Note 16. Income Taxes

On December 22, 2017, the U.S. government enacted tax reform. The primary provisions of tax reform affecting the Company in 2018 were a reduction to the corporate income tax rate from 35 percent to 21 percent and a transition from a worldwide corporate tax system to a primarily territorial tax system. The reduction in the corporate income tax rate required the Company to remeasure its U.S. net deferred tax liabilities to the new corporate tax rate and the transition to a territorial tax system requires payment of a one-time tax on the deemed repatriation of undistributed and previously untaxed non-U.S. earnings. Under current tax law, the Company plans to pay the deemed earnings repatriation tax (repatriation tax) in 2019 with an expected U.S. income tax overpayment.

The income tax (benefit) expense for the net deferred tax liability remeasurement and the repatriation tax in 2018 were as follows (in millions of dollars):


	2018
Net deferred tax liability remeasurement	$	(362.9)
Deemed earnings repatriation tax		20.6
Total discrete tax (benefit) expense	$	(342.3)

The provision for income taxes was also affected primarily by the lower corporate income tax rate on current year income.

The 21 percent corporate income tax rate was effective January 1, 2018. Based on the Company’s October fiscal year end, the U.S. statutory income tax rate for fiscal year 2018 was approximately 23.3 percent.

The 2018 repatriation tax expense is based on interpretations of existing laws, regulations, and certain assumptions. Further regulatory guidance is expected, which could affect the recorded expense. The Company continues to analyze the repatriation tax provisions, and monitor legislative and regulatory developments.

The taxable income of the Company is included in the consolidated U.S. income tax return of Deere & Company. Under a tax sharing agreement with Deere & Company, the Company’s provision (credit) for income taxes is generally recorded as if Capital Corporation and each of its subsidiaries filed separate income tax returns, with a modification for realizability of certain tax benefits.

The provision (credit) for income taxes by taxing jurisdiction and by significant component consisted of the following (in millions of dollars):


	2018		2017		2016
Current:
U.S.:
Federal	$	(244.5)	$	50.0	$	(119.0)
State		6.0		3.1		4.4
Foreign		17.6		25.6		17.1
Total current		(220.9)		78.7		(97.5)

Deferred:
U.S.:
Federal		(3.4)		93.5		273.4
State		4.2		.3		(.7)
Foreign		2.9		(1.0)		5.1
Total deferred		3.7		92.8		277.8
Provision (credit) for income taxes	$	(217.2)	$	171.5	$	180.3

In 2018, the Company recorded a tax benefit under the tax sharing agreement that was $19.0 million higher than an unmodified, separate return basis. The additional tax benefit is related to deductions that will be included in the 2018 consolidated U.S. income tax return of Deere & Company at Deere & Company’s 2018 U.S. statutory income tax rate of 23.3 percent. On an unmodified, separate return basis, a net operating loss would have been generated and a deferred tax asset recorded in 2018 at a U.S. statutory income tax rate of 21 percent. The pro forma provision (credit) for income taxes and net income on this basis would have been as follows (in millions of dollars):


	2018
Provision (credit) for income taxes assuming computation on an unmodified, separate return basis	$	(198.2)
Pro forma net income attributable to the Company		780.2

The amounts due from (payable to) Deere and Company under the tax sharing agreement at October 28, 2018 and October 29, 2017 were $439.1 million and $(44.0) million, respectively. The current year tax sharing receivable is included in other receivables on the consolidated balance sheet and was settled in November 2018. The prior year tax sharing payable is included in accounts payable and accrued expenses on the consolidated balance sheet.

A comparison of the statutory and effective income tax provision and reasons for related differences follows (in millions of dollars):


	2018		2017		2016
U.S. federal income tax provision at a statutory rate (2018 - 23.3 percent, 2017 and 2016 - 35 percent)	$	135.3	$	174.6	$	182.0
Increase (decrease) resulting from:
Net deferred tax liability remeasurement		(362.9)
Deemed earnings repatriation tax		20.6
Other effects of tax reform		(8.5)
Tax rates on foreign earnings		2.1		(6.8)		(5.9)
Municipal lease income not taxable		(.8)		(1.3)		(1.4)
State and local income taxes, net of federal income tax benefit		7.8		2.2		2.4
Other – net		(10.8)		2.8		3.2
Provision (credit) for income taxes	$	(217.2)	$	171.5	$	180.3

At October 28, 2018, accumulated earnings in certain subsidiaries outside the U.S. totaled $68.8 million, which were subject to the repatriation tax. No provision for foreign withholding taxes has been made because it is expected that these earnings will remain indefinitely reinvested outside the U.S. Determination of the amount of a foreign withholding tax liability on these unremitted earnings is not practicable.

An additional $372.8 million of earnings in subsidiaries outside the U.S., which were previously expected to be reinvested outside the U.S., were also subject to the repatriation tax. In the fourth quarter of 2018, the Company reviewed its global funding requirements and determined those earnings would no longer be indefinitely reinvested. Although these earnings will not be subject to U.S. income tax when repatriated to the U.S., in the fourth quarter of 2018, an accrual of $.7 million was recorded for foreign withholding taxes.

Deferred income taxes arise because there are certain items that are treated differently for financial accounting than for income tax reporting purposes. An analysis of deferred income tax assets and liabilities at October 28, 2018 and October 29, 2017 was as follows (in millions of dollars):


	2018				2017
	Deferred		Deferred		Deferred		Deferred
	Tax		Tax		Tax		Tax
	Assets		Liabilities		Assets		Liabilities
Lease transactions			$	856.5			$	898.4
Tax over book depreciation				5.2				2.5
Deferred retail note finance income				1.6				4.6
Accrual for retirement and other benefits				.5	$	29.9
Allowance for credit losses	$	31.8				54.5
Tax loss and tax credit carryforwards		33.6				29.5
Federal taxes on deferred state tax deductions		13.4				14.5
Miscellaneous accruals and other		4.1		3.9		1.7		2.3
Less valuation allowances		(2.6)				(2.9)
Deferred income tax assets and liabilities	$	80.3	$	867.7	$	127.2	$	907.8

At October 28, 2018, certain tax affected tax loss and tax credit carryforwards of $33.6 million were available, with $28.2 million expiring from 2019 through 2038 and $5.4 million with an indefinite carryforward period.

A reconciliation of the total amounts of unrecognized tax benefits at October 28, 2018, October 29, 2017, and October 30, 2016 was as follows (in millions of dollars):


	2018		2017		2016
Beginning of year balance	$	35.5	$	36.5	$	36.0
Increases to tax positions taken during the current year		9.1		7.6		9.7
Increases to tax positions taken during prior years		.9		1.2		1.1
Decreases to tax positions taken during prior years		(4.6)		(5.9)		(7.3)
Decreases due to lapse of statute of limitations		(4.6)		(3.9)		(3.0)
End of year balance	$	36.3	$	35.5	$	36.5

The amount of unrecognized tax benefits at October 28, 2018 and October 29, 2017 that would affect the effective tax rate if the tax benefits were recognized was $19.4 million and $18.0 million, respectively. The remaining liability was related to tax positions for which there are offsetting tax receivables, or the uncertainty was only related to timing. The Company expects that any reasonably possible change in the amounts of unrecognized tax benefits in the next twelve months would not be significant.

The Company files its tax returns according to the tax laws of the jurisdictions in which it operates, which includes the U.S. federal jurisdiction, and various state and foreign jurisdictions. The Company is included in the consolidated U.S. income tax return and various state returns of Deere & Company. The U.S. Internal Revenue Service has completed the examination of Deere & Company’s federal income tax returns for periods prior to 2015. The years’ 2008 through 2014 returns are subject to final approval on limited issues, of which the tax effects are recorded. The years 2015, 2016, and 2017 federal income tax returns are currently under examination. Various state and foreign income tax returns also remain subject to examination by taxing authorities.

The Company’s policy is to recognize interest related to income taxes in interest expense and other income, and recognize penalties in administrative and operating expenses. During 2018, 2017, and 2016, the total amount of expense from interest and penalties was $1.8 million, $.6 million, and $1.8 million, respectively, and the interest income was not material for any of the periods. At October 28, 2018 and October 29, 2017, the liability for accrued interest and penalties totaled $19.2 million and $17.4 million, respectively.

The Company will be subject to additional requirements of tax reform beginning in 2019. Those provisions include a tax on global intangible low-taxed income (GILTI), a tax determined by base erosion and anti-abuse tax benefits (BEAT) from certain payments between a U.S. corporation and foreign subsidiaries, a deduction for foreign derived intangible income (FDII), and interest expense limitations. Through the preliminary review of these provisions, the Company does not expect the net effect to be significant for the 2019 provision for income taxes. The Company’s accounting policy election is to treat the taxes due on future U.S. inclusions in taxable income under GILTI as a period cost when incurred.