Income Taxes
Provision for Income Taxes
The components of income before income taxes and the related provision for income taxes for 2017, 2016 and 2015 are presented below.
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| | | | | | | | | | | |
(In millions) | 2017 | | 2016 | | 2015 |
(Loss) income before income taxes: | | | | | |
Domestic | $ | (27.4 | ) | | $ | (5.9 | ) | | $ | 56.4 |
|
Foreign | (0.9 | ) | | 41.2 |
| | 0.2 |
|
Total | $ | (28.3 | ) | | $ | 35.3 |
| | $ | 56.6 |
|
Provision for (benefit from) income taxes: | | | | | |
Federal—current | $ | 27.2 |
| | $ | (4.2 | ) | | $ | 32.2 |
|
Federal—deferred | 39.4 |
| | 0.5 |
| | 0.6 |
|
State and local—current | (3.8 | ) | | (0.5 | ) | | 7.0 |
|
State and local—deferred | 2.7 |
| | — |
| | 0.1 |
|
Foreign—current | 5.7 |
| | 10.4 |
| | 21.4 |
|
Foreign—deferred | 10.9 |
| | 0.5 |
| | (5.3 | ) |
Total | $ | 82.1 |
| | $ | 6.7 |
| | $ | 56.0 |
|
The income by jurisdiction above does not reflect $277.0 million, $15.5 million and $173.1 million of domestic income resulting from repatriated earnings in 2017, 2016 and 2015, respectively.
Tax Reform
The 2017 Tax Act, which was signed into law on December 22, 2017, has resulted in significant changes to the Internal Revenue Code. These significant changes include, but are not limited to, the federal corporate tax rate being reduced from 35% to 21%, the elimination or reduction of certain domestic deductions and credits, along with limitations on interest expense and executive compensation. The 2017 Tax Act also transitions international taxation from a worldwide system to a modified territorial system and includes base erosion prevention measures on non-US earnings, which has the effect of subjecting certain earnings of our foreign subsidiaries to US taxation as global intangible low-taxed income (GILTI). Due to the complexity of the new GILTI rules, the Company is continuing to evaluate this provision of the Tax Act. The Company has not recorded any provisional amounts as of December 31, 2017 nor has management made an accounting policy choice of including taxable income related to GILTI as either a current period tax expense or factoring such amounts into our measurement of deferred taxes. All these changes are effective beginning in 2018.
The 2017 Tax Act also includes a one-time mandatory deemed repatriation tax on accumulated foreign subsidiaries previously untaxed foreign earnings (the "Transition Toll Tax").
During the year ended December 31, 2017, the Company recorded a provisional net charge of $81.7 million related to the provisions of the 2017 Tax Act, which is comprised of a $70.5 million Transition Toll Tax and a $11.2 million revaluation of net deferred tax assets. Changes in tax rates and tax laws are accounted for in the period of enactment.
Transition Toll Tax
The 2017 Tax Act eliminates the deferral of U.S. income tax on the historical unrepatriated earnings by imposing the Transition Toll Tax, which is a one-time mandatory deemed repatriation tax on undistributed earnings. The Transition Toll Tax is assessed on the U.S. shareholder's share of the foreign corporation's accumulated foreign earnings that have not previously been taxed. Earnings in the form of cash and cash equivalents will be taxed at a 15.5% and all other earnings will be taxed at 8.0%.
As of December 31, 2017, the Company has calculated its best estimate of the impact of the 2017 Tax Act in its year end income tax provision in accordance with its understanding of the act and guidance available as of the date of this filing. The provisional amount related to the one-time transition tax expense on the mandatory deemed repatriation of foreign earnings is approximately $70.5 million, which is net of foreign tax credits generated. The Transition Toll Tax will be paid over an eight-year period, starting in 2018, and will not accrue interest. After giving effect to the utilization of foreign tax credits and the consideration of state tax, the Company’s estimate of its payment for 2018 is approximately $6 million.
Effect on Deferred Assets and Liabilities
The Company's deferred tax assets and liabilities are measured at the enacted tax rate expected to apply when these temporary differences are expected to be realized or settled.
As the Company's deferred tax assets exceed the balance of deferred tax liabilities at the date of enactment, the Company has recorded a provisional tax expense of $11.2 million, reflecting the decrease in the U.S. corporate income tax rate and other changes in U.S. tax law.
Status of Company's Assessment of the 2017 Tax Act
On December 22, 2017, the SEC issued Staff Accounting Bulletin No. 118 ("SAB 118") 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 Act. The Company's accounting for the effects of the 2017 Tax Act, including the preliminary estimates of the Transition Toll Tax and the remeasurement of its deferred tax assets and liabilities is subject to the finalization of management's analysis related to certain matters, such as developing interpretations of the provisions of the 2017 Tax Act, changes to certain estimates and amounts related to the earnings and profits of certain subsidiaries and the filing of the Company's tax returns. Future U.S. Treasury regulations, administrative interpretations or court decisions interpreting the 2017 Tax Act may require further adjustments and changes in management's estimates.
The Company's final determination of the accounting of the effects of the 2017 Tax Act, including the Transition Toll Tax and the remeasurement of our deferred assets and liabilities, will be completed as additional information becomes available, but no later than one year from the enactment of the 2017 Tax Act.
The difference between the provision for income taxes at the U.S. federal income tax rate of 35.0% and GCP's overall income tax provision is summarized below.
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| | | | | | | | | | | |
(In millions) | 2017 | | 2016 | | 2015 |
Tax (benefit) provision at U.S. federal income tax rate | $ | (9.9 | ) | | $ | 12.4 |
| | $ | 19.8 |
|
Change in provision resulting from: | | | | | |
Deconsolidation of Venezuela(1) | 11.5 |
| | — |
| | — |
|
Devaluation in Venezuela | 1.4 |
| | — |
| | 21.5 |
|
2017 Tax Act | 81.7 |
| | — |
| | — |
|
Recognition of outside basis differences | (13.9 | ) | | — |
| | 9.3 |
|
U.S. foreign income inclusions | 1.1 |
| | | | (3.1 | ) |
Effect of tax rates in foreign jurisdictions | (1.0 | ) | | (4.5 | ) | | 8.6 |
|
Valuation allowance | 11.4 |
| | 0.4 |
| | — |
|
State and local income taxes, net | (1.2 | ) | | — |
| | 4.2 |
|
Benefit from domestic production activities | — |
| | — |
| | (2.6 | ) |
Return to provision – change in estimate | 0.4 |
| | — |
| | 1.2 |
|
Nondeductible expenses and non-taxable items | 3.5 |
| | 2.5 |
| | (3.0 | ) |
Research and other state credits | (0.8 | ) | | (0.7 | ) | | (0.2 | ) |
Uncertain tax positions | (0.7 | ) | | (1.6 | ) | | 0.9 |
|
Equity compensation | (1.2 | ) | | (1.7 | ) | | — |
|
Other | (0.2 | ) | | (0.1 | ) | | (0.6 | ) |
Provision for income taxes | $ | 82.1 |
| | $ | 6.7 |
| | $ | 56.0 |
|
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(1) | Amount in 2017 is offset by the benefit resulting from outside basis differences in primarily Mexico and Venezuela, which is included in the table above in "Recognition of outside basis differences." |
The income tax provision for the years ended December 31, 2017, 2016, and 2015 was $82.1 million, $6.7 million and $56.0 million respectively, representing effective tax rates of 290.1%, 19.0%, and 98.9% respectively.
The increase in the Company's effective tax rate for the year ended December 31, 2017 compared to the same period in 2016 was primarily due to the provisions of the 2017 Tax Act, an increase in valuation allowances due to the sale of Darex, partially off-set by a benefit for taxes related to outside basis differences in foreign subsidiaries. The decrease in the Company's effective tax rate for the year ended December 31, 2016 compared to the same period in 2015 was primarily due to a 2015 repatriation of foreign earnings and a non-deductible loss in Venezuela recorded in 2015.
The Company's 2017 effective tax rate of 290.1% was higher than the 35% U.S. statutory rate primarily due to net expenses recognized during the year comprised of $81.7 million due to the 2017 Tax Act, $11.5 million due to non-deductible charges for the Venezuela deconsolidation, a $13.9 million benefit due to differences between book and tax basis in Venezuela and Mexico and $11.4 million of expense due to an increase in valuation allowance primarily due to the sale of Darex.
The Company's 2016 effective tax rate of approximately 19% was lower than the 35% U.S. statutory rate primarily due to benefits recognized during the year, including $4.5 million benefit due to lower taxes in non-U.S. jurisdictions, $0.7 million benefit related to income tax credits and $1.6 million benefit related to the release of reserves for uncertain tax positions and $2.5 million expense for non-deductible expenses.
The Company's 2015 effective tax rate of approximately 99% was higher than the 35% U.S. statutory rate primarily due to $21.5 million expense related to the Venezuela nondeductible charge, $9.3 million U.S. tax expense related to the repatriation of foreign earnings in connection with the Separation, $4.2 million expense related to state and local income taxes and $3 million benefit for non-taxable amounts, $2.6 million benefit related to the domestic production activities deduction and an $8.6 million expense related to foreign withholding taxes.
For 2015, (cost) benefit from U.S. taxes on foreign earnings includes repatriation of current and prior year earnings pursuant to the Separation and is discussed in further detail below under "Unrepatriated Foreign Earnings." The nondeductible Venezuela charge is the tax effect of the $63.0 million nondeductible charge recorded during the third quarter of 2015.
As also discussed in Note 1, on February 3, 2016, the Separation of Grace and GCP was completed. In conjunction with the Separation, GCP has increased its deferred tax assets and prepaid taxes in the U.S. by approximately $76 million, which primarily relates to the step up in tax basis and transfer of a net pension liability.
Deferred Tax Assets and Liabilities
At December 31, 2017 and 2016, the deferred tax assets and liabilities consisted of the below items.
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| | | | | | | |
(In millions) | December 31, 2017 | | December 31, 2016 |
Deferred tax assets: | | | |
Foreign net operating loss carryforwards | $ | 24.5 |
| | $ | 11.6 |
|
Research and development | 2.4 |
| | 6.3 |
|
Reserves and allowances | 12.5 |
| | 14.3 |
|
Pension benefits | 8.3 |
| | 21.4 |
|
Intangible assets/goodwill | 1.4 |
| | 24.5 |
|
Stock compensation | 3.8 |
| | 4.4 |
|
Foreign tax credits | — |
| | 3.5 |
|
Other | 2.5 |
| | 2.6 |
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Total deferred tax assets | $ | 55.4 |
| | $ | 88.6 |
|
Deferred tax liabilities: | | | |
|
Properties and equipment | $ | (12.1 | ) | | $ | (12.2 | ) |
Intangible assets/goodwill | — |
| | — |
|
Other | (3.9 | ) | | (3.8 | ) |
Total deferred tax liabilities | $ | (16.0 | ) | | $ | (16.0 | ) |
Valuation Allowance: | | | |
Foreign net operating loss carryforwards | (23.9 | ) | | (2.3 | ) |
Net deferred tax assets | $ | 15.5 |
| | $ | 70.3 |
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In evaluating GCP's ability to realize its deferred tax assets ("DTAs"), GCP considers all reasonably available positive and negative evidence, including recent earnings experience, expectations of future taxable income and the tax character of that income, the period of time over which the temporary differences become deductible and the carryforward and/or carryback periods available to GCP for tax reporting purposes in the related jurisdiction. In estimating future taxable income, GCP relies upon assumptions and estimates about future activities, including the amount of future federal, state and foreign pretax operating income that GCP will generate; the reversal of temporary differences; and the implementation of feasible and prudent tax planning strategies. GCP records a valuation allowance to reduce deferred tax assets to the amount that it believes is more likely than not to be realized.
At December 31, 2017 and 2016, GCP has recorded a valuation allowance of $23.9 million and $2.3 million respectively, to reduce its net deferred tax assets to the amount that is more likely than not to be realized. The realization of deferred tax assets is dependent on the generation of sufficient taxable income in the appropriate tax jurisdictions. GCP believes it is more likely than not that the remaining deferred tax assets will be realized. If GCP were to determine that it would not be able to realize a portion of its deferred tax assets in the future, for which there is currently no valuation allowance, an adjustment to the deferred tax assets would be charged to earnings in the period such determination was made. Conversely, if GCP were to make a determination that it is more likely than not that deferred tax assets, for which there is currently a valuation allowance, would be realized, the related valuation allowance would be reduced and a benefit to earnings would be recorded.
As of December 31, 2016, the Company asserted that the weight of the positive evidence outweighed the negative evidence regarding the realization of the net deferred tax assets in Grace Brasil. In 2017, however, as a result of the sale of Darex, the Company believes it is no longer more likely than not that it will realize its Brazil deferred tax assets and has recorded a valuation allowance accordingly.
In addition to Brazil, the Company has also recorded in 2017 a valuation allowance against deferred tax assets in France and Germany, predominantly due to the sale of the Darex business. As part of sale of Darex, a capital loss was recognized in Japan on the sale of stock of the Company's Japanese subsidiary. Although this loss can be carried over in Japan, the Company may not have sufficient income to utilize this asset and has recorded a valuation allowance.
As of December 31, 2017, the company had net operating losses for income tax purposes of approximately $76.3 million. These net operating losses consist primarily of Brazil net operating losses of $23.9 million with an unlimited carryover period, $32.0 million of Japan net operating losses that begin to expire in 2026 and $7.7 million of India net operating losses that begin to expire in 2018.
Unrepatriated Foreign Earnings
As of December 31, 2017, no provision has been made for income taxes on certain undistributed earnings of foreign subsidiaries the Company provisionally intends to permanently reinvest or that may be remitted substantially tax-free. Due the transition tax on deemed repatriation required by the 2017 Tax Act, the Company has been subject to tax in 2017 on substantially all of its previously undistributed earnings from foreign subsidiaries. Beginning in 2018, the Act will generally provide a 100% deduction for U.S. federal tax purposes of dividends received by the Company from its foreign subsidiaries. However, the Company is currently evaluating the potential foreign and U.S. state tax liabilities that would result from future repatriations, if any, and how the Act will affect the Company's existing accounting position with regard to the indefinite reinvestment of undistributed foreign earnings. The Company expects to complete this evaluation and determine the impact the legislation may have on its indefinite reinvestment assertion within the measurement period provided by SAB 118.
As of December 31, 2017, the Company has $827.5 million of undistributed earnings of foreign subsidiaries. The estimated unrecorded deferred tax liability associated with these earnings is $7.8 million. Earnings of $277.0 million, $15.5 million and $173.1 million were repatriated from non-U.S. GCP subsidiaries in 2017, 2016 and 2015, respectively, resulting in an insignificant amount of U.S. income tax expense or benefit in 2017 and 2016. The tax effect of the repatriation of foreign earnings in 2015 is discussed in detail below. The tax effect of the repatriation is determined by several variables, including the tax rate applicable to the entity making the distribution, the cumulative earnings and associated foreign taxes of the entity and the extent to which those earnings may have already been taxed in the U.S.
In 2015, Grace repatriated a total of $173.1 million of foreign earnings from foreign subsidiaries transferred to GCP pursuant to the Separation. Such amount was determined based on an analysis of each non-U.S. subsidiary's requirements for working capital, debt repayment and strategic initiatives. In 2015, on a stand-alone basis (see Note 1, "Basis of Presentation and Summary of Significant Accounting and Financial Reporting Policies"), GCP incurred $9.3 million in U.S. tax expense as a result of such repatriation, increasing the Company's 2015 effective tax rate by 13.6 percentage points when compared to the U.S. federal statutory rate.
GCP believes that the Separation is a one-time, non-recurring event and that recognition of deferred taxes of undistributed earnings during 2015 would not have occurred if not for the Separation. Subsequent to the Separation, GCP expects undistributed prior year earnings of its foreign subsidiaries to remain permanently reinvested except in certain instances where repatriation of such earnings would result in minimal or no tax. GCP bases this assertion on:
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(1) | the expectation that it will satisfy its U.S. cash obligations in the foreseeable future without requiring the repatriation of prior year foreign earnings; |
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(2) | plans for significant and continued reinvestment of foreign earnings in organic and inorganic growth initiatives outside the U.S.; and |
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(3) | remittance restrictions imposed by local governments. |
GCP will continually analyze and evaluate its cash needs to determine the appropriateness of its indefinite reinvestment assertion, including further assessment under the 2017 Tax Act. The Company considers its assertion of indefinite reinvestment provisional as of December 31, 2017. As of December 31, 2017, in accordance with this assertion, the Company has not provided for any state or withholding tax exposure that would be incurred related to repatriation of foreign earnings.
In connection with the Separation, GCP and Grace entered into various agreements that govern the relationship between the parties going forward, including a tax matters agreement (the "Tax Sharing Agreement"). Under the Tax Sharing Agreement, which was entered into on the distribution date, GCP and Grace will indemnify and hold each other harmless in accordance with the principles outlined therein. Pursuant to SAB 118, GCP will continually analyze measurement and evaluate its indemnifications to determine the appropriateness under the 2017 Tax Act.
Unrecognized Tax Benefits
A reconciliation of the unrecognized tax benefits excluding interest and penalties, for the three years ended December 31, 2017, is presented below. The Company is currently evaluating the potential foreign and U.S. state tax liabilities and how the Act will affect the Company's existing accounting positions. The Company expects to complete this evaluation and determine the impact which the legislation may have on its unrecognized tax benefits within the measurement period provided by SAB 118.
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| | | |
(In millions) | Unrecognized Tax Benefits |
Balance, December 31, 2014 | $ | 5.3 |
|
Additions for prior year tax positions | 0.3 |
|
Reductions for prior year tax positions and reclassifications | (0.8 | ) |
Settlements | (0.9 | ) |
Balance, December 31, 2015 | 3.9 |
|
Transfers from Parent | 4.1 |
|
Additions for prior year tax positions | 2.5 |
|
Reductions for expirations of statute of limitations | (1.1 | ) |
Settlements | (2.0 | ) |
Balance, December 31, 2016 | 7.4 |
|
Additions for prior year tax positions | 7.0 |
|
Additions for current year tax positions | 26.0 |
|
Reductions for expirations of statute of limitations | (1.0 | ) |
Reductions for prior year tax positions and reclassifications | (5.3 | ) |
Balance, December 31, 2017 | $ | 34.1 |
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The balance of unrecognized tax benefits as of December 31, 2017, 2016 and 2015, that if recognized, would affect GCP’s effective tax rate are $33.4 million, $7.4 million and $3.9 million, respectively, GCP accrues potential interest and any associated penalties related to uncertain tax positions within "Provision for income taxes" in the Consolidated Statements of Operations. The balances of unrecognized tax benefits in the preceding table do not include accrued interest and penalties. The total amount of interest and penalties accrued on uncertain tax positions and included in the Consolidated Balance Sheets as of December 31, 2017 and 2016 was $9.0 million and $2.3 million, respectively, net of applicable federal income tax benefits.
Unrecognized tax benefits from GCP's operations are reflected in its Consolidated Financial Statements, including those that in certain jurisdictions have historically been included in tax returns filed by Grace. In such instances, uncertain tax positions related to GCP's operations may be indemnified by Grace. As of December 31, 2017, 2016 and 2015, the amount of unrecognized tax benefits considered obligations of Grace (including both interest and penalties) were $3.8 million, $3.7 million and $2.1 million, respectively.
GCP believes it is reasonably possible that in the next 12 months due to expiration of statute of limitation that the amount of the liability for unrecognized tax benefits could decrease by approximately $1.3 million, of which $0.7 million is indemnified by Grace.
GCP files U.S. federal income tax returns as well as income tax returns in various state and foreign jurisdictions. Unrecognized tax benefits relate to income tax returns for tax years that remain subject to examination by the relevant tax authorities. Since GCP's operations have historically been included in federal and state returns filed by Grace, the information reflected below for the U.S. relates to historical Grace returns.
As of December 31, 2017, the tax years for which we remain subject to United States federal income tax assessment and state and local income tax assessment upon examination are 2015 and thereafter. We are currently under examination by the Internal Revenue Service (“IRS”) for the period ended December 31, 2016.
We are also subject to taxation in various foreign jurisdictions including in Europe, the Middle East, Africa, Asia Pacific, Canada and Latin America. We are under, or may be subject to, audit or examination and additional assessments in respect of these particular jurisdictions in general for tax years 2011 and thereafter.
Foreign jurisdiction audits that have been initiated and/or are ongoing include two German audits relating to GCP Darex GmbH and GCP Germany GmbH for taxable years 2014-2015, and an Indian audit relating to GCP Applied Technologies (India) Private Limited for taxable years 2013-2014. Since GCP Darex Germany was recently sold in July 2017, any assessments pursuant to the audit will be reimbursed by GCP to the buyer.