TAXES ON EARNINGS
Taxes on earnings, as presented, are calculated on a separate return basis. Under this method, the Company computes taxes on earnings as if it were a separate taxpayer filing its own income tax returns for the full year. However, as the Company only became an actual separate taxpayer upon separation from Varian, the amounts recorded may differ from the amounts that would have been reflected in the financial statements had it been an entity that operated independently of Varian for the entire period. This is partially due to a different tax structure and tax accounting elections and assertions for the periods before and after separation.
The Company’s operations have historically been included in Varian’s U.S. federal and state income tax returns and non-U.S. jurisdiction tax returns. Income tax expense is based on reported income or loss before income taxes. Deferred income taxes reflect the effect of temporary differences between asset and liability amounts that are recognized for financial reporting purposes and the amounts that are recognized for income tax purposes. These deferred taxes are measured by applying currently enacted tax laws. Valuation allowances are recognized to reduce deferred tax assets to the amount that is more likely than not to be realized.
Taxes on earnings were as follows:
|
| | | | | | | | | | | |
| Fiscal Years |
(In millions) | 2017 | | 2016 | | 2015 |
Current provision: | | | | | |
Federal | $ | 24.8 |
| | $ | 26.4 |
| | $ | 40.2 |
|
State and local | 1.6 |
| | 3.9 |
| | 4.9 |
|
Foreign | 5.3 |
| | 2.0 |
| | 2.5 |
|
Total current | 31.7 |
| | 32.3 |
| | 47.6 |
|
Deferred provision (benefit): | | | | | |
Federal | (7.0 | ) | | 3.6 |
| | (1.4 | ) |
State and local | (1.0 | ) | | — |
| | (0.1 | ) |
Foreign | (0.9 | ) | | 0.1 |
| | 0.7 |
|
Total deferred | (8.9 | ) | | 3.7 |
| | (0.8 | ) |
Taxes on earnings | $ | 22.8 |
| | $ | 36.0 |
| | $ | 46.8 |
|
Earnings before taxes are generated from the following geographic areas:
|
| | | | | | | | | | | |
| Fiscal Years |
(In millions) | 2017 | | 2016 | | 2015 |
United States | $ | 55.5 |
| | $ | 105.6 |
| | $ | 122.9 |
|
Foreign | 19.3 |
| | (0.6 | ) | | 4.7 |
|
Earnings before taxes | $ | 74.8 |
| | $ | 105.0 |
| | $ | 127.6 |
|
The effective tax rate differs from the U.S. federal statutory tax rate as a result of the following:
|
| | | | | | | | |
| Fiscal Years |
| 2017 | | 2016 | | 2015 |
Federal statutory income tax rate | 35.0 | % | | 35.0 | % | | 35.0 | % |
State and local taxes, net of federal tax benefit | 1.3 | % | | 2.4 | % | | 2.5 | % |
Domestic production activities deduction | (2.4 | )% | | (2.2 | )% | | (2.3 | )% |
Research and development credit | (2.6 | )% | | (2.2 | )% | | (0.6 | )% |
Foreign deferred tax adjustments | (4.0 | )% | | — | % | | — | % |
Change in valuation allowance | 3.8 | % | | — | % | | — | % |
Other | (0.6 | )% | | 1.3 | % | | 2.1 | % |
Effective tax rate | 30.5 | % | | 34.3 | % | | 36.7 | % |
During fiscal years 2017, 2016 and 2015, the Company’s effective tax rate varied from the U.S. federal statutory rate primarily because of a difference in the mix of earnings by jurisdiction and overall global tax structure for Varex as a stand-alone company compared to the prior years when it was part of Varian. The effective tax rate is also impacted by the benefit of adjustments to certain deferred tax assets and the release of valuation allowances in jurisdictions where increased earnings allowed for the utilization of net operating loss carryforwards. The effective tax rate also differs from the U.S. federal statutory rate due to increases resulting from U.S. state income tax expense and earnings in certain foreign jurisdictions that are taxed currently in the U.S. These increases are partially offset by decreases due to earnings in foreign jurisdictions that are taxed at lower rates, a U.S. domestic production activities deduction, and research and development credits. Due to the timing of lapses and retroactive reinstatements of the federal research and development credit, the Company received seven quarters of benefit in fiscal year 2016 and four quarters of benefit in fiscal year 2015.
Significant components of deferred tax assets and liabilities are as follows:
|
| | | | | | | |
(In millions) | September 29, 2017 | | September 30, 2016 |
Deferred Tax Assets: | | | |
Inventory adjustments | $ | 15.0 |
| | $ | 13.3 |
|
Share-based compensation | 1.9 |
| | 2.8 |
|
Product warranty | 2.2 |
| | 2.3 |
|
Deferred compensation | 1.3 |
| | 1.2 |
|
Net operating loss carryforwards | 2.4 |
| | 7.7 |
|
Accrued vacation | 2.1 |
| | — |
|
Excess foreign tax credits | 1.9 |
| | — |
|
Other | 2.2 |
| | 6.0 |
|
| 29.0 |
| | 33.3 |
|
Valuation allowance | (4.3 | ) | | (6.4 | ) |
Total deferred tax assets | 24.7 |
| | 26.9 |
|
Deferred Tax Liabilities: | | | |
Acquired intangibles | (26.4 | ) | | (6.5 | ) |
Property, plant and equipment | (19.9 | ) | | (10.1 | ) |
Investments in privately held companies | (6.9 | ) | | (6.7 | ) |
Other | (1 | ) | | (1.1 | ) |
Total deferred tax liabilities | (54.2 | ) | | (24.4 | ) |
Net deferred tax (liabilities) assets | $ | (29.5 | ) | | $ | 2.5 |
|
Reported As: | | | |
Deferred tax assets | $ | 25.3 |
| | $ | 5.5 |
|
Deferred tax liabilities | (54.8 | ) | | (3.0 | ) |
Net deferred tax (liabilities) assets | $ | (29.5 | ) | | $ | 2.5 |
|
The Company has not provided for U.S. federal income and foreign withholding taxes on approximately $45.5 million of cumulative undistributed earnings of non-U.S. subsidiaries as of September 29, 2017. Such earnings are intended to be reinvested in the non-U.S. subsidiaries for an indefinite period of time. If such earnings were not considered to be reinvested indefinitely, an additional deferred tax liability of approximately $4.9 million would be provided.
The Company has federal net operating loss carryforwards of approximately $10.9 million expiring between 2019 and 2024.
The valuation allowance relates primarily to excess foreign tax credits in the U.S. and net operating losses in certain foreign jurisdictions where, based on the weight of available evidence, it is more likely than not that the tax benefit of the net operating losses will not be realized. The valuation allowance decreased by $2.1 million during fiscal year 2017, increased by $1.7 million during fiscal year 2016 and increased by $3.2 million during fiscal year 2015. In addition, the current year change in the valuation allowance is impacted by adjustments to deferred tax balances resulting from the separation from Varian that did not impact the current year effective tax rate.
In fiscal year 2017, the Company paid U.S and foreign taxes of approximately $6.0 million. In fiscal year 2016, the Company’s separate, taxpaying legal entities received a federal refund of approximately $0.6 million and paid foreign taxes of approximately $1.0 million. In fiscal year 2015, the Company’s separate, taxpaying legal entities paid foreign taxes of approximately $0.7 million. For other jurisdictions and periods, the Company’s operations have been included in Varian’s U.S. federal and state income tax returns and non-U.S. jurisdiction tax returns.
The Company accounts for uncertainty in income taxes following a two-step approach for recognizing and measuring uncertain tax positions. The first step is to evaluate the tax position for recognition by determining whether the weight of available evidence indicates that it is more likely than not that, based on the technical merits, the position will be sustained on audit, including resolution of related appeals or litigation processes, if any. The second step is to measure the tax benefit as the largest amount that is more than 50% likely of being realized upon settlement.
Changes in the Company’s unrecognized tax benefits were as follows:
|
| | | | | | | | | | | |
| Fiscal Years |
(In millions) | 2017 | | 2016 | | 2015 |
Unrecognized tax benefits balance–beginning of fiscal year | $ | 4.4 |
| | $ | 4.5 |
| | $ | 4.5 |
|
Additions based on tax positions related to a prior year | — |
| | — |
| | 0.1 |
|
Additions based on tax positions related to the current year | 0.5 |
| | 1.0 |
| | 1.0 |
|
Reductions resulting from the expiration of the applicable statute of limitations | — |
| | (1.1 | ) | | (1.1 | ) |
Adjustments resulting from current year separation | (4.4 | ) | | — |
| | — |
|
Unrecognized tax benefits balance—end of fiscal year | $ | 0.5 |
| | $ | 4.4 |
| | $ | 4.5 |
|
As of September 29, 2017, the total amount of gross unrecognized tax benefits was $0.5 million, all of which would affect the effective tax rate if recognized. As of September 30, 2016, the total amount of gross unrecognized tax benefits was $4.4 million. As a result of the separation from Varian, all of the gross unrecognized tax benefits through September 30, 2016 were retained by Varian and none were transferred to Varex.
The Company includes interest and penalties related to income taxes within taxes on earnings on the Combined Statements of Earnings. As the initial tax returns for the year ended September 29, 2017 are not yet due, no interest or penalties related to unrecognized tax benefits have been included in taxes on earnings for that period. As of September 30, 2016, the Company had accrued $0.4 million for the payment of interest and penalties related to unrecognized tax benefits. During fiscal year 2016, a net benefit of an immaterial amount related to interest and penalties was included in taxes on earnings. As of October 2, 2015, the Company had accrued $0.5 million for the payment of interest and penalties related to unrecognized tax benefits. During fiscal year 2015, a net benefit of an immaterial amount related to interest and penalties was included in taxes on earnings.
The Company will file U.S. Federal and state income tax returns and non-U.S. income tax returns in various jurisdictions. All of these returns will be subject to examination by their respective taxing jurisdictions from the date of filing through each applicable statute of limitation period. The Company’s significant operations up to the date of separation have historically been included in Varian’s U.S. federal and state income tax returns and non-U.S. jurisdiction tax returns. The Varian group’s U.S. federal tax returns are generally no longer subject to tax examinations for years prior to 2013. For U.S. states and other foreign tax returns, the Company is generally no longer subject to tax examinations for years prior to 2007.