| Income Taxes |
Note 12. Income Taxes
The Company's income tax expense or benefit is impacted by a number of factors, including the amount of taxable earnings generated in foreign jurisdictions with tax rates that are lower than the U.S. federal statutory rate, permanent items, state tax rates, changes in tax laws, acquisitions and divestitures and the ability to utilize various tax credits and net operating loss carryforwards. The Company's global operations, acquisition activity and specific tax attributes provide opportunities for continuous global tax planning initiatives to maximize tax credits and deductions. Both fiscal 2018 and 2017 include the benefits of tax planning initiatives. Comparative earnings before income taxes, income tax expense or benefit and effective income tax rates are as follows (amounts in thousands):
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Three Months Ended May 31, |
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Nine Months Ended May 31, |
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2018 |
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2017 |
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2018 |
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2017 |
Earnings before income taxes |
$ |
25,017 |
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$ |
18,482 |
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$ |
33,465 |
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$ |
25,724 |
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Income tax (benefit) expense |
(3,995 |
) |
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(4,029 |
) |
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17,448 |
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(6,827 |
) |
Effective income tax rate |
(16.0 |
)% |
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(21.8 |
)% |
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52.1 |
% |
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(26.5 |
)% |
The Company’s income tax expense and effective tax rate for the three and nine months ended May 31, 2018 were impacted by the Tax Cuts and Jobs Act (the “Act”), which was enacted into law on December 22, 2017. The Act includes significant changes to the U.S. corporate income tax system which reduces the U.S. federal corporate income tax rate from 35% to 21% as of January 1, 2018; shifts to a modified territorial tax regime which requires companies to pay a transition tax on earnings of certain foreign subsidiaries that were previously deferred from U.S. income tax; and creates new taxes on certain foreign-sourced earnings. The decrease in the U.S. federal corporate income tax rate from 35% to 21% results in a blended statutory tax rate of 25.7% for the Company's fiscal year ending August 31, 2018. The new taxes for certain foreign-sourced earnings under the Act are effective for the Company in fiscal 2019.
Income tax effects resulting from changes in tax laws are accounted for by the Company in the period in which the law is enacted and the effects are recorded as a component of income tax expense or benefit. However, pursuant to SEC Staff Accounting Bulletin No. 118, provisional amounts resulting from the Act were recorded in the second quarter of fiscal 2018 and those amounts continue to be revised as new and better information becomes available. During the third quarter of fiscal 2018, the IRS published Notice 2018-26 which required modifications to the tax planning and provisional Act-related amounts recorded by the Company in its second quarter. As a result, the Company recorded provisional income tax benefits resulting from the Act totaling $12.9 million during the three months ended May 31, 2018 and $4.5 million during the nine months ended May 31, 2018. The year-to-date income tax benefit includes (i) a transition tax of $6.1 million on the Company’s total post-1986 earnings and profits (“E&P”) which, prior to the Act, were previously deferred from U.S. income tax, (ii) a $13.2 million decrease in income tax expense as a result of the re-measurement of the Company’s deferred tax assets and liabilities to the new corporate tax rate of 21% and (iii) $2.6 million in valuation allowances recorded against foreign tax credits as future utilization is now uncertain.
The amounts recorded are provisional and represent the Company’s best estimate of the tax effects of the Act as of May 31, 2018. Amounts recorded are based in part on a reasonable estimate of the effects on the transition tax and existing deferred tax balances which are subject to change and modification. Provisional amounts recorded may further change as a result of the following:
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The amount recorded for the transition tax liability is a provisional amount based on current estimates of total post-1986 foreign E&P and the income tax pools for all foreign subsidiaries which will continue to be refined over the coming periods. Further, the transition tax is based in part on the amount of those earnings held in cash and other specified assets. The transition tax liability may change when the Company finalizes the 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 as of August 31, 2018. Further interpretations from U.S. federal and state governments and regulatory organizations may change the provisional tax liability or the accounting treatment of the provisional tax liability. It is anticipated that the amounts resulting from the transition tax will be fully offset by available foreign tax credits and will not result in significant future cash tax payments. In addition, there is a foreign tax credit carryforward on the balance sheet after the calculation of the transition tax liability. The Company is continuing to analyze the new provisions in order to determine future utilization of the credits and is anticipating further interpretive guidance in connection with the utilization of foreign tax credits going forward. As such, we are not yet able to reasonably estimate the future utilization of the foreign tax credits and have recorded the aforementioned valuation allowance.
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The Company is still analyzing certain aspects of the Act and refining the estimate of the expected revaluation of its deferred tax balances. This can potentially affect the measurement of these balances or potentially give rise to new deferred tax amounts. In addition, the Act provides for accelerated first year expensing of certain capital expenditures for which an estimate has been included in the estimated deferred balances for the year but will continue to be refined as the year progresses. The Act also provides changes related to the limits of deduction for employee compensation. The Company is treating any future non-deductible compensation as impacting deductible compensation expenses in the period incurred until further guidance is provided. |
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The Act also includes a provision designed to tax global intangible low taxed income (GILTI) which will be effective in fiscal 2019. Under the provision, a U.S. shareholder is required to include in gross income the amount of its GILTI, which is generally the net income of its controlled foreign corporations in excess of a 10% return on depreciable tangible assets after identification of other income subject to non-deferral rules. Due to the complexity of the new GILTI tax rules and uncertainty of the application of the foreign tax credit rules in relation to GILTI, we are continuing to evaluate this provision of the Act, the application of ASC 740, and are considering available accounting policy alternatives to either record the U.S. income tax effect of future GILTI inclusions in the period in which they arise or establish deferred taxes with respect to the expected future tax liabilities associated with future GILTI inclusions. Our accounting policies depend, in part, on analyzing our global income to determine whether we expect a tax liability resulting from the application of this provision, and, if so, whether and when to record related current and deferred income taxes. Whether we intend to recognize deferred tax liabilities related to the GILTI provisions is dependent, in part, on our assessment of the Company's future operating structure. In addition, we are awaiting further interpretive guidance in connection with the computation of the GILTI tax. For these reasons, we are not yet able to reasonably estimate the effect of this provision of the Act. Therefore, we have not made any adjustments relating to potential GILTI tax in our consolidated financial statements and have not made a policy decision regarding our accounting for GILTI. |
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Prior to the Act, our practice and intention was to reinvest the earnings in our non-U.S. subsidiaries outside of the U.S., and no U.S. deferred income taxes or foreign withholding taxes were recorded. The transition tax noted above will result in the previously untaxed foreign earnings being included in the federal and state fiscal 2018 taxable income. We are currently analyzing our global working capital requirements and the potential tax liabilities that would be incurred if the non-U.S. subsidiaries distribute cash to the U.S. parent, which may include withholding taxes, local country taxes and potential U.S. state taxation. Furthermore, the transition tax will reduce the outside basis differences in our foreign corporations and any remaining temporary difference will potentially have some interaction with the GILTI tax noted above. For these reasons, we are not yet able to reasonably estimate the effect of this provision of the Act and have not recorded any withholding or state tax liabilities, any deferred taxes attributable to GILTI (as noted above) or any deferred taxes attributable to our investment in our foreign subsidiaries. |
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We are also currently analyzing certain additional provisions of the Act that come into effect in fiscal 2019 and will determine if and how these items would impact the effective tax rate in the year the income or expense occurs. These provisions include the Base Erosion Anti-Abuse Tax (BEAT), eliminating U.S. federal income taxes on dividends from foreign subsidiaries, the new provision that could limit the amount of deductible interest expense, and the limitations on the deductibility of certain executive compensation. |
The Company's effective tax rate for the nine months ended May 31, 2018 was 52.1% compared to (26.5)% for the comparable prior year period. The effective tax rate for the current year results in significantly greater tax expense than the comparable prior year period due to the non-recurrence of the fiscal 2017 recognition of income tax planning benefits resulting from certain losses from prior years for which no benefit was previously recognized and the fiscal 2018 tax planning impact of Notice 2018-26, offset by the provisional year-to-date tax benefits of the Act as described above. Additionally, the nine months ended May 31, 2018 also include discrete income tax expense of $9.4 million related to the Viking divestiture, $1.6 million related to excess deferred tax deficiencies on deductible equity compensation and the expiration of unexercised stock options, and tax expense related to the net increase in valuation allowances that is offset by a reduction in tax reserves primarily associated with the lapsing of income tax statutes of limitations. Both the current and prior year income tax rates were impacted by the proportion of earnings in foreign jurisdictions (with income tax rates lower than the U.S. federal income tax rate) and tax benefits derived from tax planning initiatives. In addition, the Company may release a material valuation allowance in a foreign jurisdiction in late fiscal 2018 or in fiscal 2019, if the Company determines that it is more likely than not the deferred tax assets will be realized.
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