Income Taxes
In December 2017, the Tax Cuts and Jobs Act (the “2017 Tax Act”) was enacted. The 2017 Tax Act includes a number of changes to existing U.S. tax laws that impact the Company, most notably a reduction of the U.S. corporate income tax rate from 35% to 21%, effective as of January 1, 2018. The 2017 Tax Act also provides for a one-time transition tax on certain foreign earnings that were previously deferred, immediate expensing for certain assets placed into service after September 27, 2017, and a Global intangible low-taxed income (“GILTI”) provision which requires U.S. income inclusion of foreign subsidiary earnings in excess of an allowable return on the foreign subsidiary’s tangible assets.
The Company recognized the income tax effects of the 2017 Tax Act in its 2017 financial statements in accordance with Staff Accounting Bulletin No. 118 (“SAB 118”), which provides SEC staff guidance for the application of ASC Topic 740, Income Taxes, in the reporting period in which the 2017 Tax Act was signed into law. At December 31, 2017, the Company has not completed its accounting for the tax effects of enactment of the 2017 Tax Act; however, in certain instances, as described below, the Company has made a reasonable estimate (provisional amount) of the effects on its existing deferred tax balances and one-time transition tax. In other cases, the Company has not been able to make a reasonable estimate and continues to account for those items based on the existing accounting under ASC Topic 740, and the provisions of the tax laws that were in effect prior to enactment. For the items which the Company was able to determine a reasonable estimate, a provisional benefit of $3.2 million was recognized, as described below, which is included as a component of income tax expense from continuing operations. In all cases, the Company will continue to make and refine its calculations as additional analysis is completed. Moreover, the Company’s provisional estimates may also be affected as it gains a more thorough understanding of the 2017 Tax Act. Finally, the Company is evaluating whether it will be subject to incremental U.S. tax on GILTI, beginning in 2018, due to expense allocations required under the U.S. foreign tax credit rules. The Company has provisionally elected to account for GILTI tax in the period in which it is incurred, and therefore, has not provided any provisional deferred tax impacts of GILTI in its consolidated financial statements for the year ended December 31, 2017.
Provisional amounts
Deferred tax assets and liabilities - the Company re-measured certain deferred tax assets and liabilities based on the rates at which these items are expected to reverse in the future, which is 21%. However, the Company is still analyzing certain aspects of the 2017 Tax Act and refining its calculations, which potentially could affect the measurement of these balances or potentially give rise to new deferred tax amounts. The provisional amount recorded related to the re-measurement of the Company’s deferred tax balance was a benefit of $4.5 million.
Foreign tax effects - the one-time transition tax is based on the Company’s total post-1986 earnings and profits (“E&P”) that were previously deferred from U.S. income taxes. The Company recorded a provisional amount for the one-time transition tax liability on E&P from its Canadian subsidiary, resulting in an increase in income tax expense of $1.3 million. The Company has not yet completed its calculation of the total post-1986 E&P for the Canadian subsidiary. Further, the transition tax is based in part on the amount of those earnings held in cash and other specified assets. This amount may change when the Company finalizes its calculation of post-1986 foreign E&P previously deferred from U.S. federal taxation, and finalizes the amounts held in cash or other specified assets.
Components of net income before taxes were as follows (in millions):
|
| | | | | | | | | | | | |
| | For the year
January 2, 2017 to December 31, 2017 | | For the year
January 4, 2016 to January 1, 2017 | | For the year
December 29, 2014 to January 3, 2016 |
U.S. | | $ | 69.2 |
| | $ | 49.6 |
| | $ | 47.1 |
|
Foreign | | 3.4 |
| | 2.3 |
| | 1.3 |
|
Total | | $ | 72.6 |
| | $ | 51.9 |
| | $ | 48.4 |
|
Components of income tax expense (benefit) were as follows (in millions):
|
| | | | | | | | | | | | |
| | For the year
January 2, 2017 to December 31, 2017 | | For the year
January 4, 2016 to January 1, 2017 | | For the year
December 29, 2014 to January 3, 2016 |
Current income tax expense | | | | | | |
U.S. federal | | $ | 28.7 |
| | $ | 26.1 |
| | $ | 21.7 |
|
U.S. state and local | | 4.9 |
| | 4.5 |
| | 4.9 |
|
Foreign | | 0.9 |
| | 0.6 |
| | 0.4 |
|
Total current | | 34.5 |
| | 31.2 |
| | 27.0 |
|
Deferred income tax (benefit) expense | | | | | | |
U.S. federal | | (15.5 | ) | | (8.9 | ) | | (6.8 | ) |
U.S. state and local | | (1.0 | ) | | (1.0 | ) | | (0.7 | ) |
Foreign | | — |
| | — |
| | — |
|
Total deferred | | (16.5 | ) | | (9.9 | ) | | (7.5 | ) |
Total | | $ | 18.0 |
| | $ | 21.3 |
| | $ | 19.5 |
|
The Company’s effective tax rate was 24.8%, 41.0%, and 40.3% for the years ended December 31, 2017, January 1, 2017, and January 3, 2016, respectively. The following table provides a reconciliation of income tax expense (benefit) at the statutory U.S. federal tax rate to actual income tax expense (benefit) for the periods presented (in millions):
|
| | | | | | | | | | | | |
| | For the year
January 2, 2017 to December 31, 2017 | | For the year
January 4, 2016 to January 1, 2017 | | For the year
December 29, 2014 to January 3, 2016 |
U.S. federal statutory expense (benefit) | | $ | 25.4 |
| | $ | 18.2 |
| | $ | 16.9 |
|
State and local income taxes, net | | 2.0 |
| * | 1.9 |
| | 2.5 |
|
Excess tax benefits pursuant to ASU 2016-09 | | (6.1 | ) | | — |
| | — |
|
Enactment of 2017 Tax Act - deferred tax re-measurement, net | | (4.5 | ) | | — |
| | — |
|
Enactment of 2017 Tax Act - transition tax | | 1.3 |
| | — |
| | — |
|
Transaction costs | | 0.4 |
| | 1.1 |
| | — |
|
Other, net | | (0.5 | ) | | 0.1 |
| | 0.1 |
|
Income tax expense (benefit) | | $ | 18.0 |
| | $ | 21.3 |
| | $ | 19.5 |
|
* Includes excess tax benefits pursuant to ASU 2016-09 of $(0.7) million.
Historically, U.S. income tax has not been recognized on the excess of the amount for financial reporting over the tax basis of the Company’s investment in its Canadian subsidiary caused by foreign earnings that are indefinitely reinvested outside the U.S. At December 31, 2017, unremitted earnings of the Canadian subsidiary have been included in the computation of the transition tax associated with the 2017 Tax Act. The Company remains indefinitely reinvested with respect to its initial investment and any associated potential withholding tax on earnings of its Canadian subsidiary subject to the transition tax, as well as with respect to future earnings that will primarily fund the operations of the subsidiary; however, the Company continues to evaluate its position under SAB 118.
Deferred income taxes reflect the expected future tax consequences of temporary differences between the financial statement carrying amount of the Company’s assets and liabilities, tax credits, and loss carry forwards. The significant components of deferred income taxes are as follows (in millions):
|
| | | | | | | | |
| | December 31, 2017 | | January 1, 2017 |
Deferred tax assets: | | | | |
Net operating losses | | $ | 5.2 |
| | $ | 4.1 |
|
Allowance for uncollectible accounts | | 3.2 |
| | 4.2 |
|
Inventory | | 2.2 |
| | 3.1 |
|
Reserve for sales bonuses | | 3.6 |
| | 4.2 |
|
Accrued compensation | | 2.8 |
| | 3.1 |
|
Stock compensation | | 2.5 |
| | 2.5 |
|
Rent accrual | | 1.6 |
| | 2.1 |
|
Environmental reserve | | 0.6 |
| | 0.9 |
|
Deferred transaction costs | | 1.8 |
| | 2.3 |
|
Other | | 1.1 |
| | 1.8 |
|
Total gross deferred tax assets | | 24.6 |
| | 28.3 |
|
Valuation allowance | | (5.2 | ) | | (4.1 | ) |
Total net deferred tax assets | | 19.4 |
| | 24.2 |
|
Deferred tax liabilities: | | | | |
Fixed assets and land | | (5.8 | ) | | (8.0 | ) |
Intangible assets | | (16.9 | ) | | (30.3 | ) |
Goodwill | | (2.5 | ) | | (2.8 | ) |
Deferred financing costs | | (1.7 | ) | | (2.4 | ) |
Other | | (0.9 | ) | | (0.7 | ) |
Total deferred tax liabilities | | (27.8 | ) | | (44.2 | ) |
Net deferred tax liabilities | | $ | (8.4 | ) | | $ | (20.0 | ) |
The Company evaluates its deferred tax assets to determine the need for a valuation allowance, and to conclude whether it is more likely than not that those deferred income tax assets will be realized. Management assesses the available positive and negative evidence to establish whether sufficient future taxable income will be generated to permit use of the existing deferred tax assets. On the basis of this evaluation, as of December 31, 2017 and January 1, 2017, a valuation allowance of $5.2 million and $4.1 million, respectively, has been recorded against deferred tax assets related primarily to state net operating loss carryforwards for separate returns the Company believes are more likely than not to expire unused. Activity within the tax valuation allowance for the periods was as follows (in millions):
|
| | | | | | | | | | | | |
| | For the year
January 2, 2017 to December 31, 2017 | | For the year
January 4, 2016 to January 1, 2017 | | For the year
December 29, 2014 to January 3, 2016 |
Beginning balance | | $ | 4.1 |
| | $ | 4.2 |
| | $ | 4.6 |
|
Increase in valuation allowance | | 1.1 |
| | — |
| | — |
|
Decrease in valuation allowance | | — |
| | (0.1 | ) | | (0.4 | ) |
Ending balance | | $ | 5.2 |
| | $ | 4.1 |
| | $ | 4.2 |
|
As of December 31, 2017, the Company had available tax-effected state NOL carryforwards of approximately $5.2 million that will expire at various dates from 2017 through 2028, if not utilized.
The Company recognizes the tax effects of uncertain tax positions only if such positions are more likely than not to be sustained based solely upon its technical merits at the reporting date. The Company refers to the difference between the tax benefit recognized in its financial statements and the tax benefit claimed in the income tax return as an unrecognized tax benefit. There was no expense or liability recorded for unrecognized tax benefits for each period presented. The Company does not expect that the unrecognized tax benefit will materially change over the next 12 months.
The Company’s policy for recording interest and penalties, if any, associated with uncertain tax positions is to recognize interest within the Interest and other non-operating expenses line item, and to recognize penalties in Selling, general and administrative expenses. For each period presented, the Company had no accrued interest or penalties related to uncertain tax positions.
The Company is subject to U.S. federal income tax, income tax in multiple state jurisdictions, and Canadian federal and provincial income tax with respect to its foreign subsidiary. With limited exceptions, years prior to 2009 are no longer open to federal, state and local examination by taxing authorities. As part of the Deere consolidated federal return audit, the Company is currently under audit for federal income tax years 2009 through 2013. The Company is also under audit by a number of state and local jurisdictions; however, no audit adjustments are anticipated that would result in a material change to the Company’s financial position.
Deere has indemnified the Company against any taxes, penalties or interest for tax periods prior to the CD&R Acquisition, accruing after the CD&R Acquisition date.