11. INCOME TAXES
On December 22, 2017, the TCJA was enacted into law. The TCJA significantly revises the U.S. corporate income tax laws by, among other things, lowering the corporate income tax rate to 21%, implementing a modified territorial tax system and imposing a one-time repatriation tax on deemed repatriated earnings and profits of U.S.-owned foreign subsidiaries (the “transition tax”). The U.S. federal income tax rate reduction was effective as of January 1, 2018. While the provisions of the TCJA are generally effective January 1, 2018, several provisions impact the Company’s current period financial statements. The provisions of the TCJA have and will continue to impact our accounting treatment of certain items in our financial statements. As of December 31, 2017, we have not completed our assessment of the accounting impact of the tax effects of enactment of the TCJA and accordingly our accounting is provisional as of and for the year ended December 31, 2017. Where we have been able to make a reasonable estimate of the impact we have accounted for such provisional impact in the accompanying 2017 financial statements. For items related to the TCJA for which we were able to determine a reasonable estimate, we recognized a provisional tax benefit amount of approximately $25.5 million, which is included as a component of the income tax provision from continuing operations
The TCJA is complex and includes significant changes to the Internal Revenue Code which impact the Company. The Company has subsidiaries in 23 countries outside the U.S. To complete the accounting associated with the TCJA, the Company will continue to review the technical tax interpretations associated with the underlying law, monitor state legislative changes, and review U.S. federal and state guidance as it is issued. Further, the Company will continue to accumulate and refine the relevant data and computational elements needed to finalize its accounting by December 22, 2018.
Our 2017 accompanying financial statements reflect provisional estimates for the revaluation of US deferred tax assets and liabilities in accordance with ASC 740 based on rates at which they are expected to reverse in the future, which is generally 21%.
With respect to our deferred tax balances, we have made provisional estimates on amounts impacted by the TCJA but we are still analyzing certain aspects of the TCJA and refining our calculation, which could potentially affect the measurement of these balances or potentially give rise to new deferred tax amounts. As the Company continues to monitor and evaluate the external factors impacting our provisional amounts, the Company will also obtain, prepare and analyze additional information to further refine our provisional estimate for the transition tax and to determine whether an additional provisional amount is required with respect to deferred taxes.
The Company also evaluated the impact of the TCJA on its uncertain tax positions and recorded provisional estimates of these impacts.
Our provisional accounting for the transition tax is based on our estimate of both earnings and profits (“E&P”) and the portion of E&P which is held in cash and other specified assets measured as of specific dates. This transition tax charge, while not expected to be material, will be updated throughout the measurement period as we finalize our calculations and the amounts held in cash or other specified assets, relative to the date such assets are required to be measured.
The income tax benefit (expense) consisted of the following:
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For the Year Ended December 31, |
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2017 |
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2016 |
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2015 |
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(in millions) |
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Current: |
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|
|
|
|
|
|
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Federal |
|
$ |
— |
|
|
$ |
0.4 |
|
|
$ |
(0.4 |
) |
|
State |
|
|
(0.7 |
) |
|
|
(0.4 |
) |
|
|
(1.0 |
) |
|
Foreign |
|
|
(3.4 |
) |
|
|
(5.0 |
) |
|
|
(3.3 |
) |
|
|
|
|
(4.1 |
) |
|
|
(5.0 |
) |
|
|
(4.7 |
) |
|
Deferred: |
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|
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|
|
|
|
|
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Federal |
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|
21.9 |
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|
|
(3.1 |
) |
|
|
(3.1 |
) |
|
State |
|
|
0.1 |
|
|
|
0.1 |
|
|
|
0.7 |
|
|
Foreign |
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|
— |
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|
0.6 |
|
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|
1.2 |
|
|
|
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22.0 |
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|
|
(2.4 |
) |
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|
(1.2 |
) |
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Total income tax benefit (expense) |
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$ |
17.9 |
|
|
$ |
(7.4 |
) |
|
$ |
(5.9 |
) |
Pre-tax income (loss) for domestic and foreign operations before non-controlling interests consisted of the following:
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For the Year Ended December 31, |
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2017 |
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2016 |
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2015 |
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(in millions) |
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Domestic |
|
$ |
(42.7 |
) |
|
$ |
37.7 |
|
|
$ |
192.0 |
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|
Foreign |
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|
0.4 |
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|
|
(14.0 |
) |
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|
(50.2 |
) |
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Pre-tax income (loss) |
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$ |
(42.3 |
) |
|
$ |
23.7 |
|
|
$ |
141.8 |
|
Deferred income tax assets and liabilities consisted of the following:
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December 31, |
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2017 |
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2016 (a) |
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(in millions) |
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Non-current deferred income tax assets: |
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Net operating loss carryforwards |
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$ |
250.1 |
|
|
$ |
297.0 |
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State net operating loss carryforwards |
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|
18.9 |
|
|
|
26.1 |
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Depreciation and amortization |
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70.8 |
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|
156.3 |
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Accrued expenses and deferred revenue |
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17.2 |
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30.3 |
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Prepaid expenses |
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1.3 |
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|
0.5 |
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Provision for doubtful accounts |
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0.5 |
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|
0.1 |
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Other |
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13.4 |
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20.5 |
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Non-current deferred income tax assets |
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372.2 |
|
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|
530.8 |
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Non-current deferred income tax liabilities: |
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Other |
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|
(1.2 |
) |
|
|
(2.7 |
) |
|
Accrued expenses and deferred revenue |
|
|
— |
|
|
|
(0.6 |
) |
|
Profit-sharing receivables from insurance carriers |
|
|
(1.6 |
) |
|
|
(0.9 |
) |
|
Non-current deferred income tax liabilities |
|
|
(2.8 |
) |
|
|
(4.2 |
) |
|
Valuation allowance |
|
|
(371.8 |
) |
|
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(551.0 |
) |
|
Non-current net deferred income tax liability (net of non-current deferred income tax asset included in other non-current assets on the 2017 and 2016 consolidated balance sheet of $3.1 and $2.5, respectively) |
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$ |
(2.4 |
) |
|
$ |
(24.4 |
) |
|
(a) |
Prior year amounts for depreciation and amortization have been revised to conform to the current year presentation. |
As of December 31, 2017, Affinion Holdings and its subsidiaries had federal net operating loss carryforwards available to offset future taxable income of approximately $818.0 million (which will expire in 2026 through 2037).
As of December 31, 2017, Affinion Holdings and its subsidiaries have state net operating loss carryforwards of approximately $693.6 million (which expire, depending on the jurisdiction, between 2018 and 2037) and state tax credits of $1.8 million (which expire between 2018 and 2022). A full valuation allowance has been recognized with respect to these carryforwards and credits net of the impact of the future reversal of existing taxable temporary differences because it is more likely than not that these assets will not be realized.
The Company also has net operating loss carryforwards in foreign jurisdictions. These net operating losses total approximately $266.9 million (which expire, depending on the jurisdiction, between 2018 and 2037, or may be carried forward indefinitely). Affinion Holdings and its subsidiaries have concluded that a valuation allowance relating to approximately $266.9 million of these net operating losses is required due to the uncertainty of their realization.
The net operating losses for tax return purposes are different than the net operating losses for financial statement purposes, primarily due to book to tax differences associated with the Section 338 election and uncertain tax positions. The carrying value of Affinion Holdings’ valuation allowance against all of its deferred tax assets at December 31, 2017 and 2016 totaled $371.8 million and $551.0 million, respectively. The decrease in valuation allowance of $179.2 million is attributable to the SAB 118 estimates applicable to the TCJA, a decrease in the book to tax temporary differences that require a valuation allowance and a decrease in the valuation allowance attributable to tax attributes (i.e., net operating losses).
As of December 31, 2016, Affinion Holdings and its subsidiaries had federal net operating loss carryforwards of approximately $664.8 million (which will expire in 2032 through 2036).
As of December 31, 2016, Affinion Holdings and its subsidiaries have state net operating loss carryforwards of approximately $609.6 million (which expire, depending on the jurisdiction, between 2017 and 2036) and state tax credits of $1.9 million (which expire between 2017 and 2021). A full valuation allowance has been recognized with respect to these carryforwards and credits net of the impact of the future reversal of existing taxable temporary differences because it is more likely than not that these assets will not be realized.
The Company also has net operating loss carryforwards in foreign jurisdictions. These net operating losses total approximately $216.4 million (which expire, depending on the jurisdiction, between 2017 and 2036, or may be carried forward indefinitely). Affinion Holdings and its subsidiaries have concluded that a valuation allowance relating to approximately $216.3 million of these net operating losses is required due to the uncertainty of their realization.
The net operating losses for tax return purposes are different than the net operating losses for financial statement purposes, primarily due to book to tax differences associated with the Section 338 election and uncertain tax positions. The carrying value of Affinion Holdings’ valuation allowance against all of its deferred tax assets at December 31, 2016 and 2015 totaled $551.0 million and $565.8 million, respectively. The decrease in valuation allowance of $14.8 million is attributable to a decrease in the book to tax temporary differences that require a valuation allowance offset by an increase in the valuation allowance attributable to tax attributes (i.e., net operating losses).
With the exception of South African, Italian and Turkish subsidiaries, foreign taxable income is recognized currently for U.S. federal and state income tax purposes because such operations are entities disregarded for U.S. federal and state income tax purposes. The Company does not provide for deferred taxes on the excess of the amount for the tax over the financial reporting basis in its South African, Italian and Turkish subsidiaries because they are permanent in duration. A deferred tax asset is recognized in this circumstance only if it is apparent that the temporary difference will reverse in the foreseeable future. As of December 31, 2017, there is a $16.8 million deficit in retained earnings of the South African, Italian and Turkish subsidiaries.
The effective income tax rate differs from the U.S. federal statutory rate as follows:
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For the Year Ended December 31, |
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2017 |
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2016 |
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2015 |
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Federal statutory rate |
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35.0 |
% |
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|
35.0 |
% |
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|
35.0 |
% |
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State and local income taxes, net of federal expense |
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(18.0 |
) |
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(3.1 |
) |
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12.3 |
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Change in valuation allowance and other |
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(39.8 |
) |
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(0.1 |
) |
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(170.1 |
) |
|
Taxes on foreign operations at rates different than U.S. federal rates |
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(8.1 |
) |
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18.1 |
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1.6 |
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SAB 118 impact of TCJA |
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60.1 |
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— |
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— |
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Impairment of goodwill and other long-lived assets |
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— |
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|
— |
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|
8.8 |
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|
Impact of debt exchanges and subscription rights offering |
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|
9.9 |
|
|
|
(13.7 |
) |
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|
(57.3 |
) |
|
Foreign taxes deduction |
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|
3.2 |
|
|
|
(6.4 |
) |
|
|
— |
|
|
Foreign tax credit net operating loss reclassification |
|
|
— |
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|
— |
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17.5 |
|
|
Federal net operating loss adjustments |
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— |
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— |
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|
145.9 |
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Stock compensation |
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|
— |
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|
|
— |
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|
7.8 |
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|
Prior year accrual and adjustments |
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0.2 |
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|
0.6 |
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|
|
2.1 |
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Non-deductible expenses |
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(0.3 |
) |
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|
0.6 |
|
|
|
0.6 |
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|
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|
42.2 |
% |
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31.0 |
% |
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|
4.2 |
% |
As noted above, the effective tax rate has fluctuated significantly over the last three years. These fluctuations are primarily the results of the 2015 goodwill impairment charges, a change in the valuation allowances due to changes in the corresponding deferred tax balances, and the impacts associated with the debt exchange and subscriptions right offering. The 2016 tax benefit associated with the 2015 debt exchange and subscriptions right offering resulted from a change in the estimated tax relative to the same. The fluctuation for 2017 is primarily the result of the change on deferred tax balance requirements, including valuation allowances, estimated pursuant to SAB 118 in accordance with the TCJA enactment and the impact of the 2017 AGI Exchange Offer. These fluctuations are also the result of the change to a loss before income taxes and non-controlling interest of $42.3 million for the year ended December 31, 2017 compared to income before income taxes and non-controlling interest of $23.7 million and $141.8 million for the years ended December 31, 2016 and 2015, respectively.
The Company was granted a 50% tax holiday in the Swiss canton of Vaud in 2013. The tax holiday is valid for cantonal purposes from the 2012 start date until the end of the 2017 tax period. The Company is currently subject to Cantonal law.
The Company recognizes interest and penalties related to uncertain tax positions in income tax expense. The Company recognized $(0.2) million, $(0.1) million and $(0.4) million of interest in income tax expense related to uncertain tax positions arising in 2017, 2016 and 2015, respectively. The Company’s gross unrecognized tax benefits decreased by $1.6 million, increased by $11.0 million and decreased by $0.7 million for the years ended December 31, 2017, 2016 and 2015, respectively, as a result of tax positions for the applicable year.
A reconciliation of the beginning and ending amount of tax reserves for uncertain tax positions for the years ended December 31, 2017, 2016 and 2015 is as follows:
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For the Year Ended December 31, |
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2017 |
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2016 |
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2015 |
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(in millions) |
|
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Unrecognized tax benefits – January 1 |
|
$ |
6.6 |
|
|
$ |
(4.4 |
) |
|
$ |
(3.7 |
) |
|
Gross increase – prior period tax positions |
|
|
— |
|
|
|
11.3 |
|
|
|
— |
|
|
Gross decrease – prior period tax positions |
|
|
(2.1 |
) |
|
|
— |
|
|
|
— |
|
|
Gross increase – current period tax positions |
|
|
0.7 |
|
|
|
0.2 |
|
|
|
0.4 |
|
|
Gross decrease – current period tax positions |
|
|
(0.2 |
) |
|
|
(0.5 |
) |
|
|
(1.1 |
) |
|
Unrecognized tax benefits – December 31 |
|
$ |
5.0 |
|
|
$ |
6.6 |
|
|
$ |
(4.4 |
) |
The Company’s income tax returns are periodically examined by various tax authorities. In connection with these and future examinations, certain tax authorities, including the Internal Revenue Service, may raise issues and impose additional assessments. The Company regularly evaluates the likelihood of additional assessments resulting from these examinations and establishes liabilities, through the provision for income taxes, for potential amounts that may result therefrom. The recognition of uncertain tax benefits are not expected to have a material impact on the Company’s effective tax rate or results of operations. Federal, state and local jurisdictions are subject to examination by the taxing authorities for all open years as prescribed by applicable statute. For significant foreign jurisdictions, tax years in Germany, France, Turkey, Switzerland and the United Kingdom remain open as prescribed by applicable statute. During 2017, income tax waivers were executed in certain states that extend the period subject to examination beyond the period prescribed by statute. There are no significant changes anticipated in accordance with the extension of the income tax statutes in these jurisdictions. The Company does not believe that it is reasonably possible that the total amount of unrecognized tax benefits will change significantly within the next 12 months.