Prior to the Separation, income taxes have been calculated as if we filed income tax returns for the Company on a standalone basis. The Company’s operations historically have been included in the income tax returns of IBM.

The components of the provision for income taxes by taxing jurisdiction were as follows:

A reconciliation of the statutory U.S. federal tax rate to the Company’s effective tax rate from continuing operations was as follows:

* Includes intercompany prepayment of 0.5% and 0.7% in 2021 and 2020, respectively.

The provision for income taxes for the year ended March 31, 2023 was $524 million compared to $402 million for the year ended December 31, 2021. The increase in income tax expense was primarily driven by the changes in valuation allowances, offset by tax charges in 2021 related to the transfer of Kyndryl’s operations that were considered a one-time item from Separation. The provision for income taxes for the year ended December 31, 2021 was $402 million compared to $247 million for the year ended December 31, 2020. The increase in income tax expense was primarily driven by foreign operations, tax charges related to the transfer of Kyndryl’s operations from IBM that were deemed to be immediately settled with IBM through the Net Parent Investment account and changes in uncertain tax positions, offset by valuation allowance reductions.

The Company’s effective tax rate for the year ended March 31, 2023 was lower than the Company’s statutory tax rate primarily due to changes in valuation allowances, taxes on foreign operations and uncertain tax positions. The Company’s effective tax rate for the three months ended March 31, 2022 was lower than the Company’s statutory tax rate primarily due to tax effects of cross-border tax laws, undistributed foreign earnings, taxes on foreign operations, uncertain tax positions and the establishment of valuation allowances in certain jurisdictions against deferred tax assets that are not more likely than not to be realized. The Company’s effective tax rate for 2021 was lower than the statutory tax rate primarily due to changes in valuation allowances, losses in certain jurisdictions that cannot be benefited from and tax charges related to the transfer of Kyndryl’s operations from IBM that were deemed to be immediately settled with IBM through the Net Parent Investment account. The Company’s effective tax rate for 2020 was lower than the statutory tax rate primarily due to changes in valuation allowances and losses in certain jurisdictions that cannot be benefited from.

The tax effects of temporary differences that give rise to significant portions of the deferred taxes were as follows:


	March 31,				December 31,
(Dollars in millions)	2023		2022		2021
Deferred tax assets
Retirement benefits	$	115	$	201	$	255
Leases		280		408		340
Stock-based and other compensation		36		64		60
U.S. tax loss/credit carryforwards		412		35		16
Deferred income		47		55		31
Foreign tax loss/credit carryforwards		118		102		76
Allowance for credit losses		28		16		10
Fixed assets and depreciation		—		112		130
Goodwill and intangible assets		34		—		—
Workforce rebalancing charges		25		—		—
Limitation on deductibility of interest		35		5		—
Accruals		61		63		57
Other		124		74		54
Gross deferred tax assets	$	1,314	$	1,135	$	1,029
Less: valuation allowance		(620)		(65)		(6)
Net deferred tax assets	$	694	$	1,069	$	1,023

Deferred tax liabilities
Fixed assets and depreciation	$	7	$	—	$	—
Goodwill and intangible assets		—		25		—
Leases and right-of-use assets		267		411		331
Undistributed foreign earnings		19		32		25
Deferred transition costs		135		122		106
Prepaids		30		3		—
Other		87		6		21
Gross deferred tax liabilities	$	544	$	600	$	483

As of March 31, 2023, the Company had tax-effected U.S. and foreign net operating loss deferred tax assets of $412 million and $118 million, respectively. As of March 31, 2022, the Company had tax-effected U.S. and foreign net operating loss deferred tax assets of $35 million and $102 million, respectively. As of December 31, 2021, the Company had tax-effected U.S. and foreign net operating loss deferred tax assets of $16 million and $76 million, respectively. If not utilized, the U.S. state net operating loss carryforwards will begin to expire in 2026 and foreign net operating loss carryforwards will begin to expire in 2024. The U.S. federal net operating loss can be carried forward indefinitely.

The valuation allowances as of March 31, 2023 and 2022, and December 31, 2021 were $620 million, $65 million, and $6 million, respectively. The increase in valuation allowances from March 31, 2022 to March 31, 2023 was

$555 million. The increase in valuation allowance is primarily a result of current year net operating losses generated in the U.S. that are not supported by the reversal of taxable temporary differences and changes in judgment associated with the realizability of deferred tax assets in certain foreign jurisdictions. For purposes of the historical periods presented on a “carve-out” basis, the Company’s income tax provisions were calculated using the separate return basis, as if the Company filed separate tax returns. Prior to Separation, the Company’s operations were included in the consolidated U.S. federal and certain state, local and foreign income tax returns filed by IBM. Post-Separation, certain net operating losses and tax credit carryforwards that were included for purposes of the historical periods presented on a “carve-out” basis available to be utilized by IBM are not available for future utilization by the Company and were settled through Net Parent investment immediately prior to the Separation. As of March 31, 2023, based on all available evidence, management concluded that no other valuation allowance was necessary to reduce the deferred tax assets remaining post-Separation since estimated future taxable income is expected to be sufficient to utilize these assets prior to their expiration. Estimates of future taxable income could change, perhaps materially, which may require us to revise our assessment of the recoverability of the deferred tax asset at that time.

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


			Three Months
	Year Ended		Ended
	March 31,		March 31,		Year Ended December 31,
(Dollars in millions)	2023		2022		2021		2020
Balance at beginning of period	$	55	$	44	$	18	$	15
Additions based on tax positions related to the current year		46		12		479		89
Additions for tax positions of prior years		3		—		—		—
Reductions for tax positions of prior years (including impacts due to a lapse of statute)		—		(1)		—		—
Settlements (closed out to Net Parent investment)		—		—		(453)		(86)
Balance at end of period	$	104	$	55	$	44	$	18

Post-Separation, liabilities related to unrecognized tax benefits for which the Company is liable are reported within the Consolidated Balance Sheet based upon tax authorities’ ability to assert the Company may be the primary obligor for historical taxes, among other factors.

With limited exceptions, the Company is generally subject to income tax audits for tax years subsequent to September 1, 2021, or post-Separation, including the U.S., Germany, Japan, and Spain, which constitutes the Company’s major jurisdictions. Pursuant to the Tax Matters Agreement, any tax liabilities attributable to the tax period (or portion thereof) ending on or before November 3, 2021, are generally not the Company’s liability. As of March 31, 2023, the Company is not aware of any material open income tax audits that would result in a liability owed by the Company. The Company does not expect a significant increase or decrease in unrecognized tax benefits within the next twelve months. The net amount of $104 million unrecognized tax benefits, if recognized, would favorably affect the Company’s effective tax rate. Interest and penalties related to income tax liabilities are included in income tax expense. During the year ended March 31, 2023, the Company recognized $6 million in interest expense and penalties. The Company had $6 million for interest and penalties accrued at March 31, 2023.

Pursuant to the Tax Matters Agreement with Kyndryl’s former Parent, the Company identified certain tax refunds related to estimated tax payments and refundable value-added taxes for which we are required to reimburse our former Parent as the refunds are received, as well as certain tax benefits related to net operating losses that were transferred to the Company for which we are required to indemnify our former Parent as the tax benefits are realized. As of March 31, 2023, the Company estimated the amount of our indemnification obligations to our former Parent related to these tax refunds and tax benefits to be approximately $14 million, where $2 million is recorded in other accrued expenses and liabilities expected to be paid within one year, and $12 million is recorded in other liabilities expected to be paid beyond the one-year period. The Company also estimated the amount of our former Parent’s indemnification obligations to us related to income tax liabilities attributable to tax periods (or portions thereof) ending on or before November 3, 2021, to be approximately $45 million, which is recorded in prepaid expenses and other current assets on our Consolidated Balance Sheet.

At March 31, 2023, the Company’s undistributed earnings from certain non-U.S. subsidiaries were not indefinitely reinvested. Accordingly, the Company recorded a deferred tax liability of $19 million for the estimated taxes associated with the repatriation of these earnings. The Company intends to repatriate certain foreign earnings that have been taxed in the U.S. and undistributed earnings to the extent the foreign earnings are not restricted by local laws and can be accessed in a cost-effective manner. Undistributed earnings of approximately $185 million in foreign subsidiaries are indefinitely reinvested and would only be taxable upon future distributions, liquidation or other disposition of the foreign subsidiaries. Quantification of the deferred tax liability, if any, associated with indefinitely reinvested earnings is not practicable.