impact of U.S. Tax Reform | (127.3 | )% | | — | % | | — | % |
Other | (1.2 | )% | | 0.1 | % | | (0.2 | )% |
Effective tax rate | (98.7 | )% | | 27.5 | % | | 36.2 | % |
The provision for income taxes consists of provisions for federal, state and foreign income taxes. We operate in an international environment; accordingly, the consolidated effective tax rate is a composite rate reflecting the earnings in various locations and the applicable tax rates. Additionally, the calculation of the percentage point impact of U.S. Tax Reform, domestic manufacturing deductions, tax exempt income, uncertain tax positions and other items on the effective tax rate shown in the table above are affected by income/(loss) before income taxes. Fluctuations in the amount of income generated across locations around the world could impact comparability of reconciling items between periods.
The tax provision for the 2017 tax year benefited from U.S. Tax Reform enacted on December 22, 2017. The related income tax benefit of 127.3% in 2017 primarily reflects adjustments to our deferred tax positions for the lower federal income tax rate, partially offset by our provision for the one-time toll charge.
Due to the 2015 Merger, the tax provision for 2016 reflected a much greater percentage of U.S. income, which unfavorably impacted the effective tax rate compared to 2015. The tax provision for the 2015 tax year benefited from a favorable jurisdictional income mix and from impairment losses recorded in the U.S.
The 2016 and 2015 tax years included a benefit related to the tax effect of statutory tax rate changes. Small movements in tax rates due to a change in tax law or a change in tax rates that causes us to revalue our deferred tax balances produces volatility in our effective tax rate. In addition:
| |
• | The 2016 tax year included a benefit related to the impact on deferred taxes of a 10 basis point reduction in the state tax rate and a 100 basis point statutory rate reduction in the United Kingdom. |
| |
• | The 2015 tax year included a benefit related to the impact on deferred taxes of a 200 basis point statutory rate reduction in the United Kingdom. |
The tax effects of temporary differences and carryforwards that gave rise to deferred income tax assets and liabilities consisted of the following (in millions):
|
| | | | | | | |
| December 30, 2017 | | December 31, 2016 |
Deferred income tax liabilities: | | | |
Intangible assets, net | $ | 13,637 |
| | $ | 20,946 |
|
Property, plant and equipment, net | 641 |
| | 1,035 |
|
Other | 293 |
| | 532 |
|
Deferred income tax liabilities | 14,571 |
| | 22,513 |
|
Deferred income tax assets: | | | |
Benefit plans | (212 | ) | | (1,025 | ) |
Other | (428 | ) | | (782 | ) |
Deferred income tax assets | (640 | ) | | (1,807 | ) |
Valuation allowance | 80 |
| | 89 |
|
Net deferred income tax liabilities | $ | 14,011 |
| | $ | 20,795 |
|
The $9 million decrease in our valuation allowance in 2017 reflects the impact of releasing valuation allowances for foreign net operating losses and foreign tax credits that we anticipate being able to utilize.
At December 30, 2017, foreign operating loss carryforwards totaled $336 million. Of that amount, $41 million expire between 2018 and 2037; the other $295 million do not expire. We have recorded $84 million of deferred tax assets related to these foreign operating loss carryforwards. Additionally, we have foreign operating loss carryforwards of $1.0 billion for which the realization of a tax benefit is considered remote and, as a result, we have recorded a full valuation allowance for the tax benefits. However, due to the remote likelihood of utilizing these losses, neither the deferred tax asset nor the offsetting valuation allowance has been presented in the table above. Deferred tax assets of $39 million have been recorded for U.S. state and local operating loss carryforwards. These losses expire between 2018 and 2037.
Deferred tax assets of $7 million have been recorded for U.S. foreign tax credit carryforwards. These credit carryforwards expire between 2020 and 2025.
At December 30, 2017, our unrecognized tax benefits for uncertain tax positions were $408 million. If we had recognized all of these benefits, the impact on our effective tax rate would have been $316 million. It is reasonably possible that our unrecognized tax benefits will decrease by as much as $105 million in the next 12 months primarily due to the progression of federal, state, and foreign audits in process. Our unrecognized tax benefits for uncertain tax positions are included in income taxes payable (current liabilities) and other liabilities (long-term) on our consolidated balance sheets.
The changes in our unrecognized tax benefits were (in millions):
|
| | | | | | | | | | | |
| December 30,
2017
(52 weeks) | | December 31,
2016
(52 weeks) | | January 3,
2016
(53 weeks) |
Balance at the beginning of the period | $ | 389 |
| | $ | 353 |
| | $ | 71 |
|
Increases for tax positions of prior years | 2 |
| | 59 |
| | 25 |
|
Decreases for tax positions of prior years | (35 | ) | | (18 | ) | | (9 | ) |
Increases based on tax positions related to the current year | 135 |
| | 62 |
| | 33 |
|
Increases due to acquisitions of businesses | — |
| | — |
| | 242 |
|
Decreases due to settlements with taxing authorities | (59 | ) | | (62 | ) | | — |
|
Decreases due to lapse of statute of limitations | (24 | ) | | (5 | ) | | (9 | ) |
Balance at the end of the period | $ | 408 |
| | $ | 389 |
| | $ | 353 |
|
Our unrecognized tax benefits increased during 2017 as a result of evaluating tax positions taken or expected to be taken on our federal, state, and foreign income tax returns. This increase was partially offset primarily as a result of audit settlements with federal, state and foreign taxing authorities and statute of limitations expirations.
In the third quarter of 2016, we reached an agreement with the IRS resolving all Kraft open matters related to the audits of taxable years 2012 through 2014. This settlement reduced our reserves for uncertain tax positions and resulted in a non-cash tax benefit of $42 million.
The gross unrecognized tax balance increased substantially for the year ended January 3, 2016 as a result of the 2015 Merger purchase accounting.
We include interest and penalties related to uncertain tax positions in our tax provision. Our provision for/(benefit from) income taxes included a $24 million benefit in 2017, $8 million expense in 2016, and $18 million expense in 2015 related to interest and penalties. Accrued interest and penalties were $57 million as of December 30, 2017 and $81 million as of December 31, 2016.
In the normal course of business, we are subject to examination by taxing authorities throughout the world, including such major jurisdictions as Australia, Canada, Italy, the Netherlands, the United Kingdom, and the United States. We have substantially concluded all national income tax matters through 2015 for the Netherlands, through 2014 for the United States, through 2012 for the United Kingdom, through 2011 for Australia, and through 2010 for Canada and Italy. We have substantially concluded all state income tax matters through 2007.
We have a tax sharing agreement with Mondelēz International, Inc. (“Mondelēz International”), which generally provides that (i) we are liable for U.S. state income taxes and Canadian federal and provincial income taxes for Kraft periods prior to October 1, 2012 and (ii) Mondelēz International is responsible for U.S. federal income taxes and substantially all non-U.S. income taxes, excluding Canadian income taxes, for Kraft periods prior to October 1, 2012.
Kraft's U.S. operations were included in Mondelēz International's U.S. federal consolidated income tax returns for tax periods through October 1, 2012. In December 2016, Mondelēz International reached a final resolution on a U.S. federal income tax audit of the 2010-2012 tax years. As noted above, we are indemnified for U.S. federal income taxes related to these periods.