9. Income Taxes

Income before income taxes for the Company’s U.S. and foreign operations for the years ended December 31, 2016, 2015 and 2014 was as follows:


	2016		2015		2014
	(In thousands)
U.S.	$	52,742	$	42,342	$	23,966
Foreign		220,643		284,859		294,907

	$	273,385	$	327,201	$	318,873

Income taxes for the years ended December 31, 2016, 2015 and 2014 consisted of the following:


	2016			2015			2014
	(In thousands)
Current:
Federal	$	65,636		$	14,521		$	8,904
State		3,192			2,639			1,686
City		533			439			281
Foreign		256,117			61,393			65,187

Total current provision		325,478			78,992			76,058

Deferred:
Federal		(150	)		(537	)		(1,328	)
State		(28	)		(99	)		(245	)
City		(5	)		(16	)		(41	)
Foreign		5,480			(3,665	)		(5,311	)

Total deferred expense (benefit)		5,297			(4,317	)		(6,925	)

Total provision for income taxes	$	330,775		$	74,675		$	69,133

The components of net deferred tax assets as of December 31, 2016 and 2015 are as follows:


	2016			2015
	(In thousands)
Deferred tax assets
Carry-forward losses of subsidiaries	$	7		$	53
Minimum alternate tax credit of subsidiaries		35,979			30,752
Property, plant and equipment		198			394
Accrued expenses and allowances		15,055			13,820
Valuation allowance		(9,167	)		(5,454	)

Total deferred tax assets		42,072			39,565

Deferred tax liabilities
Provision for branch tax on dividend equivalent in India		(9,782	)		(1,726	)
Provision for tax on unrealized gains in India		(33	)		(53	)
Others		(258	)

Total deferred tax liabilities		(10,073	)		(1,779	)

Net deferred tax assets	$	31,999		$	37,786

The balance sheet classification of the net deferred tax asset is summarized as follows:


	2016			2015
	(In thousands)
Deferred tax asset, non-current		42,072			39,565
Deferred tax liabilities, non-current		(10,073	)		(1,779	)

	$	31,999		$	37,786

Syntel’s software development centers/units in India are located in Mumbai, Chennai, Pune and Gurugram. Software development centers/units enjoy favorable tax provisions due to their registration in Special Economic Zone (SEZ), as Export Oriented Unit (EOU) and as units located in Software Technologies Parks of India (STPI). Units registered with STPI, EOUs and certain units located in SEZ were exempt from payment of corporate income taxes for ten years of operations on the profits generated by these units or March 31, 2011, whichever was earlier. Certain units located in SEZ are eligible for 100% exemption from payment of corporate taxes for the first five years of operation and 50% exemption for the next two years and a further 50% exemption for another three years, subject to fulfillment of certain criteria laid down. New units in SEZ operational after April 1, 2005 are eligible for 100% exemption from payment of corporate taxes for the first five years of operation, 50% exemption for the next five years and a further 50% exemption for another five years, subject to fulfillment of criteria.

The Company’s units located at SEEPZ Mumbai and the STPI/EOU units ceased to enjoy the tax exemption on March 31, 2011. Three SEZ units have completed their first five years of 100% exemption as of March 31, 2016. One SEZ unit located at Chennai has completed its first five years of 100% exemption as of March 31, 2015. The Company has started operations in KPO SEZs unit in Airoli, Navi Mumbai in the quarters ended June 30, 2015 and June 30, 2016, respectively.

Syntel’s SEZ in Pune set up under the SEZ Act 2005, commenced operations in 2008. The SEZ for Chennai commenced operations in 2010. Income from operation of the SEZ, as a developer, is exempt from payment of corporate income taxes for ten out of 15 years from the date of SEZ notification.

Provision for Indian Income Tax is made only in respect of business profits generated from these software development units, to the extent they are not covered by the above exemptions and on income from treasury operations and other income.

The benefit of the tax holiday under Indian Income Tax was $38.97 million, $45.6 million and $43.1 million for the years ended December 31, 2016, 2015 and 2014, respectively.

During the three months ended September 30, 2016, and after a comprehensive review of anticipated sources and uses of capital both domestically and abroad, as well as other considerations, the Board of Directors determined that it was in the best interests of the Company and its shareholders to declare a special cash dividend of fifteen dollars ($15.00) per share. In conducting this evaluation, the Board of Directors considered, among other factors, the operational and financial objectives of the Company, long-term and short-term capital needs, the Company’s projections on growth and working capital needs, planned uses of U.S. and foreign earnings, the available sources of liquidity in the U.S., and growth plans outside of the U.S. As part of this evaluation, the Company determined that certain amounts which had been previously designated for internal and external expansion and investment at its foreign subsidiaries were no longer required for these purposes. The special cash dividend was funded through a one-time repatriation of approximately $1.03 billion (net of foreign income tax $210 million paid outside of the U.S) of cash held by the Company’s foreign subsidiaries and a portion of borrowings under the new Senior Credit Facility. In connection with the one-time repatriation, the Company recognized a one-time tax expense of approximately $270.6 million (net of foreign tax credits) in the third quarter of 2016.

Other than the amounts affected by the one-time repatriation, the Company’s accumulated foreign earnings are deemed to be permanently reinvested outside the United States and the Company has not provided for income taxes on such earnings. Management regularly evaluates foreign earnings to determine whether future foreign earnings that accumulate will be permanently invested outside the U.S. In conducting this evaluation, management considers, among other factors, the operational and financial objectives of the Company, long-term and short-term capital needs, the Company’s projections on growth and working capital needs, planned uses of U.S. and foreign earnings, the available sources of liquidity in the U.S., and growth plans outside of the U.S. If in the future, management were to conclude that any portion of foreign earnings will not be permanently reinvested outside the U.S., this would result in an additional provision for income taxes, which could affect the Company’s future effective tax rate. If the Company determines to repatriate all undistributed repatriable earnings of foreign subsidiaries as of December 31, 2016, the Company would have accrued taxes of approximately $24.2 million.

For the year ended December 31, 2016, the Company has provided a tax charge of $16.75 million related to repatriation and recorded liabilities for unrecognized tax benefits related to repatriation. The Company has also classified a deferred tax liability of $1.73 million as unrecognized tax benefits related to repatriation.

The Company reversed a provision for tax of $3.08 million for the quarter ended March 31, 2016 due to the expiration of the time limit with respect to a particular tax provision.

During the years ended December 31, 2016, 2015 and 2014, the effective income tax rate was 121.0%, 22.8% and 21.7%, respectively.

The tax rate for the year ended December 31, 2016 was primarily impacted by a one-time repatriation. Where the Company recognized a one-time tax expense of approximately $270.6 million (net of foreign tax credits) and reversal of unrecognized tax benefits of $3.08 million. Without the above, the effective tax rate for the year ended December 31, 2016 would have been 23.0%.

The tax rate for the year ended December 31, 2015 was impacted by a favorable adjustments of $1.10 million relating to the true up of tax provisions upon the finalization of the India tax computation and $1.20 million relating to the finalization of state tax and local tax matters. The company has provided tax charges of $0.84 million on account of valuation allowances against the minimum alternative tax. Without the above, the effective tax rate for the year ended December 31, 2015 would have been 23.3%.

The tax rate for the year ended December 31, 2014 was impacted by a favorable adjustment of $1.20 million, relating to the true up of tax provisions, upon the finalization of the tax computation of Syntel India, which was finalized after setoff of unabsorbed inter-company expenses. Further, a $0.86 million charge of tax has arisen on account of a tax dispute raised during the year. The Company has provided tax charges of $1.63 million and $0.88 million on account of valuation allowances against deferred tax assets recognized on investments and the minimum alternative tax. Without the above, the effective tax rate for the year ended December 31, 2014 would have been 21.1%.

The Company records provisions for income taxes based on enacted tax laws and rates in the various taxing jurisdictions in which it operates. In determining the tax provisions, the Company provides for tax uncertainties in income taxes, when it is more likely than not, based on the technical merits, that a tax position would not be sustained upon examination. Such uncertainties, which are recorded in income taxes payable, are based on management’s estimates and accordingly, are subject to revision based on additional information. The provision no longer required for any particular tax year is credited to the current period’s income tax expense. Conversely, in the event of a future tax examination, any additional tax expense not previously provided for will be recognized in the period in which the actual liability is concluded or the management determines that the Company will not prevail on certain tax positions taken in filed returns, based on the “more likely than not” concept.

Syntel Inc. and its subsidiaries file income tax returns in various tax jurisdictions. The Company is no longer subject to U.S. federal tax examinations by tax authorities for years before 2013 and for state tax examinations for years before 2012.

Syntel India, the Company’s India subsidiary, has disputed tax matters for the financial years 1996-97 to 2013-14 pending at various levels of tax authorities. Financial year 2014-15 and onwards are open for regular tax examination by the Indian tax authorities. However, the tax authorities in India are authorized to reopen the already concluded tax assessments for financial years 2009-10 and onwards.

The following table accounts for the differences between the actual effective tax rate and the statutory U.S. Federal income tax rate of 35% for the years ended December 31, 2016, 2015 and 2014:


	2016			2015			2014
Statutory rate		35.0	%		35.0	%		35.0	%
State taxes, net of federal Benefit		1.0	%		0.6	%		0.2	%
City taxes		0.0	%		0.0	%		0.1	%
Foreign effective tax rates different from U.S. Statutory Rate¹		(13.0	%)		(12.6	%)		(14.2	%)
Tax reserves		(1.0	%)		(0.0	%)		(0.1	%)
Prior Year state tax payment		—			(0.4	%)		0.0	%
Valuation Allowance		—			0.2	%		0.7	%
Tax related to repatriation		99.0			—			—

Effective income tax rate		121.0	%		22.8	%		21.7	%

1	The foreign jurisdiction that materially affects the effective income tax rate is India.

During the years ended December 31, 2016, 2015 and 2014, the effective income tax rates were 121.0%, 22.8% and 21.7%, respectively.

A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows:


	(in millions)
	2016			2015
Balance as at January 1	$	50.24		$	40.47
Additions based on tax positions related to the current year		22.48			11.72
Additions based on tax positions for prior years		0.0			0.18
Reductions for tax positions of prior years		(3.08	)		(0.14	)
Foreign currency translation effect		(1.13	)		(1.99	)

Balance as at December 31	$	68.51		$	50.24
Income taxes paid, see below		(41.41	)		(42.18	)

Amounts, net of income taxes paid	$	27.10		$	8.06

The above table shows the unrecognized tax benefits that, if recognized, would affect the effective tax rate.

The Company has paid income taxes of $41.41 million and $42.18 million against the liabilities for unrecognized tax benefits of $68.51 million and $50.24 million, as at December 31, 2016 and 2015, respectively. The Company has paid the taxes in order to reduce the possible interest and penalties related to these unrecognized tax benefits.

The Company recognizes accrued interest and penalties related to unrecognized tax benefits as part of tax expense. During the years ended December 31, 2016 and December 31, 2015, the Company recognized a tax charge and tax reversal towards interest of approximately $0.15 million and $0.07 million, respectively.

The Company had accrued approximately $1.45 million and $1.33 million for interest and penalties as of December 31, 2016 and December 31, 2015, respectively.

The Company’s amount of net unrecognized tax benefits for the tax disputes of $1.54 million could change in the next twelve months as litigation and global tax audits progress. At this time, due to the uncertain nature of this process, it is not reasonably possible to estimate an overall range of possible change.

Syntel has not provided for India Income Tax which are disputed and pending at various level (including potential tax dispute) of $13.70 million for the financial year 1996-97 to December 31, 2016, which is after providing $51.50 million as unrecognized tax benefits under ASC740. Indian tax exposures involve complex issues and may need an extended period to resolve the issues with the Indian income tax authorities. Syntel’s management, after consultation with legal counsel, believes that the resolution of these matters will not have a material adverse effect on the Company’s consolidated financial position or results of operations.

Branch Profit Tax

Syntel India is subject to a 15% U.S. Branch Profit Tax (BPT) related to its effectively connected income in the United States, to the extent its U.S. taxable adjusted net income during the taxable year is not invested in the United States. The Company expected that U.S. profits earned on or after January 1, 2008 would be permanently invested in the U.S. Accordingly, effective January 1, 2008 to June 30, 2016, a provision for BPT was not required. The accumulated deferred tax liability of $1.73 million as of December 31, 2007 continues to be carried forward.

As a result of the dividends declared during the third quarter of 2016, as of September 30, 2016, the Company expects that U.S. profits earned will not be permanently invested in the U.S. Accordingly, the Company has recorded a provision for additional BPT of $8.05 million for the year ended December 31, 2016.

SERVICE TAX AUDIT

Syntel India regularly files quarterly Service Tax refund applications and claims refunds of Service Tax on input services, which remain unutilized against a no service tax on export of services. As of December 31, 2016, Syntel Indian entities has not provided against Service tax refunds claims of $3.24 million disputed by Service tax Department which are pending at various level.

The Company obtained a tax consultant’s advice on the aforesaid disputes. The consultant is of the view that the tax disputes are contrary to the wording of the service tax notifications and provisions. The Company therefore believes that its claims of service tax refunds should be upheld at the appellate stage and the refunds should be accordingly granted. Based on the consultant’s tax advice, the Company believes that it has a reasonable basis to defend the rejection of the refunds. Accordingly, no provision has been made in the Company’s books.

Local Taxes

As of December 31, 2016, the Company had a local tax liability provision of approximately $0.4 million, equal to $0.3 million net of federal tax benefit, relating to local taxes including employer withholding taxes, employer payroll expense taxes, business licenses, and corporate income taxes. As of December 31, 2015, the Company had a local tax liability provision of approximately $1.1 million, equal to $0.7 million net of tax, relating to local taxes including employer withholding taxes, employer payroll expense taxes, business license registrations, and corporate income taxes. The decrease in December 31, 2016 as compared December 31, 2015 is mainly on account of result of filing, payment, or settlement of such local taxes.

Minimum Alternate Tax (MAT)

Minimum Alternate Tax (“MAT”) is payable on Book Income, including the income for which deduction is claimed under Section 10A and Section 10AA of the Indian Income Tax Act. The excess MAT over the normal tax liability is “MAT Credit”. MAT Credit can be carried forward for 10 years and set-off against future tax liabilities, if normal tax provisions are in excess of taxes payable under MAT. The Company estimated that the Company may not be able to utilize part of the MAT credit for two Indian subsidiaries. Accordingly, a valuation allowance of $5.19 million was recorded against the accumulated MAT credit recognized as deferred tax assets. The MAT credit as of December 31, 2016 of $30.78 million (net of valuation allowance of $5.19 million) shall be utilized before March 31 of the following financial years and shall expire as follows:


Year of Expiry of MAT Credit
	(In millions)
2017-18	$	0.19
2018-19		0.26
2019-20		0.95
2020-21		1.59
2021-22		0.78
2022-23		5.86
2023-24		6.94
2024-25		7.62
2025-26		9.80
2026-27		1.98
Total	$	35.97

Less: Valuation allowance		(5.19	)

Total (net of valuation allowance)	$	30.78

India Budget Proposal 2017

The Finance Bill 2017 was presented on February 1, 2017. These proposals include provisions that the MAT credit can be carried forward up to 15 years, as compared to the existing provision for the MAT credit to be carried forward up to 10 years. The Indian corporate tax rate would be reduced to 25%, as compared to the existing 30% for companies with annual turnover below INR 500 million ($7.3 million). The proposal includes no other changes to corporate income tax rates outside of the changes included above.

If enacted, these proposals would have a one time tax benefit to Syntel of $2.7 million. These tax benefits would be accounted in the quarter in which the aforesaid proposal is enacted.