INCOME TAXES
For purposes of our consolidated and combined financial statements, income taxes have been calculated as if we filed income tax returns on a stand-alone basis for the period prior to the Spin-Off. The Company’s U.S. operations and certain of its non-U.S. operations historically were included in the tax returns of the former Parent or its subsidiaries that were not part of the Spin-Off. Therefore, the Company’s tax results for the period prior to the Spin-Off, as presented in the consolidated and combined financial statements, may not be reflective of the results that the Company will generate in the future. In jurisdictions where the Company was included in the tax returns filed by the former Parent or its subsidiaries that were not part of the Spin-Off, any income taxes payable resulting from the related income tax provision were reflected in combined balance sheets prior to and through the date of the Spin-Off within ‘‘Former parent company investment.’’
Income (loss) before income taxes and the provision for (benefit from) income taxes consisted of the following:
|
| | | | | | | | | | | |
| Year ended December 31, |
| 2017 | | 2016 | | 2015 |
Income (loss) before income taxes: | | | | | |
United States | $ | 100.6 |
| | $ | (65.5 | ) | | $ | 110.0 |
|
Foreign | (42.7 | ) | | (416.5 | ) | | 27.2 |
|
| $ | 57.9 |
| | $ | (482.0 | ) | | $ | 137.2 |
|
Provision for (benefit from) income taxes: | | | | | |
Current: | | | | | |
United States | $ | 26.6 |
| | $ | (3.9 | ) | | $ | 55.5 |
|
Foreign | 16.4 |
| | 4.9 |
| | 19.7 |
|
Total current | 43.0 |
| | 1.0 |
| | 75.2 |
|
Deferred and other: | | | | | |
United States | (30.2 | ) | | (47.4 | ) | | (13.1 | ) |
Foreign | (1.7 | ) | | (54.6 | ) | | (12.3 | ) |
Total deferred and other | (31.9 | ) | | (102.0 | ) | | (25.4 | ) |
Total provision (benefit) | $ | 11.1 |
| | $ | (101.0 | ) | | $ | 49.8 |
|
The reconciliation of income tax computed at the U.S. federal statutory tax rate to our effective income tax rate was as follows:
|
| | | | | | | | |
| Year ended December 31, |
| 2017 | | 2016 | | 2015 |
Tax at U.S. federal statutory rate | 35.0 | % | | 35.0 | % | | 35.0 | % |
State and local taxes, net of U.S. federal benefit | 1.8 |
| | 0.8 |
| | 1.7 |
|
U.S. credits and exemptions | (9.0 | ) | | 0.2 |
| | (1.6 | ) |
Tax rate differential on foreign earnings | 9.6 |
| | (3.8 | ) | | (5.5 | ) |
Adjustments to uncertain tax positions | (7.4 | ) | | 0.2 |
| | (1.7 | ) |
Changes in valuation allowance | 17.5 |
| | (1.4 | ) | | 3.8 |
|
Tax on repatriation of foreign earnings | 93.9 |
| | 0.2 |
| | 7.3 |
|
U.S. federal rate change | (123.0 | ) | | — |
| | — |
|
Stock compensation vestings | 2.2 |
| | — |
| | — |
|
Non-deductible goodwill impairment | — |
| | (15.7 | ) | | — |
|
Poland economic development incentive | — |
| | 4.9 |
| | — |
|
Other | (1.4 | ) | | 0.6 |
| | (2.7 | ) |
| 19.2 | % | | 21.0 | % | | 36.3 | % |
Significant components of our deferred tax assets and liabilities were as follows:
|
| | | | | | | |
| As of December 31, |
| 2017 | | 2016 |
Deferred tax assets: | | | |
Net operating loss and credit carryforwards | $ | 406.6 |
| | $ | 230.8 |
|
Pension, other postretirement and postemployment benefits | 10.0 |
| | 12.4 |
|
Payroll and compensation | 12.3 |
| | 19.1 |
|
Working capital accruals | 13.9 |
| | 20.6 |
|
Other | 49.7 |
| | 43.0 |
|
Total deferred tax assets | 492.5 |
| | 325.9 |
|
Valuation allowance | (83.6 | ) | | (74.9 | ) |
Net deferred tax assets | 408.9 |
| | 251.0 |
|
Deferred tax liabilities: | | | |
Accelerated depreciation | 2.4 |
| | 17.7 |
|
Intangible assets recorded in acquisitions | 74.1 |
| | 87.7 |
|
Basis difference in affiliates | 308.0 |
| | 138.3 |
|
Other | 7.2 |
| | 5.2 |
|
Total deferred tax liabilities | 391.7 |
| | 248.9 |
|
| $ | 17.2 |
| | $ | 2.1 |
|
Enactment of the Tax Cuts and Jobs Act
On December 22, 2017, the President of the United States signed into law the Tax Cuts and Jobs Act (the “Act”). The Act includes numerous changes to existing tax law, including a permanent reduction in the federal corporate income tax rate from 35% to 21%. The rate reduction is effective for the Company as of January 1, 2018. As a result of the reduction in the federal corporate income tax rate, the Company has revalued its net U.S. federal deferred tax liability. The Company has substantially completed its accounting for the revaluation of its net U.S. federal deferred tax liabilities and recorded a tax benefit of approximately $17.8 in the fourth quarter of 2017, excluding the impact for rate change on earnings which were not considered indefinitely reinvested. There are certain deferred tax balances that can only be estimated at this time, so the rate change on these balances is a provisional estimate as of December 31, 2017.
The Act provides a full dividends received deduction for any future dividends from non-U.S. subsidiaries to their U.S. parent company. Generally, this will allow the Company to repatriate cash more freely than under the historical U.S. tax system. To transition to this new tax regime, the Act also provided for a mandatory one-time "deemed repatriation" of accumulated post-1986 foreign earnings which have not been previously taxed. The Company recorded a provisional estimate for this transition tax of $50.4 in the fourth quarter of 2017. Previously, the Company had recorded taxes of $59.8 on earnings not indefinitely reinvested. In the fourth quarter, the Company recorded a benefit of $53.4 for the reduced tax rate on such earnings. The Company expects to pay U.S. federal tax of approximately $20.8 on the deemed repatriation after utilization of tax loss and foreign tax credit carryforwards. The Company will pay this amount over a period of up to the next nine years as a result of fiscal year-ends of certain foreign subsidiaries ending after December 31, 2017. The accounting for the transition tax as required by the Act is provisional at December 31, 2017 due to (1) anticipated guidance from the U.S. Treasury department on interpreting various provisions of the Act, (2) foreign subsidiaries with differing U.S. tax year-ends where final cash balances will not be known until November 2018 and (3) final foreign tax credit amounts from foreign subsidiaries that have not yet filed tax returns.
The Act is comprehensive containing several other provisions, some of which will not materially impact the Company. Other provisions, such as the taxation of Global Intangible Low-Taxed Income (“GILTI”) and the limitation of deductions for interest expense, could have significant impact to the Company’s future tax position and cash taxes. The Company has not yet adopted an accounting policy related to the provision of deferred taxes related to GILTI. As such, the Company has not recorded any deferred taxes for GILTI. The Company anticipates future issuance of U.S. Treasury department regulations and notices that will clarify significant issues dealing with the application and computation of taxes due under the GILTI provisions.
General Matters
Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. We periodically assess deferred tax assets to determine if they will likely be realized and the adequacy of deferred tax liabilities, incorporating the results of local, state, federal and foreign tax audits in our estimates and judgments.
At December 31, 2017, we had the following tax loss carryforwards available: tax loss carryforwards of various foreign jurisdictions of approximately $1,607.1 and state tax loss carryforwards of approximately $152.7. Of these amounts, $1.8 expire in 2018 and $185.5 expires at various times between 2019 and 2037. The remaining carryforwards have no expiration date. Of the respective increases during 2017 in “net operating loss and credit carryforwards” deferred tax assets and “basis difference in affiliates” deferred tax liabilities reflected in the summary of components of deferred taxes above, $177.0 related to certain of our Luxembourg subsidiaries which reported net operating losses for statutory and tax purposes resulting from impairments of the carrying values of certain of their subsidiaries. These impairments created an outside basis difference that required the recording of a deferred tax liability, and which resulted in a corresponding and offsetting increase in the Company’s net operating loss carryforwards. These increases in the components of our deferred tax positions had no impact on our results of operations in 2017 or the presentation of deferred tax assets and liabilities in our consolidated balance sheet at December 31, 2017.
Realization of deferred tax assets, including those associated with net operating loss and credit carryforwards, is dependent upon generating sufficient taxable income in the appropriate tax jurisdiction. We believe that it is more likely than not that we may not realize the benefit of certain of these deferred tax assets and, accordingly, have established a valuation allowance against certain of these deferred tax assets. Although realization is not assured for the remaining deferred tax assets, we believe it is more likely than not that the deferred tax assets will be realized through future taxable earnings or tax planning strategies. However, deferred tax assets could be reduced in the near term if our estimates of taxable income are significantly reduced or tax planning strategies are no longer viable. The valuation allowance increased by $8.7 in 2017 and increased by $4.6 in 2016. Of the net changes in 2017 and 2016, $10.2 and $6.8 were recognized as an increase in tax expense. The increase in the valuation allowance during 2017 was primarily due to current year losses carried forward and the impact of a weaker U.S. dollar on foreign currency-denominated balances, offset by previously carried forward losses which were written off during the year as a result of entity rationalization. The increase in the valuation allowance during 2016 was primarily due to current year losses carried forward, offset by the impact of a stronger U.S. dollar on foreign currency-denominated balances.
The amount of income tax that we pay annually is dependent on various factors, including the timing of certain deductions. These deductions can vary from year to year and, consequently, the amount of income taxes paid in future years will vary from the amounts paid in prior years.
Undistributed Foreign Earnings
Generally, it has been our practice and intention to reinvest the earnings of most of our non-U.S. subsidiaries in those operations with a few limited exceptions. As previously noted, the Act made significant changes to the taxation of undistributed foreign earnings, requiring that all previously untaxed earnings and profits of our controlled foreign corporations be subjected to a one-time mandatory repatriation tax. The transition tax will substantially eliminate the basis difference that existed previously for purposes of ASC 740. However, there are limited other taxes that could continue to apply such as foreign withholding and certain state taxes.
As of December 31, 2017, we have recorded a provision of $2.3 for foreign withholding and state taxes on the earnings we expect to repatriate. However, the Company is still evaluating the full impact of the Act on our assertion to indefinitely reinvest the earnings of our other foreign operations. Since these earnings have already been subjected to U.S. federal tax they would only be potentially subject to limited other taxes, including foreign withholding and certain state taxes.
During the fourth quarter of 2015, we repatriated sufficient foreign source income for U.S. tax purposes to allow us to utilize our 2015 foreign tax credit capacity and provided U.S. taxes of $4.2 related to the dividend.
Unrecognized Tax Benefits
As of December 31, 2017, we had gross unrecognized tax benefits of $5.6 (net unrecognized tax benefits of $2.2), of which $2.2, if recognized, would impact our effective tax rate. Similarly, at December 31, 2016, we had gross unrecognized tax benefits of $13.9 (net unrecognized tax benefits of $5.3).
We classify interest and penalties related to unrecognized tax benefits as a component of our income tax provision. As of December 31, 2017, gross accrued interest totaled $0.2 (net accrued interest of $0.2), while the related amount as of December 31, 2016 was $1.8 (net accrued interest of $1.7). Our income tax provision for the years ended December 31, 2017, 2016 and 2015 included gross interest expense (income) of $(1.5), $0.3 and $(0.1), respectively. There were no significant penalties recorded during any year presented.
Based on the outcome of certain examinations or as a result of the expiration of statutes of limitations for certain jurisdictions, we believe that within the next 12 months it is reasonably possible that our previously unrecognized tax benefits could decrease by $0.0 to $1.5. The previously unrecognized tax benefits relate to transfer pricing matters.
The aggregate changes in the balance of unrecognized tax benefits for the years ended December 31, 2017, 2016 and 2015 were as follows:
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| | | | | | | | | | | |
| Year ended December 31, |
| 2017 | | 2016 | | 2015 |
Unrecognized tax benefit - beginning of year | $ | 13.9 |
| | $ | 25.4 |
| | $ | 27.3 |
|
Gross increases - tax positions in prior period | — |
| | 0.1 |
| | 3.6 |
|
Gross decreases - tax positions in prior period | (2.3 | ) | | (3.8 | ) | | (5.9 | ) |
Gross increases - tax positions in current period | 0.4 |
| | 2.5 |
| | 5.3 |
|
Settlements | — |
| | (8.5 | ) | | — |
|
Lapse of statute of limitations | (6.4 | ) | | (1.9 | ) | | (4.3 | ) |
Change due to foreign currency exchange rates | — |
| | 0.1 |
| | (0.6 | ) |
Unrecognized tax benefit - end of year | $ | 5.6 |
| | $ | 13.9 |
| | $ | 25.4 |
|
The unrecognized tax benefits described above represent amounts that were included in tax returns filed by the Company. Historically, a portion of the Company's operations were included in tax returns filed by the former Parent or its subsidiaries that were not part of the Spin-Off. As a result, some uncertain tax positions related to the Company's operations resulted in unrecognized tax benefits that are now potential obligations of the former Parent or its subsidiaries that were part of the Spin-Off. Because activities that gave rise to these unrecognized tax benefits related to the Company's operations, the impact of these items was recorded to "Income tax provision" within our combined statements of operations prior to the Spin-Off date, with the offset recorded to "Former parent company investment" within our combined balance sheets prior to the Spin-Off date, which were reclassified to "Paid-in capital" as of December 31, 2015.
In addition, some of the Company's tax returns included the operations of the former Parent's subsidiaries that were not part of the Spin-Off. In certain of these cases, these subsidiaries' activities gave rise to unrecognized tax benefits for which the Company could be potentially liable. When required under the Income Taxes Topic of the Codification, we have recorded a liability for these uncertain tax positions within our consolidated balance sheets. However, since the potential obligations were the result of activities associated with operations that were not part of the Spin-Off, we have not reflected any related amounts within our "Income tax provision," but instead recorded the amounts directly to "Former parent company investment" within our combined balance sheets prior to the Spin-Off date, which were reclassified to "Paid-in capital" as of December 31, 2015.
Other Tax Matters
During 2017, we recorded an income tax provision of $11.1 on $57.9 of income before income taxes, resulting in an effective tax rate of 19.2%. The effective tax rate for 2017 was impacted by an income tax benefit of $71.2 related to revaluation of our net deferred tax liabilities resulting from the change in the U.S. federal tax rate, including the reduction for earnings that were not indefinitely reinvested, and income tax charges of (i) $50.4 for the deemed repatriation tax and (ii) $11.6 resulting from losses occurring in certain jurisdictions where the tax benefit of those losses is not expected to be realized.
During 2016, our effective tax rate of 21.0% was impacted by tax benefits of (i) $59.3 resulting from the $426.4 goodwill and intangible assets impairment charge recorded by our Power and Energy reporting unit during the second quarter (an effective tax rate of 13.9%), as (a) the majority of the goodwill for the Power and Energy reporting unit had no basis for income tax purposes and (b) the impairment charge resulted in the addition of a valuation allowance for deferred income tax assets in certain jurisdictions, and (ii) $23.8 resulting from a tax incentive realized in Poland related to the expansion of our manufacturing facility in that country.
During 2015, our effective tax rate of 36.3% was impacted by tax charges of $11.7 related to dividends from foreign subsidiaries, partially offset by tax benefits of (i) $5.1 related to net changes in uncertain tax positions, (ii) $2.8 related to tax rate decreases in Italy and the U.K. and (iii) $2.0 related to foreign exchange losses recognized for income tax purposes with respect to a foreign branch.
We review our income tax positions on a continuous basis and record unrecognized tax benefits for potential uncertain positions when we determine that an uncertain position meets the criteria of the Income Taxes Topic of the Codification. As events change and resolutions occur, adjustments are made to amounts previously provided, such as in the case of audit settlements with taxing authorities.
In connection with the Spin-Off, we and the former Parent entered into a Tax Matters Agreement which, among other matters, addresses the allocation of certain tax adjustments that might arise upon examination of the 2013, 2014 and the pre-Spin-Off portion of the 2015 federal income tax returns of the former Parent. None of those returns are currently under examination, and we believe any contingencies have been adequately provided for.
State income tax returns generally are subject to examination for a period of three to five years after filing the respective tax returns. The impact on such tax returns of any federal changes remains subject to examination by various states for a period of up to one year after formal notification to the states. We have various state income tax returns in the process of examination. We believe any uncertain tax positions related to these examinations have been appropriately reflected as unrecognized tax benefits.
We have various non-U.S. income tax returns under examination. The most significant of these is the examination in Germany for the 2010 through 2014 tax years. We expect this examination will conclude in 2018. We believe that any uncertain tax positions related to these examinations have been appropriately reflected as unrecognized tax benefits.
An unfavorable resolution of one or more of the above matters could have a material adverse effect on our results of operations or cash flows in the quarter and year in which an adjustment is recorded or the tax is due or paid. As audits and examinations are still in process or we have not yet reached the final stages of the appeals process, the timing of the ultimate resolution and any payments that may be required for the above matters cannot be determined at this time.