Note 17 – Income Taxes

Prior to October 31, 2016, the Company’s results have historically been included in the consolidated U.S. federal tax return and U.S. state income tax filings of YUM. Our foreign income tax returns, primarily those filed by our China subsidiaries, are filed on an individual entity basis. The Company has calculated its provision using the separate return method in these Consolidated and Combined Financial Statements. Under this method, the Company is assumed to have filed hypothetical tax returns on a standalone basis separate from YUM in the relevant tax jurisdictions. Any additional accrued tax liability attributable to the Company arising from the separate return method has been shown as settled against the net Parent Company Investment account in these Consolidated and Combined Financial Statements. The Company has recorded deferred taxes on its temporary differences, including hypothetical carryforwards and tax credits created by the separate tax return filings. The established current and deferred tax balances may not be indicative of the Company’s actual balances prior to the separation.

Subsequent to October 31, 2016, the Company became a separate taxpayer and will prepare its own consolidated U.S. federal income tax return and U.S. state income tax filings. As of December 31, 2016, the current and deferred taxes, including carryforwards and tax credits, are reflective of the Company’s actual balances subsequent to the separation.

U.S. and foreign income before taxes are set forth below:

	2016		2015			2014
U.S.	$	5	$	(7	)	$	15
China		659		502			—
Other Foreign		8		1			2
	$	672	$	496		$	17

The details of our income tax provision (benefit) are set forth below:

		2016			2015			2014
Current:	Federal	$	(2	)	$	7		$	9
	Foreign		200			132			149
		$	198		$	139		$	158

Deferred:	Federal	$	(36	)	$	(7	)	$	(9	)
	Foreign		(4	)		36			(95	)
		$	(40	)	$	29		$	(104	)
		$	158		$	168		$	54

The reconciliation of income taxes calculated at the U.S. federal statutory rate to our effective tax rate is set forth below:

	2016					2015					2014
U.S. federal statutory rate	$	235		35.0	%	$	173		35.0	%	$	6		35.0	%
Statutory rate differential attributable to foreign operations		(55	)	(8.4	)		(15	)	(3.1	)		5		32.2
Adjustments to reserves and prior years		16		2.4			3		0.6			(3	)	(20.9	)
Change in valuation allowances		—		—			12		2.4			13		79.8
Tax benefit from Little Sheep restructuring		(26	)	(3.8	)		—		—			—		—
Tax impact from Little Sheep goodwill impairment		—		—			—		—			40		240.8
Other, net		(12	)	(1.7	)		(5	)	(1.0	)		(7	)	(44.6	)
Effective income tax rate	$	158		23.5	%	$	168		33.9	%	$	54		322.3	%

Statutory rate differential attributable to foreign operations. This item includes local taxes, withholding taxes, and shareholder-level taxes, net of foreign tax credits. The favorable impact is primarily attributable to a majority of our income being earned in China where it is subject to a 25% tax rate, which is lower than the U.S. federal statutory rate of 35%

In 2016, 2015 and 2014, this benefit was negatively impacted by the actual and deemed repatriation of current year foreign earnings to the U.S. as we recognized additional tax expense, resulting from the related effective tax rate being lower than the U.S. federal statutory rate.

Adjustments to reserves and prior years. This item includes: (1) changes in tax reserves, including interest thereon, established for potential exposure we may incur if a taxing authority takes a position on a matter contrary to our position; and (2) the effects of reconciling income tax amounts recorded in our Consolidated and Combined Statements of Income to amounts reflected on our tax returns, including any adjustments to the Consolidated and Combined Balance Sheets. The impact of certain effects or changes may offset items reflected in the ‘Statutory rate differential attributable to foreign operations’ line.

In 2016, this item was negatively impacted by the additional amount recorded for uncertain tax positions in China, whereas in 2014, it was favorably impacted by the resolution of uncertain tax positions in China.

Change in valuation allowances. This item relates to changes for deferred tax assets generated or utilized during the current year and changes in our judgment regarding the likelihood of using deferred tax assets that existed at the beginning of the year. The impact of certain changes may offset items reflected in the ‘Statutory rate differential attributable to foreign operations’ line.

In 2015 and 2014, $12 million and $13 million, respectively, of net tax expense was driven by valuation allowances recorded against deferred tax assets generated during the current year.

Tax benefit from Little Sheep restructuring. In 2016, we recognized tax benefit of $26 million as a result of Little Sheep legal entity restructuring completed prior to the separation. The cash tax savings associated with this benefit will be realized as we recognize future U.S. taxable income.

Tax impact from Little Sheep goodwill impairment. In 2014, we recorded $160 million of non-cash impairment of Little Sheep goodwill, which resulted in no related tax benefit. See Note 5.

Other. This item primarily includes the impact of permanent differences related to current year earnings as well as U.S. tax credits and deductions.

In 2016, this item was favorably impacted by non-taxable gain from changes in fair value of financial instruments associated with the Investors’ strategic investment in Yum China. See Note 13.

The details of 2016 and 2015 deferred tax assets (liabilities) are set forth below:

	2016			2015
Operating losses and tax credit carryforwards	$	86		$	66
Tax benefit from Little Sheep restructuring		26			—
Employee benefits		4			2
Share-based compensation		8			11
Deferred escalating minimum rent		42			43
Various liabilities		8			14
Deferred income and other		35			37
Gross deferred tax assets		209			173
Deferred tax asset valuation allowances		(41	)		(45	)
Net deferred tax assets	$	168		$	128
Intangible assets		(22	)	$	(23	)
Property, plant and equipment		(1	)		(4	)
Other		(9	)		(9	)
Gross deferred tax liabilities	$	(32	)	$	(36	)
Net deferred tax assets	$	136		$	92
Reported in Consolidated and Combined Balance Sheets as:
Deferred income taxes		162		$	116
Other liabilities and deferred credits		(26	)		(24	)
	$	136		$	92

We have investments in our foreign subsidiaries where the carrying values for financial reporting exceed the tax basis. We have not provided deferred tax on the portion of the excess that we believe is indefinitely reinvested, as we have the ability and intent to indefinitely postpone the basis differences from reversing with a tax consequence. The Company’s separation from YUM is intended to qualify as a tax-free reorganization for U.S. income tax purposes resulting in the excess of financial reporting basis over tax basis in our investment in the China business continuing to be indefinitely reinvested. This amount may become taxable upon an actual or deemed repatriation of assets from the subsidiaries or a sale or liquidation of the subsidiaries. We estimate that our total temporary difference upon which we have not provided deferred tax is approximately $1.5 billion at December 31, 2016. However, it is not practicable to determine the deferred tax liability on this amount due to uncertainty with regard to the timing or manner of repatriation and the related impact on local taxes, withholding taxes and foreign tax credits.

At December 31, 2016, the Company has operating loss carryforwards of $160 million, primarily related to our Little Sheep business, all of which will expire by 2021. These losses are being carried forward in jurisdictions where we are permitted to use tax losses from prior periods to reduce future taxable income.

As of December 31, 2016, the Company has U.S. tax credit carryforwards of $46 million, which represents Yum China’s foreign tax credit carryforwards as a result of the separation. This was attributable to the distributions from the Company’s China business to YUM after Yum China was incorporated and became the parent of the Company’s operating entities in China. The tax credits will expire by 2026.

At December 31, 2016, the Company also has tax benefit from Little Sheep restructuring of $26 million, $12 million and $14 million of which will expire by 2026 and 2036, respectively.

Cash payments for tax liabilities on income tax returns filed in China were $182 million, $143 million and $186 million in 2016, 2015 and 2014, respectively.

We recognize the benefit of positions taken or expected to be taken in tax returns in the financial statements when it is more likely than not that the position would be sustained upon examination by tax authorities. A recognized tax position is measured at the largest amount of benefit that is greater than fifty percent likely of being realized upon settlement.

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

	2016			2015
Beginning of Year	$	15		$	13
Additions on tax positions		14			4
Reductions due to statute expiration		(3	)		(2	)
End of Year	$	26		$	15

In 2016 and 2015, we increased our unrecognized tax benefits by $14 million and $4 million, respectively, related to uncertainty with regard to the deductibility of certain business expenses incurred during the year. The Company believes it is reasonably possible its unrecognized tax benefits may decrease by approximately $6 million in the next twelve months, all of which, if recognized upon audit settlement or statute expiration, would affect the 2017 effective tax rate.

The Company’s results are subject to examination in the U.S. federal jurisdiction as well as various U.S. state jurisdictions as part of YUM’s and our own income tax filings, and separately in foreign jurisdictions. Any liability arising from these examinations is expected to be settled among the Company, YCCL and YUM in accordance with the tax matters agreement we entered into in connection with the separation.

YUM has settled audits with the IRS through fiscal year 2010. The Company’s operations in foreign jurisdictions generally remain subject to examination for tax years as far back as 2006, some of which years are currently under audit by local tax authorities. The accrued interest and penalties related to income taxes at December 31, 2016 and 2015 are set forth below:

		2016				2015
Accrued interest and penalties		$	5			$	3

During 2016, 2015 and 2014, a net expense of $3 million, $1 million and a net benefit of $4 million, respectively, for interest and penalties was recognized in our Consolidated and Combined Statements of Income as components of our income tax provision.