INCOME TAXES

Earnings before income taxes consisted of the following:



	December 31,
(DOLLARS IN THOUSANDS)	2018			2017			2016
U.S. (loss) income before taxes	$	(99,125	)	$	(24	)	$	9,078
Foreign income before taxes	546,882			537,069			514,639
Total income before taxes	$	447,757		$	537,045		$	523,717

The income tax provision consisted of the following:



	December 31,
(DOLLARS IN THOUSANDS)	2018			2017			2016
Current tax provision
Federal	$	(11,568	)	$	68,886		$	(2,920	)
State and local	1,709			137			1,383
Foreign	98,433			113,468			105,873
	88,574			182,491			104,336
Deferred tax provision
Federal	(8,287		)	74,446			8,838
State and local	(7,092		)	(11,537		)	(631		)
Foreign	34,781			(4,020		)	6,143
	19,402			58,889			14,350
Total income taxes	$	107,976		$	241,380		$	118,686

Effective Tax Rate Reconciliation

Reconciliation between the U.S. federal statutory income tax rate to the actual effective tax rate was as follows:



	December 31,
	2018		2017		2016
Statutory tax rate	21.0	%	35.0	%	35.0	%
Difference in effective tax rate on foreign earnings and remittances	(6.1	)	(12.6	)	(12.6	)
Tax benefit from supply chain optimization	(3.0	)	(2.3	)	(0.7	)
Unrecognized tax benefit, net of reversals	2.9		2.3		0.6
U.S. tax reform	(1.8	)	26.5		—
Deferred taxes on deemed repatriation	10.1		0.3		1.1
Global intangible low-taxed income (GILTI)	1.8		—		—
Acquisition costs	1.3		—		—
Release of valuation allowance on state deferred	(1.5	)	(1.7	)	—
State and local taxes	0.6		0.1		0.1
Other, net	(1.2	)	(2.7	)	(0.8	)
Effective tax rate	24.1	%	44.9	%	22.7	%

The effective tax rate reflects the impact of deferred taxes on deemed repatriation and an unfavorable mix of earnings, partially offset by U.S. tax reform as discussed below and the reversal of a valuation allowance on certain state deferred tax assets. The 2018, 2017 and 2016 effective tax rates were also favorably impacted by the reversals of liabilities for uncertain tax positions of $3.9 million, $9.5 million and $7.5 million, respectively, principally due to statutory expiry and effective settlement.

U.S. Tax Reform

On December 22, 2017, the U.S. government enacted comprehensive tax legislation commonly referred to as the Tax Cuts and Jobs Act (the “Tax Act”) that significantly revised the U.S. tax code effective January 1, 2018 by, among other things, lowering the corporate income tax rate from a top marginal rate of 35% to a flat 21% and establishing a modified territorial system requiring a mandatory deemed repatriation tax on undistributed earnings of foreign subsidiaries. Beginning in 2018, the Act also requires a minimum tax on certain future earnings generated by foreign subsidiaries while providing for future tax-free repatriation of such earnings through a 100% dividends-received deduction.

The Tax Act impacted the Company's consolidated results of operations during the 2017 fourth quarter. In particular, the transition to the new territorial tax system required the Company to record a one-time tax or “toll charge” which resulted in a provisional incremental tax expense of $100.6 million principally related to previously unremitted earnings on non-U.S. subsidiaries. The cash portion of the "toll charge" is payable in installments over 8 years beginning in 2018. In addition, the reduction of the U.S. corporate tax rate resulted in a provisional net deferred tax expense of $38.6 million related to the remeasurement of net deferred tax assets as a result of the reduction in the corporate income tax rate.

During the first quarter of 2018, the Company recorded an additional charge of $0.6 million to adjust an accrual related to withholding taxes on planned repatriations. During the second quarter of 2018, the Company paid the first installment of the “toll charge”. During the third quarter of 2018, the Company recorded a benefit of $8.0 million to adjust the provisional “toll charge” required from the transition to the new territorial tax system, and a benefit of $0.2 million to adjust the remeasurement of net deferred tax assets as a result of U.S. tax reform. During the fourth quarter, the Company completed its final assessment under SAB 118, and recorded an additional charge of $32.8 million to adjust an accrual related to the U.S. state impact and foreign withholding taxes on planned repatriations. The charge in the fourth quarter of 2018 is consistent with the Company's need to repatriate funds for debt repayment purposes.

The U.S. consolidated group has historically generated taxable income after the inclusion of foreign dividends which has allowed the Company to realize its federal deferred tax assets. In the future foreign dividends will be subject to a 100% dividends received deduction under the Tax Act and will not serve as a source of federal taxable income. However, as of December 31, 2018 the U.S. consolidated group is in a cumulative income position, and is expected to continue to be in a cumulative income position principally due to the inclusion of global intangible low-taxed income and expects to realize tax benefits for the reversal of temporary differences. The corresponding U.S. federal taxable income is sufficient to realize $52.9 million in deferred tax assets as of December 31, 2018.

Annually, the Company will generate foreign tax credits to utilize against federal tax due. As the Company does not expect sufficient foreign source income to utilize the entire amount of credits generated, it has recorded a valuation allowance on $3.8 million on the federal tax attributes and has not recorded a foreign tax credit on the expected foreign withholding taxes related to the Company’s change in indefinite reinvestment assertion as of December 31, 2018.

Further, as of December 31, 2018 the Company recorded a benefit for $6.7 million related to a valuation allowance release previously recorded against state deferred tax assets. This was principally due to certain state tax treatment of global intangible low-taxed income, along with other enactments under the Tax Act. The majority of the Company’s state deferred tax assets relate to net operating loss and tax credit carryforwards that have a specified carryforward period. Therefore, the Company has maintained a valuation allowance of $3.4 million on certain state tax attributes based on a state taxable income forecast. The main input into the forecast is the 2018 taxable income projection. Changes in the performance of the North American business, the Company’s transfer pricing policies and adjustments to the Company’s U.S. tax profile due to the Tax Act could impact the estimate.

Deferred Taxes

The deferred tax assets consisted of the following amounts:



	December 31,
(DOLLARS IN THOUSANDS)	2018			2017
Employee and retiree benefits	$	80,382		$	87,400
Credit and net operating loss carryforwards^(a)	225,152			218,933
Intangible assets	12,489			13,622
Gain on foreign currency translation	—			10,885
Interest limitation	19,380			1,120
Inventory	13,308			4,428
Other, net	18,009			7,103
Gross deferred tax assets	368,720			343,491

Property, plant and equipment, net	(22,511		)	(11,745		)
Intangible assets	(616,333		)	(73,979		)
Loss on foreign currency translation	(7,717		)	—
Deferred taxes on deemed repatriation	(88,759		)	(1,610		)
Gross deferred tax liabilities	(735,320		)	(87,334		)
Valuation allowance^(a)	(200,280		)	(207,483		)
Total net deferred tax (liabilities)/assets	$	(566,880	)	$	48,674

_______________________

(a)

During 2018 and 2017, the Company increased its deferred tax assets by $5.9 million and by $58.8 million, respectively, relating to an adjustment to the 2017 and 2016 foreign net operating loss carryforwards, respectively. The entire adjustments of $5.9 million and $58.8 million were offset by corresponding adjustments in valuation allowances. These adjustments are not considered material to the previously issued financial statements.

The Tax Act created significant international tax provisions, including a new category of income, global intangible low-taxed income (GILTI). The Company has elected to treat GILTI as a current period cost if and when incurred. This tax position resulted in an $8.2 million income tax expense for the year ended December 31, 2018.

Net operating loss carryforwards were $209.4 million and $212.5 million at December 31, 2018 and 2017, respectively. If unused, $8.5 million will expire between 2019 and 2038. The remainder, totaling $200.9 million, may be carried forward indefinitely. Tax credit carryforwards were $17.8 million and $12.5 million at December 31, 2018 and 2017, respectively. If unused, the $17.8 million will expire between 2019 and 2038.

Of the $227.2 million deferred tax asset for net operating loss carryforwards and credits at December 31, 2018, the Company considers it unlikely that a portion of the tax benefit will be realized. Accordingly, a valuation allowance of $195.5 million of net operating loss carryforwards and $3.8 million of tax credits has been established against these deferred tax assets. In addition, due to realizability concerns, the Company established a valuation allowance against certain other net deferred tax assets of $3 million.

Uncertain Tax Positions

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



	December 31,
(DOLLARS IN THOUSANDS)	2018			2017			2016
Balance of unrecognized tax benefits at beginning of year	$	38,162		$	26,428		$	24,198
Gross amount of increases in unrecognized tax benefits as a result of positions taken during a prior year	9,751			1,169			1,254
Gross amount of decreases in unrecognized tax benefits as a result of positions taken during a prior year	(5,362		)	(268		)	(3		)
Gross amount of increases in unrecognized tax benefits as a result of positions taken during the current year	14,677			13,191			8,131
The amounts of decreases in unrecognized benefits relating to settlements with taxing authorities	(4,550		)	—			(6,075		)
Reduction in unrecognized tax benefits due to the lapse of applicable statute of limitation	(1,725		)	(2,358		)	(1,077		)
Balance of unrecognized tax benefits at end of year	$	50,953		$	38,162		$	26,428

At December 31, 2018, 2017 and 2016, there were $47.3 million, $28.5 million, and $19.1 million, respectively, of unrecognized tax benefits recorded to Other liabilities and $3.6 million and $9.7 million recorded to Other current liabilities for 2018 and 2017, respectively. If these unrecognized tax benefits were recognized, all the benefits and related interest would be recorded as a benefit to income tax expense.

For the year ended December 31, 2018, the Company reduced its liabilities for interest and penalties by $1.1 million, net, and increased its liabilities for interest and penalties by $3.0 million, net, and $0.3 million, net for the years ended 2017 and 2016, respectively. At December 31, 2018, 2017 and 2016, the Company had accrued $3.0 million, $2.8 million and $0.8 million, respectively, of interest and penalties classified as Other liabilities and $1.3 million and $0.3 million in 2017 and 2016, respectively, recorded to Other current liabilities. No such liabilities were accrued for the year ended December 31, 2018.

As of December 31, 2018, the Company’s aggregate provision for unrecognized tax benefits, including interest and penalties, was $53.9 million, associated with various tax positions asserted in foreign jurisdictions, none of which is individually material. Of this total, $13.5 million is associated with the Frutarom acquisition.

Other

Tax benefits credited to Shareholders’ equity were de minimis for the year ended December 31, 2018, and were $0.1 million and $0.2 million for the years ended December 31, 2017 and 2016, respectively, associated with stock option exercises and PRSU dividends.

The Tax Act requires a mandatory deemed repatriation tax on undistributed earnings of foreign subsidiaries, and as a result, all previously unremitted earnings for which no U.S. deferred tax liability had been accrued have now been subject to U.S. federal tax and will not be subject to additional U.S. federal tax when repatriated. U.S. state and foreign withholding taxes, however, may still apply in certain jurisdictions. As a result of the Tax Act, the $2.0 billion held by the Company’s non-U.S. subsidiaries was subject to current tax in the U.S. in 2017. Management has changed its assertion with regards to earnings generated in 2018 and prior as part of its final analysis under SAB 118, and consistent with the Company's need to repatriate funds for debt repayment purposes. As we repatriate these funds to the U.S. we will be required to pay income taxes in certain U.S. states and applicable foreign withholding taxes during the period when such repatriation occurs. Accordingly, we have accrued a deferred tax liability of $88.8 million for the effect of repatriating the funds to the U.S. This balance consists of $43.8 million attributable to IFF non-U.S. subsidiaries, and $45.0 million associated with the Frutarom structure which is still preliminary and will be refined through the purchase accounting measurement period.

The Company has ongoing income tax audits and legal proceedings which are at various stages of administrative or judicial review, of which the material items are discussed below. In addition, the Company has other ongoing tax audits and legal proceedings that relate to indirect taxes, such as value-added taxes, capital tax, sales and use and property taxes, which are discussed in Note 20.

The Company also has several other tax audits in process and has open tax years with various taxing jurisdictions that range primarily from 2008 to 2017. Based on currently available information, the Company does not believe the ultimate outcome of any of these tax audits and other tax positions related to open tax years, when finalized, will have a material impact on its financial position.