Income Taxes
Prior to the spin-off from Xerox Corporation, Conduent’s operating results were included in various Xerox consolidated U.S. federal and state income tax returns, as well as non-U.S. tax filings. For the purposes of the Company’s Consolidated and Combined Financial Statements for periods prior to the spin-off, income tax expense and deferred tax balances have been recorded as if the Company filed tax returns on a standalone basis, separate from Xerox. The Separate Return Method applies the accounting guidance for income taxes to the standalone financial statements as if the Company was a separate taxpayer and a standalone enterprise for fiscal 2016 and prior.
On December 22, 2017, the Tax Reform was enacted. The effects of changes in tax rates and laws are recognized in the period in which the new legislation is enacted. In the case of US federal income taxes, the enactment date is the date the bill becomes law. The income tax effects of the Tax Reform have been initially accounted for on a provisional basis pursuant to the SEC staff guidance on income taxes. Reasonable estimates for all material tax effects of the Tax Reform (other than amounts related to accounting policy elections) have been provided and adjustments to provisional amounts will be made in subsequent reporting periods as information becomes available to complete provisional computations. With respect to this legislation, we recorded a provisional tax benefit of $198 million, which included a $210 million tax benefit due to the re-measurement of deferred tax assets and liabilities resulting from the decrease in the corporate U.S. federal income tax rate from 35% to 21%, and $12 million as a one-time-charge on the transition tax for Post-1986 undistributed and not previously taxed foreign earnings and profits. The impacts of Tax Reform on our 2017 Consolidated Financial Statements are provisional, and could change during 2018 as we further evaluate the impacts of the Tax Reform. The Company has provisionally adopted the policy of treating the Global Intangible Low Taxed Income (GILTI) regime as a period cost. The GILTI regime enacted as part of Tax Reform subjects certain post 2017 foreign earnings (i.e. amounts in excess of deemed return on net tangible assets of non-US subsidiaries) to US tax. In January 2018, the FASB released guidance on the accounting for tax on GILTI. The guidance indicates that either accounting for deferred taxes on GILTI or treating GILTI as a period cost are both acceptable accounting elections.
(Loss) income before income taxes (pre-tax (loss) income) was as follows:
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| | | | | | | | | | | | |
| | Year Ended December 31, |
(in millions) | | 2017 | | 2016 | | 2015 |
Domestic loss | | $ | (91 | ) | | $ | (1,329 | ) | | $ | (654 | ) |
Foreign income | | 75 |
| | 102 |
| | 80 |
|
Loss Before Income Taxes | | $ | (16 | ) | | $ | (1,227 | ) | | $ | (574 | ) |
(Benefit) provision for income taxes were as follows:
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| | | | | | | | | | | | |
| | Year Ended December 31, |
(in millions) | | 2017 | | 2016 | | 2015 |
Federal Income Taxes | | | | | | |
Current | | $ | 4 |
| | $ | (116 | ) | | $ | (130 | ) |
Deferred | | (233 | ) | | (132 | ) | | (99 | ) |
Foreign Income Taxes | | | | | | |
Current | | 25 |
| | 31 |
| | 24 |
|
Deferred | | (3 | ) | | (3 | ) | | 6 |
|
State Income Taxes | | | | | | |
Current | | 8 |
| | 1 |
| | (17 | ) |
Deferred | | 6 |
| | (25 | ) | | (22 | ) |
Total Benefit | | $ | (193 | ) | | $ | (244 | ) | | $ | (238 | ) |
A reconciliation of the U.S. federal statutory income tax rate to the consolidated effective income tax rate is as follows:
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| | | | | | | | | |
| | Year Ended December 31, |
| | 2017 | | 2016 | | 2015 |
U.S. federal statutory income tax rate | | 35.0 | % | | 35.0 | % | | 35.0 | % |
Nondeductible expenses(1) | | (155.9 | )% | | (19.0 | )% | | (1.3 | )% |
Effect of tax law changes | | 1,282.4 | % | | — | % | | 0.9 | % |
Change in valuation allowance for deferred tax assets | | (39.5 | )% | | 0.1 | % | | (1.0 | )% |
State taxes, net of federal benefit | | 1.2 | % | | 1.8 | % | | 4.2 | % |
Audit and other tax return adjustments | | — | % | | 1.4 | % | | 0.1 | % |
Tax-exempt income, credits and incentives | | 38.9 | % | | 0.7 | % | | 0.7 | % |
Foreign rate differential adjusted for U.S. taxation of foreign profits(2) | | 47.7 | % | | 0.7 | % | | 2.4 | % |
Other | | (3.5 | )% | | (0.8 | )% | | 0.5 | % |
Effective Income Tax Rate | | 1,206.3 | % | | 19.9 | % | | 41.5 | % |
____________
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(1) | In 2017, nondeductible expenses primarily related to the nondeductible portion of the goodwill and officers life insurance. |
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(2) | The “U.S. taxation of foreign profits” represents the U.S. tax, net of foreign tax credits, associated with actual and deemed repatriations of earnings from our non-U.S. subsidiaries, except for transition tax, which is reported on the line Effect of tax law changes. |
On a consolidated basis, we paid/(received) a total of $29 million, $(123) million and $194 million in income taxes to federal, foreign and state jurisdictions during the three years ended December 31, 2017, 2016 and 2015, respectively.
Total income tax expense (benefit) was allocated as follows:
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| | | | | | | | | | | | |
| | Year Ended December 31, |
(in millions) | | 2017 | | 2016 | | 2015 |
Pre-tax income | | $ | (193 | ) | | $ | (244 | ) | | $ | (238 | ) |
Discontinued operations(1) | | 3 |
| | — |
| | 81 |
|
Common shareholders' equity: | |
|
| |
|
| |
|
Changes in defined benefit plans | | — |
| | 8 |
| | 2 |
|
Stock option and incentive plans, net | | — |
| | — |
| | (6 | ) |
Total Income Tax Benefit | | $ | (190 | ) | | $ | (236 | ) | | $ | (161 | ) |
_____________
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(1) | Refer to Note 3 – Assets/Liabilities Held for Sale for additional information regarding discontinued operations. |
Unrecognized Tax Benefits and Audit Resolutions
We recognize tax liabilities when, despite our belief that our tax return positions are supportable, we believe that certain positions may not be fully sustained upon review by tax authorities. Each period we assess uncertain tax positions for recognition, measurement and effective settlement. Benefits from uncertain tax positions are measured at the largest amount of benefit that is greater than 50 percent likely of being realized upon settlement. Where we have determined that our tax return filing position does not satisfy the more-likely-than-not recognition threshold, we have recorded no tax benefits.
We are also subject to ongoing tax examinations in numerous jurisdictions due to the extensive geographical scope of our operations. Our ongoing assessments of the more-likely-than-not outcomes of the examinations and related tax positions require judgment and can increase or decrease our effective tax rate, as well as impact our operating results. The specific timing of when the resolution of each tax position will be reached is uncertain. As of December 31, 2017, we do not believe that there are any positions for which it is reasonably possible that the total amount of unrecognized tax benefits will significantly increase or decrease within the next 12 months.
A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows:
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| | | | | | | | | | | | |
(in millions) | | 2017 | | 2016 | | 2015 |
Balance at January 1 | | $ | 14 |
| | $ | 24 |
| | $ | 32 |
|
Additions related to current year | | — |
| | 1 |
| | 3 |
|
Additions related to prior years positions | | — |
| | — |
| | — |
|
Reductions related to prior years positions | | — |
| | (5 | ) | | (10 | ) |
Settlements with taxing authorities(1) | | — |
| | (5 | ) | | — |
|
Currency | | 1 |
| | (1 | ) | | (1 | ) |
Balance at December 31 | | $ | 15 |
| | $ | 14 |
| | $ | 24 |
|
_______________
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(1) | 2016 settlement results in $5 million cash paid. |
Included in the balances at December 31, 2017, 2016 and 2015 are $0, $0 and $8 million, respectively, of tax positions that are highly certain of realization but for which there is uncertainty about the timing. Because of the impact of deferred tax accounting, other than for the possible incurrence of interest and penalties, the disallowance of these positions would not affect the annual effective tax rate. In addition, for other uncertain tax positions, we maintain offsetting benefits from other jurisdictions of $16 million, $16 million and $14 million, at December 31, 2017, 2016 and 2015, respectively.
We recognized interest and penalties accrued on unrecognized tax benefits, as well as interest received from favorable settlements within income tax expense. We had $6 million, $4 million and $14 million accrued for the payment of interest and penalties associated with unrecognized tax benefits at December 31, 2017, 2016 and 2015, respectively.
In the U.S., we are no longer subject to U.S. federal income tax examinations for years before 2005. With respect to our major foreign jurisdictions, the years generally remain open back to 2006.
Deferred Income Taxes
The Company is in the position of having tax basis in excess of book basis in its U.S. investment in foreign subsidiaries. Nonetheless, the Company is indefinitely reinvesting its foreign subsidiaries' undistributed earnings of $253 million. For years after 2017, the Tax Reform does allow for certain earnings to be repatriated free from US Federal taxes. However, the repatriation of earnings could give rise to additional tax liabilities.
The tax effects of temporary differences that give rise to significant portions of the deferred taxes were as follows:
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| | | | | | | | |
| | December 31, |
(in millions) | | 2017 | | 2016 |
Deferred Tax Assets | | | | |
Net operating losses | | $ | 41 |
| | $ | 42 |
|
Operating reserves, accruals and deferrals | | 90 |
| | 155 |
|
Deferred compensation | | 59 |
| | 101 |
|
Pension | | 15 |
| | 18 |
|
Other | | 45 |
| | 44 |
|
Subtotal | | 250 |
| | 360 |
|
Valuation allowance | | (35 | ) | | (24 | ) |
Total | | $ | 215 |
| | $ | 336 |
|
| | | | |
Deferred Tax Liabilities | | | | |
Unearned income | | $ | 134 |
| | $ | 217 |
|
Intangibles and goodwill | | 413 |
| | 680 |
|
Depreciation | | 10 |
| | 15 |
|
Other | | 25 |
| | 29 |
|
Total | | $ | 582 |
| | $ | 941 |
|
| | | | |
Total Deferred Taxes, Net | | $ | (367 | ) | | $ | (605 | ) |
The deferred tax assets for the respective periods were assessed for recoverability and, where applicable, a valuation allowance was recorded to reduce the total deferred tax asset to an amount that will, more-likely-than-not, be realized in the future. The net change in the total valuation allowance for the years ended December 31, 2017 and 2016 was an increase of $11 million and a decrease of $14 million, respectively. The valuation allowance relates primarily to certain net operating loss carryforwards, tax credit carryforwards and deductible temporary differences for which we have concluded it is more-likely-than-not that these items will not be realized in the ordinary course of operations.
Although realization is not assured, we have concluded that it is more-likely-than-not that the deferred tax assets, for which a valuation allowance was determined to be unnecessary, will be realized in the ordinary course of operations based on the available positive and negative evidence, including scheduling of deferred tax liabilities and projected income from operating activities. The amount of the net deferred tax assets considered realizable, however, could be reduced in the near term if actual future income or income tax rates are lower than estimated, or if there are differences in the timing or amount of future reversals of existing taxable or deductible temporary differences.
At December 31, 2017, we had tax credit carryforwards of $27 million available to offset future income taxes which will expire between 2018 and 2037 if not utilized. We also had net operating loss carryforwards for income tax purposes of $422 million that will expire between 2018 and 2037, if not utilized; and $43 million available to offset future taxable income indefinitely.