R. Income Taxes

The components of income from continuing operations before income taxes were as follows:


	2016		2015		2014
United States	$	84	$	124	$	207
Foreign		330		59		(94	)
	$	414	$	183	$	113

The provision for income taxes consisted of the following:


	2016			2015			2014
Current:
Federal*	$	-		$	-		$	-
Foreign		133			115			70
State and local		1			(1	)		1
		134			114			71
Deferred:
Federal*		1,208			196			67
Foreign		136			29			37
State and local		(2	)		-			(1	)
		1,342			225			103
Total	$	1,476		$	339		$	174

*	Includes U.S. taxes related to foreign income

The exercise of employee stock options generated a tax benefit of $0, $2 and $8 in 2016, 2015 and 2014, respectively, representing only the difference between compensation expense recognized for financial reporting and tax purposes. These amounts increased equity and either decreased current taxes payable or increased deferred tax assets (net operating losses) in the respective periods.

Arconic has unamortized tax-deductible goodwill of $23 resulting from intercompany stock sales and reorganizations. Arconic recognizes the tax benefits (at a 25% rate) associated with this tax-deductible goodwill as it is being amortized for local income tax purposes rather than in the period in which the transaction is consummated.

A reconciliation of the U.S. federal statutory rate to Arconic’s effective tax rate was as follows (the effective tax rate for all periods was a provision on income):


	2016			2015			2014
U.S. federal statutory rate		35.0	%		35.0	%		35.0	%
Taxes on foreign operations		(10.2	)		2.5			(9.4	)
Permanent differences on restructuring and other charges and asset disposals		(107.8	)		3.6			(1.0	)
Non-deductible acquisition costs		8.4			7.1			7.3
Statutory tax rate and law changes⁽¹⁾		(15.7	)		(1.0	)		78.8
Tax holidays⁽²⁾		(0.8	)		(3.9	)		38.5
Tax credits		(1.2	)		(2.8	)		(1.9	)
Changes in valuation allowances		426.8			145.8			17.3
Impairment of goodwill		-			4.8			-
Company-owned life insurance/split-dollar net premiums		23.0			(3.0	)		(9.6	)
Changes in uncertain tax positions		2.3			(2.0	)		(5.6	)
Other		(3.3	)		(0.9	)		4.6
Effective tax rate		356.5	%		185.2	%		154.0	%

⁽¹⁾

In November 2014, Spain enacted corporate tax reform that changed the corporate tax rate from 30% in 2014 to 28% in 2015 to 25% in 2016. As a result, Arconic remeasured certain deferred tax assets related to Spanish subsidiaries. In December 2016, Spain and the United States enacted tax law changes which resulted in the remeasurement of certain deferred tax liabilities recorded by Arconic.

⁽²⁾	In 2014, a tax holiday for certain former Arconic subsidiaries in Brazil became effective (see below).

The components of net deferred tax assets and liabilities were as follows:


	2016					2015
December 31,	Deferred tax assets			Deferred tax liabilities		Deferred tax assets			Deferred tax liabilities
Depreciation	$	15		$	817	$	8		$	964
Employee benefits		1,382			8		1,521			11
Loss provisions		181			1		172			2
Tax loss carryforwards		1,540			-		926			-
Tax credit carryforwards		652			-		673			-
Other		184			93		311			31
		3,954			919		3,611			1,008
Valuation allowance		(1,940	)		-		(1,291	)		-
	$	2,014		$	919	$	2,320		$	1,008

The following table details the expiration periods of the deferred tax assets presented above:


December 31, 2016	Expires within 10 years			Expires within 11-20 years			No expiration*			Other*			Total
Tax loss carryforwards	$	81		$	744		$	715		$	-		$	1,540
Tax credit carryforwards		428			89			100			35			652
Other		-			-			72			1,690			1,762
Valuation allowance		(465	)		(663	)		(677	)		(135	)		(1,940	)
	$	44		$	170		$	210		$	1,590		$	2,014

Deferred tax assets with no expiration may still have annual limitations on utilization. Other represents deferred tax assets whose expiration is dependent upon the reversal of the underlying temporary difference. A substantial amount of Other relates to employee benefits that will become deductible for tax purposes over an extended period of time as contributions are made to employee benefit plans and payments are made to retirees.

The total deferred tax asset (net of valuation allowance) is supported by projections of future taxable income exclusive of reversing temporary differences (59%) and taxable temporary differences that reverse within the carryforward period (41%).

Valuation allowances are recorded to reduce deferred tax assets when it is more likely than not (greater than 50%) that a tax benefit will not be realized. In evaluating the need for a valuation allowance, management considers all potential sources of taxable income, including income available in carryback periods, future reversals of taxable temporary differences, projections of taxable income, and income from tax planning strategies, as well as all available positive and negative evidence. Positive evidence includes factors such as a history of profitable operations, projections of future profitability within the carryforward period, including from tax planning strategies, and Arconic’s experience with similar operations. Existing favorable contracts and the ability to sell products into established markets are additional positive evidence. Negative evidence includes items such as cumulative losses, projections of future losses, or carryforward periods that are not long enough to allow for the utilization of a deferred tax asset based on existing projections of income. Deferred tax assets for which no valuation allowance is recorded may not be realized upon changes in facts and circumstances, resulting in a future charge to establish a valuation allowance. Existing valuation allowances are re-examined under the same standards of positive and negative evidence. If it is determined that it is more likely than not that a deferred tax asset will be realized, the appropriate amount of the valuation allowance, if any, is released. Deferred tax assets and liabilities are also re-measured to reflect changes in underlying tax rates due to law changes and the granting and lapse of tax holidays.

In 2016, Arconic recognized a $1,267 discrete income tax charge for valuation allowances related to the Separation Transaction, including $925 with respect to Alcoa Corporation’s net deferred tax assets in the United States, $302 with respect to Arconic’s foreign tax credits in the United States, $42 with respect to certain deferred tax assets in Luxembourg, and $(2) related to the net impact of other smaller items. After weighing all positive and negative evidence, as described above, management determined that the net deferred tax assets of Alcoa Corporation were not more likely than not to be realized due to lack of historical and projected domestic source taxable income. As such, a valuation allowance was recorded immediately prior to separation.

Upon separation, Arconic retained foreign tax credits in the United States which have a 10-year carryforward period with expirations ranging from 2017 to 2026 (as of December 31, 2016). Arconic also retained suspended foreign tax credit carryforwards whose expiration period begins when the credits become unsuspended. A valuation allowance of $135 was initially established in 2013 on a portion of the foreign tax credit carryforwards, primarily due to insufficient foreign source income to allow for full utilization of the credits within the expiration period. An incremental valuation allowance of $134 was recognized in 2015. At the end of 2015 and 2016, $15 and $128 of foreign tax credits respectively expired resulting in a corresponding decrease to the valuation allowance. As a result of the Separation Transaction, management determined that it was no longer more likely than not that Arconic would realize the full tax benefit of its foreign tax credit carryforwards based on changes in the availability of foreign sourced taxable income. After consideration of all available evidence including potential tax planning strategies and earnings of foreign subsidiaries projected to be distributable as taxable foreign dividends, an incremental valuation allowance of $302 was recognized in 2016. At December 31, 2016, the cumulative amount of the valuation allowance was $427. The need for this valuation allowance will be reassessed on a continuous basis in future periods and, as a result, the allowance may increase or decrease based on changes in facts and circumstances.

In addition, Arconic recognized a $42 discrete income tax charge in 2016 for a valuation allowance on the full value of certain net deferred tax assets in Luxembourg. Sources of taxable income which previously supported the net deferred tax asset are no longer available as a result of the Separation Transaction. The need for this valuation allowance will be reassessed on a continuous basis in future periods and, as a result, the allowance may increase or decrease based on changes in facts and circumstances.

In 2016, Arconic also recognized discrete income tax benefits related to the release of valuation allowances on certain net deferred tax assets in Russia and Canada of $19 and $20 respectively. After weighing all available evidence, management determined that it was more likely than not that the net income tax benefits associated with the underlying deferred tax assets would be realizable based on historic cumulative income and projected taxable income.

Arconic also recorded additional valuation allowances in Australia of $93 related to the Separation Transaction, in Spain of $163 related to a tax law change and in Luxembourg of $280 related to the Separation Transaction as well as a tax law change. These valuation allowances fully offset current year changes in deferred tax asset balances of each respective jurisdiction, resulting in no net impact to tax expense. The need for a valuation allowance will be reassessed on a continuous basis in future periods by each jurisdiction and, as a result, the allowances may increase or decrease based on changes in facts and circumstances.

In 2015, Arconic recognized an additional $141 discrete income tax charge for valuation allowances on certain deferred tax assets in Iceland and Suriname. Of this amount, an $85 valuation allowance was established on the full value of the deferred tax assets in Suriname, which were related mostly to employee benefits and tax loss carryforwards. These deferred tax assets have an expiration period ranging from 2016 to 2022 (as of December 31, 2015). The remaining $56 charge relates to a valuation allowance established on a portion of the deferred tax assets recorded in Iceland. These deferred tax assets have an expiration period ranging from 2017 to 2023. After weighing all available positive and negative evidence, as described above, management determined that it was no longer more likely than not that Arconic will realize the tax benefit of either of these deferred tax assets. This was mainly driven by a decline in the outlook of the Primary Metals business, combined with prior year cumulative losses and a short expiration period.

In December 2011, one of Arconic’s former subsidiaries in Brazil applied for a tax holiday related to its expanded mining and refining operations. During 2013, the application was amended and re-filed and, separately, a similar application was filed for another one of Arconic’s former subsidiaries in Brazil. The deadline for the Brazilian government to deny the application was July 11, 2014. Since Arconic did not receive notice that its applications were denied, the tax holiday took effect automatically on July 12, 2014. As a result, the tax rate applicable to qualified holiday income for these subsidiaries decreased significantly (from 34% to 15.25%), resulting in future cash tax savings over the 10-year holiday period (retroactively effective as of January 1, 2013). Additionally, a portion of one of the subsidiaries net deferred tax assets that reverses within the holiday period was remeasured at the new tax rate (the net deferred tax asset of the other subsidiary was not remeasured since it could still be utilized against the subsidiary’s future earnings not subject to the tax holiday). This remeasurement resulted in a decrease to that subsidiary’s net deferred tax assets and a noncash charge to earnings of $52 ($31 after noncontrolling interests).

The following table details the changes in the valuation allowance:


December 31,	2016			2015			2014
Balance at beginning of year	$	1,291		$	1,151		$	1,252
Increase to allowance		772			180			102
Release of allowance		(209	)		(42	)		(70	)
Acquisitions and divestitures (F)		(1	)		29			(36	)
Tax apportionment, tax rate and tax law changes		106			(15	)		(67	)
Foreign currency translation		(19	)		(12	)		(30	)
Balance at end of year	$	1,940		$	1,291		$	1,151

The cumulative amount of Arconic’s foreign undistributed net earnings for which no deferred taxes have been provided was approximately $450 at December 31, 2016. Arconic has a number of commitments and obligations related to the Company’s growth strategy in foreign jurisdictions. As such, management has no plans to distribute such earnings in the foreseeable future, and, therefore, has determined it is not practicable to determine the related deferred tax liability.

Arconic and its subsidiaries file income tax returns in the U.S. federal jurisdiction and various states and foreign jurisdictions. With a few minor exceptions, Arconic is no longer subject to income tax examinations by tax authorities for years prior to 2006. All U.S. tax years prior to 2016 have been audited by the Internal Revenue Service. Various state and foreign jurisdiction tax authorities are in the process of examining Arconic’s income tax returns for various tax years through 2015.

A reconciliation of the beginning and ending amount of unrecognized tax benefits (excluding interest and penalties) was as follows:


December 31,	2016			2015			2014
Balance at beginning of year	$	18		$	7		$	8
Additions for tax positions of the current year		12			-			-
Additions for tax positions of prior years		-			14			4
Reductions for tax positions of prior years		-			(2	)		(3	)
Settlements with tax authorities		(1	)		-			(1	)
Expiration of the statute of limitations		(1	)		(1	)		-
Foreign currency translation		-			-			(1	)
Balance at end of year	$	28		$	18		$	7

For all periods presented, a portion of the balance at end of year pertains to state tax liabilities, which are presented before any offset for federal tax benefits. The effect of unrecognized tax benefits, if recorded, that would impact the annual effective tax rate for 2016, 2015, and 2014 would be approximately 6%, 7%, and 4%, respectively, of pretax book income. Arconic does not anticipate that changes in its unrecognized tax benefits will have a material impact on the Statement of Consolidated Operations during 2017 (see Tax in Note L for a matter for which no reserve has been recognized).

It is Arconic’s policy to recognize interest and penalties related to income taxes as a component of the Provision for income taxes on the accompanying Statement of Consolidated Operations. In 2016, 2015, and 2014, Arconic did not recognize any interest or penalties. Due to the expiration of the statute of limitations, settlements with tax authorities, and refunded overpayments, Arconic recognized interest income of $1 in 2015 but did not recognize any interest income in 2016 or 2014. As of December 31, 2016 and 2015, the amount accrued for the payment of interest and penalties was $2 and $1, respectively.