
(In millions)	2020		2019		2018
Current
Federal (a)	$	16	$	10	$	(2)
State	11		5		6
Non-U.S.	15		19		17
	42		34		21
Deferred
Federal	62		24		136
State	26		—		9
Non-U.S.	4		(1)		—
	92		23		145
Income tax expense	$	134	$	57	$	166

The following table presents pre-tax income and the principal components of the reconciliation between the effective tax rate and the U.S. federal statutory income tax rate in effect for the years ended September 30:


(In millions)	2020			2019			2018
Income before income taxes
United States	$	399		$	212		$	282
Non-U.S.	52			53			50
Total income before income taxes	$	451		$	265		$	332

U.S. statutory tax rate (a)	21.0		%	21.0		%	24.5		%
Income taxes computed at U.S. statutory tax rate	$	95		$	56		$	81
Increase (decrease) in amount computed resulting from:
Unrecognized tax benefits	1			5			—
State taxes, net of federal benefit	16			9			14
International rate differential	2			2			—
Permanent items	(4)			(3)			(3)
Remeasurement of net deferred taxes (b)	1			(4)			73
Return-to-provision adjustments	(2)			(6)			—
Deemed repatriation (c)	—			—			4
Change in valuation allowance	29			(4)			1
Tax Matters Agreement activity	(6)			1			(2)
Other	2			1			(2)
Income tax expense	$	134		$	57		$	166
Effective tax rate	29.7		%	21.5		%	50.0		%

(a)As a result of U.S. tax reform legislation which generally became effective January 1, 2018, the federal corporate income tax rate was lowered from 35% to 21%. Based on the effective date of the rate reduction, the Company's federal corporate statutory income tax rate was a blended rate of 24.5% for fiscal 2018.

(b)The remeasurement of net deferred taxes relates to the enactment and clarification of tax reform legislation. During fiscal 2018, Valvoline recognized $71 million of income tax expense to remeasure net deferred tax assets at the lower enacted corporate tax rates due to U.S. and Kentucky tax reform legislation.

Higher income tax expense in fiscal 2020 from the prior year was principally driven by higher pre-tax earnings and income tax expense recognized during the year to establish a $30 million valuation allowance on certain legacy tax attributes. This increase in expense coupled with prior year benefits from the release of a valuation allowance and the clarification of certain provisions of Kentucky tax reform legislation led to a higher effective tax rate in fiscal 2020.

Deferred income taxes are provided for income and expense items recognized in different years for tax and financial reporting purposes. A summary of the deferred tax assets and liabilities included in the Consolidated Balance Sheets follows as of September 30:


(In millions)	2020		2019
Deferred tax assets
Non-U.S. net operating loss carryforwards (a)	$	2	$	2
State net operating loss carryforwards (b)	18		19
Employee benefit obligations	79		98
Compensation accruals	26		21
Credit carryforwards (c)	11		19
Operating lease liabilities	69		—
Other	17		23
Valuation allowances (d)	(30)		(2)
Net deferred tax assets	192		180
Deferred tax liabilities
Goodwill and other intangibles	11		9
Property, plant and equipment	75		47
Operating lease assets	67		—
Undistributed earnings	6		2
Total deferred tax liabilities	159		58
Total net deferred tax assets (e)	$	33	$	122

(d)Valuation allowances at September 30, 2020 primarily relate to state net operating loss carryforwards and certain other federal legacy tax attributes that are no longer expected to be realized or realizable.

(e)Due to netting of deferred tax assets and liabilities by jurisdiction, a $1 million net deferred tax liability is included within Other noncurrent liabilities in the Consolidated Balance Sheets as of September 30, 2020 and 2019.

Prior to U.S. tax reform, the Company had not provided for U.S. income taxes on undistributed earnings and other outside basis differences of its non-U.S. subsidiaries as it was the Company’s intention for these tax basis differences to remain indefinitely reinvested. Valvoline began to record estimated incremental withholding taxes during fiscal 2018 and account for certain of its non-U.S. subsidiaries as being immediately subject to tax, while certain other outside basis differences restricted by regulations, operational or investing needs for non-U.S. subsidiaries remained indefinitely reinvested. If these outside basis differences were no longer to be indefinitely reinvested in the future, the Company may be subject to additional income and withholding taxes, which are not practicable to estimate.

Prior to its initial public offering (the "IPO") in September 2016, the Valvoline business operated as a wholly-owned subsidiary of Ashland Global Holdings Inc. (which together with its predecessors and consolidated subsidiaries is referred to herein as “Ashland”). Valvoline was incorporated in May 2016 and in advance of the IPO, the Valvoline business and certain other legacy Ashland assets and liabilities were transferred from Ashland to Valvoline as a reorganization of entities under common Ashland control (the "Contribution"). In connection with the IPO, Ashland retained 83% of the total outstanding shares of Valvoline's common stock. On May 12, 2017, Ashland distributed its interest in Valvoline to Ashland stockholders through a pro rata dividend on shares of Ashland common stock outstanding (the "Distribution"), which marked the completion of Valvoline's separation from Ashland and Valvoline was no longer a controlled and consolidated subsidiary of Ashland.

An agreement (the "Tax Matters Agreement") was entered into on September 22, 2016 between Valvoline and Ashland, that generally provides that Valvoline is required to indemnify Ashland for the following items:

•Certain U.S. federal, state or local taxes for the pre-IPO period of Ashland and/or its subsidiaries that arise on audit or examination and are not directly attributable to either the Valvoline business or the Ashland chemicals business;

For the periods prior to the Distribution, Valvoline was included in Ashland’s consolidated U.S. and state income tax returns and in the income tax returns of certain Ashland international subsidiaries (collectively, the “Ashland Group Returns”). For the taxable periods that began on and after the Distribution, Valvoline is not included in the Ashland Group Returns and files tax returns that include only Valvoline and/or its subsidiaries, as appropriate.

Valvoline has joint and several liability with Ashland to the U.S. Internal Revenue Service for the consolidated U.S. federal income taxes of the Ashland consolidated group for the taxable periods in which Valvoline was part of the Ashland Group Returns. Valvoline has joint control with Ashland, over any audit or examination related to taxes for which Valvoline is required to indemnify Ashland. Accordingly, these portions of the Tax Matters Agreement will be settled as examinations of the pre-Distribution periods are completed.

Adjustments to the net obligations to Ashland under the Tax Matters Agreement are recorded within Net legacy and separation-related (income) expenses, with any resulting impacts to Valvoline's stand-alone income tax provision recorded in Income tax expense within the Consolidated Statements of Comprehensive Income.

In connection with filing the Company's fiscal 2019 income tax returns in the fourth quarter of fiscal 2020, management determined it is no longer more likely than not to realize certain tax attributes which were transferred from Ashland as a result of the Contribution. Accordingly, the Company recognized income tax expense of $30 million to establish a valuation allowance for these tax attributes with an offsetting impact to reduce the estimated indemnity obligation, the combined effects of which have no impact to net income in the fiscal year ended September 30, 2020. Total liabilities related to obligations owed to Ashland under the Tax Matters Agreement are primarily recorded in Other noncurrent liabilities in the Consolidated Balance Sheets and were $34 million and $66 million as of September 30, 2020 and 2019, respectively.

Based on information available at this time, the Company has established adequate accruals for its obligations under the Tax Matters Agreement. In certain circumstances, the actual amounts ultimately required to satisfy these obligations could significantly exceed those currently reflected in the consolidated financial statements. Such estimates cannot currently be made given the uncertainty with regard to the nature and extent of items that could arise upon examination of the pre-Distribution periods, which include the Contribution and Distribution transactions. For example, if the tax-free nature of the Contribution and/or Distribution transactions is not sustained, if certain reorganization transactions undertaken in connection with the separation and the Distribution are determined to be taxable, or if additional matters arise upon examination of the pre-Distribution periods, Valvoline could have a substantial indemnification obligation to Ashland in excess of those currently provided.


(In millions)	2020		2019		2018
Gross unrecognized tax benefits as of October 1	$	14	$	10	$	10
Increases related to tax positions from prior years	1		5		2
Increases related to tax positions taken during the current year	1		—		1
Settlements with tax authorities	—		—		(2)
Lapses of statutes of limitation	(1)		(1)		(1)
Gross unrecognized tax benefits as of September 30 (a)	$	15	$	14	$	10

The Company's U.S. federal income tax returns and certain U.S. state jurisdictions remain open to examination from fiscal 2017 forward. With certain exceptions, years beginning on or after fiscal 2008 generally remain open to examination by certain non-U.S. taxing authorities. Given the indemnification of Ashland for periods in which Valvoline was included in Ashland Group Returns and the years that remain open to examination, a significant portion of the Company's liability for unrecognized tax benefits is included in the Tax Matters Agreement obligation summarized above. These periods that remain open to examination include federal income tax returns from fiscal 2014 and certain U.S. state jurisdictions from fiscal 2011.