The United States government enacted comprehensive tax legislation in December 2017. The accounting guidance on income taxes generally requires the effects of new tax legislation to be recognized in the period of enactment. The SEC issued Staff Accounting Bulletin 118 (“SAB 118”), which provides for a measurement period of up to one year from the enactment date for companies to complete their accounting for the U.S. tax law changes. In accordance with the SEC staff guidance, companies must reflect the income tax effects of those aspects of the U.S. tax law changes for which the accounting is complete. To the extent a company’s accounting for the income tax effect of certain provisions of the U.S. tax law changes is incomplete but the Company is able to determine a reasonable estimate, a provisional estimate must be recorded in the Company’s financial
statements. If companies cannot determine a provisional estimate for the effects of an aspect of the U.S. tax law changes, they should continue applying the accounting guidance on income taxes on the basis of the provisions of the tax laws in effect immediately before the U.S. tax law changes were enacted.
The U.S. tax law changes include broad and complex changes affecting the Company’s fiscal 2018 results.
Among other things, the U.S. tax law changes reduce the federal corporate tax rate from 35% to 21% effective January 1, 2018 and require companies to immediately accrue for a one-time transition tax on certain un-repatriated earnings of foreign subsidiaries, which is payable over an eight year period. The U.S. tax law changes modify the taxation of foreign earnings, repeal of the deduction for domestic production activities, limit interest deductibility and establish a global intangible low tax income (GILTI) regime.
The lower corporate income tax rate of 21% became effective January 1, 2018, resulting in a U.S. statutory federal tax rate of approximately 26% for fiscal 2018 and 21% for subsequent fiscal years, which provided a benefit to the Company’s fiscal 2018 tax provision of approximately $307 million.
In connection with the Company’s ongoing analysis of the impact of the U.S. tax law changes, which is provisional and subject to change, the Company recorded a net tax benefit of $125 million during fiscal 2018.
This provisional net tax benefit arises from a benefit of $648 million from re-measuring the Company’s net U.S.
deferred tax liabilities, partially offset by the Company’s accrual for the transition tax and other U.S. tax law changes of $523 million. The Company’s estimated accrual for transition tax and other U.S. tax law changes decreased from $679 million as at May 31, 2018 to $523 million as at August 31, 2018 due to additional foreign tax credits and refinement of the Company’s estimated impact of tax law changes.
Based on the effective dates of certain aspects of the U.S. tax law changes as well as estimated data required to be used in the corresponding measurement calculations, the Company’s analysis of the income tax effects of the U.S. tax law changes could not be finalized as of August 31, 2018. While the Company made reasonable estimates of the impact of the transition tax and the remeasurement of its deferred tax assets and liabilities, the final impact of the U.S. tax law changes may differ from these estimates, due to, among other things, changes in its interpretations and assumptions, technical clarifications from the U.S. Department of the Treasury and IRS and actions the Company may take. The Company expects to finalize such provisional amounts within the time period prescribed by SAB 118. The U.S. tax law changes created new rules that allow the Company to make an accounting policy election to either treat taxes due on future GILTI inclusions in taxable income as either a current period expense or reflect such inclusions related to temporary basis differences in the Company’s measurement of deferred taxes. The Company’s analysis of the new GILTI rules is not complete; therefore, the Company has not made a policy election regarding the tax accounting treatment of the GILTI tax.
The U.S. tax law changes have the potential to change the Company’s assertions with respect to whether earnings of the Company’s foreign subsidiaries should remain indefinitely reinvested. The Company continues to evaluate these changes, therefore, the Company has not made any changes to its indefinite reinvestment assertions.
The components of earnings before income tax provision were (in millions):
2018 2017 2016
U.S. $3,292 $1,953 $2,577
Non–U.S. 2,683 2,900 2,567
Total $5,975 $4,853 $5,144
The provision for income taxes consists of the following (in millions):
2018 2017 2016
Current provision
Federal $ 866 $ 759 $ 999
State 103 45 56
Non–U.S. 353 390 371
1,322 1,194 1,426 Deferred provision
Federal – tax law change (648) — —
Federal – excluding tax law change 304 (306) (183)
State 78 (24) 6
Non–U.S. – tax law change — (80) (182)
Non–U.S. – excluding tax law change (58) (24) (70)
(324) (434) (429)
Income tax provision $ 998 $ 760 $ 997
The difference between the statutory federal income tax rate and the effective tax rate is as follows:
2018 2017 2016
Federal statutory rate 25.7% 35.0% 35.0%
State income taxes, net of federal benefit 2.3 0.3 0.8
Foreign income taxed at non-U.S. rates (12.2) (11.8) (7.8)
Non-taxable income (5.2) (5.3) (4.4)
Non-deductible expenses 2.1 1.5 1.1
Transition tax 12.4 — —
Tax law changes (10.9) (1.6) (3.5)
Change in valuation allowance 8.7 0.7 1.7
Tax credits (6.9) (2.9) (1.5)
Other 0.7 (0.2) (2.0)
Effective income tax rate 16.7% 15.7% 19.4%
The deferred tax assets and liabilities included in the Consolidated Balance Sheets consist of the following (in millions):
2018 2017
Deferred tax assets:
Postretirement benefits $ — $ 134
Compensation and benefits 152 207
Insurance 74 109
Accrued rent 271 174
Outside basis difference — 55
Allowance for doubtful accounts 27 55
Tax attributes 2,351 555
Stock compensation 44 73
Deferred income 110 220
Other 44 88
3,073 1,670
Less: valuation allowance 2,226 408
Total deferred tax assets 847 1,262
Deferred tax liabilities:
Accelerated depreciation 603 841
Inventory 301 416
Intangible assets 1,234 1,277
Equity method investment 459 1,002
2,597 3,536
Net deferred tax liabilities $1,750 $2,274
As of August 31, 2018, the Company has recorded deferred tax assets for tax attributes of $2.4 billion, primarily reflecting the benefit of $426 million in U.S. federal, $43 million in state and $8.5 billion in non-U.S. ordinary and capital losses. In addition, these deferred tax assets include $58 million of income tax credits. Of these deferred tax assets, $2.1 billion will expire at various dates from 2019 through 2035. The residual deferred tax assets of $227 million have no expiry date.
The Company believes it is more likely than not that the benefit from certain deferred tax assets will not be realized. In recognition of this risk, the Company has recorded a valuation allowance of $2.2 billion against those deferred tax assets as of August 31, 2018.
Income taxes paid, net of refunds were $0.6 billion, $1.1 billion and $1.1 billion for fiscal years 2018, 2017 and 2016, respectively.
ASC Topic 740, Income Taxes, provides guidance regarding the recognition, measurement, presentation and disclosure in the financial statement of tax positions taken or expected to be taken on a tax return, including the decision whether to file in a particular jurisdiction. As of August 31, 2018, unrecognized tax benefits of
$482 million were reported as long-term liabilities on the Consolidated Balance Sheets while $61 million were reported as current tax liabilities. Both of these amounts include interest and penalties, when applicable.
The following table provides a reconciliation of the total amounts of unrecognized tax benefits (in millions):
2018 2017 2016
Balance at beginning of year $409 $269 $261
Gross increases related to tax positions in a prior period 123 151 21
Gross decreases related to tax positions in a prior period (15) (36) (47)
Gross increases related to tax positions in the current period 29 33 68
Settlements with taxing authorities (87) (2) (17)
Currency — (1) (11)
Lapse of statute of limitations (3) (5) (6)
Balance at end of year $456 $409 $269
At August 31, 2018, 2017 and 2016, $331 million, $286 million and $237 million, respectively, of unrecognized tax benefits would favorably impact the effective tax rate if recognized. During the next twelve months, based on current knowledge, it is reasonably possible the amount of unrecognized tax benefits could decrease by up to $24 million due to anticipated tax audit settlements and the expirations of statutes of limitations associated with tax positions related to multiple tax jurisdictions.
The Company recognizes interest and penalties in the income tax provision in its Consolidated Statements of Earnings. At August 31, 2018 and August 31, 2017, the Company had accrued interest and penalties of $87 million and $43 million, respectively. For the year ended August 31, 2018, the amount reported in income tax expense related to interest and penalties was $44 million.
The Company files a consolidated U.S. federal income tax return as well as income tax returns in various states and multiple foreign jurisdictions. It is generally no longer under audit examinations for U.S. federal income tax purposes for any years prior to fiscal 2014. With few exceptions, it is no longer subject to state and local income tax examinations by tax authorities for years before fiscal 2007. In foreign tax jurisdictions, the Company is generally no longer subject to examination by the tax authorities in Luxembourg prior to 2013, in Germany prior to 2014, in France prior to 2008 and in Turkey prior to 2014. With respect to the United Kingdom, a number of specific issues remain open to examination by the tax authorities back to 2000.
The Company has received tax holidays from Swiss cantonal income taxes relative to certain of its Swiss operations. The income tax holidays are expected to extend through September 2022. The holidays had a beneficial impact of $127 million and $142 million during fiscal 2018 and 2017, respectively. This benefit is primarily included as part of the foreign income taxed at non-U.S. rates line in the effective tax rate
reconciliation table above.
At August 31, 2018, it is not practicable for the Company to determine the amount of the unrecognized deferred tax liability it has with respect to temporary differences related to investments in foreign subsidiaries and foreign corporate joint ventures that are essentially permanent in duration.