Income Taxes

Recent Tax Legislation

The 2017 Act was enacted into law on December 22, 2017, and significantly changes existing U.S. tax law. The 2017 Act adopts a territorial tax system, imposes a mandatory one-time transition tax on earnings of foreign subsidiaries that were previously indefinitely reinvested, and reduces the U.S. federal statutory tax rate from 35% to 21%. The reduction in the U.S. federal statutory tax rate is effective on January 1, 2018, which requires the Company to use a blended tax rate for fiscal 2018. Our blended tax rate is 23.34% for fiscal 2018 and is calculated by applying a pro-rated percentage based on the number of days in our fiscal 2018 before and after the January 1, 2018 effective date. For fiscal 2019 and subsequent years, the Company will utilize the enacted U.S. federal statutory tax rate of 21%.

The 2017 Act includes several provisions that are effective for our fiscal 2019: (i) tax on global intangible low-taxed income (GILTI) of foreign subsidiaries, (ii) tax on certain payments between a U.S. corporation and its foreign subsidiaries referred to as the base erosion and anti-abuse tax (BEAT), (iii) limitation on the tax deduction for interest payments, and (iv) expanded limitation on the tax deduction for compensation paid to certain executives.

The 2017 Act was effective in the first quarter of fiscal 2018. As of October 31, 2018, we have not completed our accounting for the tax effects of the enactment of the 2017 Act. During 2018, we recorded a provisional tax expense of $214.6 million in our financial statements, based on reasonable estimates of the tax effects of the 2017 Act. The provisional tax expense is subject to revisions as we gather and prepare additional information to complete our analysis of the 2017 Act, and interpret additional guidance issued by the FASB, Internal Revenue Service and U.S. Treasury Department. The provisional tax expense will be finalized during the measurement period, which should not extend beyond one year from the enactment date and could be materially different than our provisional tax expense. The provisional tax expense is described in more detail below.

During 2018, the Company recorded a $185.7 million provisional tax expense for the mandatory deemed repatriation of deferred foreign earnings and plans to pay the applicable amounts over eight years. The 2017 Act requires us to incur a one-time transition tax on deferred foreign income not previously subject to U.S. income tax at a rate of 15.5% for foreign cash and certain other net current assets, and 8% on the remaining deferred foreign income. We have not completed our analysis of the earnings and profits and foreign tax credits, which are critical inputs to the calculation.

During 2018, the Company completed its analysis and recorded a provisional tax expense of $20.0 million to record changes to deferred taxes resulting from the decrease in the U.S. federal tax rate. The amount is calculated using the applicable tax rates in the years in which the deferred tax assets and liabilities are expected to reverse.

Due to the changes in the 2017 Act, we reviewed our prior assertion that earnings from our foreign subsidiaries were indefinitely reinvested. For purposes of recording the provisional tax expense in 2018, we are no longer asserting that earnings from our foreign subsidiaries are indefinitely reinvested. Accordingly, we have recorded provisional estimates related to additional state income taxes of $7.0 million and withholding taxes of $1.9 million relating to the unremitted foreign earnings. We have not completed our analysis because we are still gathering additional information to quantify the impact to the individual states and to quantify the withholding taxes that would be owed when future dividends are paid to the U.S. As the Company completes its analysis, it will make appropriate changes to the financial statements within the measurement period.

The 2017 Act imposes a new tax on foreign earnings and profits in excess of a deemed return on tangible assets of foreign subsidiaries referred to as GILTI. The 2017 Act also imposes a new tax on certain payments between a U.S. corporation and its foreign subsidiaries referred to as BEAT. These new provisions are effective for fiscal 2019. Due to the complexity of the new GILTI and BEAT tax rules, we are continuing to evaluate these new provisions and the application of GAAP. With respect to GILTI, FASB Staff Q&A, Topic 740, No. 5, Accounting for Global Intangible Low-Taxed Income, states that an entity can make an accounting policy election to either recognize deferred taxes for temporary basis differences expected to reverse as GILTI in future years or provide for the tax expense related to GILTI in the year the tax is incurred. Given the complexity of the GILTI provisions, we are still evaluating the effect of the GILTI provisions and have not yet determined our accounting policy. The Company will continue its evaluation and make a policy election within the measurement period.

The 2017 Act limits the future deductions relating to interest expense and certain executive compensation. These provisions are generally effective for the Company in 2019. Pursuant to transition rules provided in the 2017 Act, companies will be allowed tax deductions for performance based plans in existence on or before November 2, 2017, if not materially modified after that date. We have completed our analysis of the executive compensation relating to plans in existence on or before November 2, 2017 and concluded that substantially all of those plans will meet the grandfather provisions and be fully deductible.

Diverted Profits Tax (DPT)

The United Kingdom enacted a Diverted Profits Tax (DPT) as of April 1, 2015 on profits of multinationals that they deemed artificially diverted from the United Kingdom. The tax rate is 25%. DPT is intended to apply in two situations: (a) where a foreign company has artificially avoided having a taxable presence in the United Kingdom; and (b) where a group adopts a structure which lacks economic substance in order to divert profits from the United Kingdom.

During fiscal 2017, the U.K. Tax Authorities began an inquiry regarding the application of the DPT in fiscal 2015. We believe that the transactions in question were at arm’s length with no intention to divert profit from the United Kingdom and therefore are outside the intended reach of the DPT.

On December 20, 2017, the U.K. Tax Authorities issued a DPT charging notice of approximately GBP 31.0 million with respect to the transfer out of the United Kingdom of certain intellectual property rights in connection with the 2014 acquisition of Sauflon Pharmaceutical Ltd. Although taxes were paid on the transfer, the U.K. Tax Authorities are challenging the value assigned to such property. We have contested the charging notice. The process for resolving such a notice can be lengthy and could involve litigation. The DPT legislation provides a one-year review period; however, it requires prepayment of the charging notice to be made within 30 days of its issuance. As required, the payment of GBP 31.0 million was made on January 19, 2018.

The Company believes final resolution of the transfer value of intellectual property with the U.K. Tax Authorities is imminent. The outcome of final resolution is not expected to have a material impact on the financial statements.

Effective Tax Rate

The Company’s effective tax rate (ETR) was 57.9%, 5.3% and 7.0% for fiscal 2018, 2017 and 2016, respectively. The ETR in fiscal 2018 increased in comparison to fiscal 2017 primarily due to the net charge related to the enactment of the 2017 Act which was partially offset by a shift in the geographic mix of income. The ETR in fiscal 2017 decreased in comparison to fiscal 2016 due to the shift in the geographic mix of income as well as excess tax benefits from share-based compensation.

The ETR for 2018 is greater than the U.S. federal statutory tax rate primarily due to the tax expense related to the enactment of the 2017 Act. The ETR for 2017 and 2016 is less than the U.S. federal statutory tax rate because a majority of our taxable income is earned in foreign jurisdictions with lower tax rates. The ratio of domestic income to worldwide income significantly impacts our overall tax rate due to the fact that the tax rates in the majority of foreign jurisdictions where we operate are significantly lower than the statutory rate in the United States.

The components of income before income taxes and the income tax provision related to income from all operations in our Consolidated Statements of Income consist of:



Years Ended October 31, (In millions)	2018			2017		2016
Income before income taxes:
United States	$	(122.8	)	$	7.8	$	31.5
Foreign	454.7			386.2		264.1
	$	331.9		$	394.0	$	295.6
Income tax provision	$	192.0		$	21.1	$	20.7

The income tax provision (benefit) related to income in our Consolidated Statements of Income consists of:



Years Ended October 31, (In millions)	2018			2017			2016
Current:
Federal	$	165.6		$	6.9		$	14.6
State	0.5			1.8			1.3
Foreign	23.0			19.5			15.5
	189.1			28.2			31.4
Deferred:
Federal	16.1			(3.9		)	(3.9		)
State	1.0			1.4			(0.7		)
Foreign	(14.2		)	(4.6		)	(6.1		)
	2.9			(7.1		)	(10.7		)
Income tax provision	$	192.0		$	21.1		$	20.7

We reconcile the provision for income taxes attributable to income from operations and the amount computed by applying the statutory federal income tax rate of 23.34% for 2018 and 35% for 2017 to income before income taxes as follows:



Years Ended October 31, (In millions)	2018			2017			2016
Computed expected provision for taxes	$	77.5		$	137.9		$	103.5
(Decrease) increase in taxes resulting from:
Income earned outside the U.S. subject to different tax rates	(97.5		)	(114.6		)	(81.2		)
State taxes, net of federal income tax benefit	(4.9		)	3.9			1.2
Research and development credit	(0.7		)	(0.7		)	(1.2		)
U.S. tax reform	214.6			—			—
Incentive stock option compensation and non-deductible employee compensation	(11.1		)	(12.9		)	0.5
Tax accrual adjustment	10.1			5.0			(5.0		)
Other, net	4.0			2.5			2.9
Actual provision for income taxes	$	192.0		$	21.1		$	20.7

The Company recognized tax expense of $214.6 million related to the U.S. tax reform comprised of the following: (i) a one-time transition tax of $185.7 million on the Company’s accumulated foreign earnings, which the Company has elected to pay over eight years, (ii) $20.0 million related to the re-measurement of the Company’s deferred taxes at the revised U.S. statutory rates and (iii) $8.9 million of other deferred taxes on foreign distributable earnings, primarily related to withholding taxes and state tax impact.

The tax effects of temporary differences that give rise to the deferred tax assets and liabilities are:



Years Ended October 31, (In millions)	2018			2017
Deferred tax assets:
Accounts receivable, principally due to allowances for doubtful accounts	$	4.0		$	5.4
Inventories	3.8			6.1
Litigation settlements	0.2			0.8
Accrued liabilities, reserves and compensation accruals	38.8			50.4
Foreign deferred tax assets⁽¹⁾	51.8			65.0
Restricted stock and stock option expenses	25.6			39.7
Net operating loss carryforwards	6.7			3.7
Intangible assets	3.1			—
Research and experimental expenses - Section 59(e)	2.5			5.1
Tax credit carryforwards	1.3			8.7
Total gross deferred tax assets	137.8			184.9
Less valuation allowance	(39.1		)	(59.1		)
Deferred tax assets	98.7			125.8
Deferred tax liabilities:
Tax deductible goodwill	(22.4		)	(32.4		)
Plant and equipment	(8.2		)	(4.8		)
Deferred tax on foreign earnings	(8.9		)	—
Transaction costs	(0.5		)	(1.1		)
Foreign deferred tax liabilities⁽¹⁾	(31.3		)	(40.1		)
Other intangible assets	—			(25.9		)
Total gross deferred tax liabilities	(71.3		)	(104.3		)
Net deferred tax assets	$	27.4		$	21.5

⁽¹⁾ A reclassification between Foreign deferred tax assets and Foreign deferred tax liabilities was made to the 2017 balances.

In assessing the realizability of deferred tax assets, we consider whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. We consider the scheduled reversal of deferred tax liabilities, projected future taxable income and tax planning strategies in making this assessment. Based upon the level of historical taxable income and projections for future taxable income over the periods in which the deferred tax assets are deductible, we believe it is more likely than not that the Company will realize the benefits of these deductible differences, net of the existing valuation allowance at October 31, 2018. The amount of the deferred tax assets considered realizable, however, could be reduced in the near term if estimates of future taxable income during the carryforward period are reduced.

A valuation allowance of $39.1 million and $59.1 million was recorded against our gross deferred tax asset balance as of October 31, 2018, and October 31, 2017, respectively. There was a $16.5 million decrease related to reversing the valuation allowance against deferred tax assets for Puerto Rico research credits that have or will be sold. The remaining reduction relates to recognizing benefits to income tax expense to utilize California net operating losses and Hungarian tax credits.

At October 31, 2018, we had state net operating loss carryforwards of $53.6 million. Additionally, we had $1.7 million of California research credits. The state net operating loss carryforwards expire on various dates between 2020 through 2038, and the California research credits carry forward indefinitely. The net operating loss and other tax credits may be subject to certain limitations upon utilization under Section 382 of the Internal Revenue Code.

The aggregated changes in the balance of unrecognized tax benefits (“UTB”) were as follows:



(In millions)
Balance at October 31, 2016	$	39.9
Increase from prior year's UTB's	12.9
Increase from current year's UTB's	9.9
UTB (decrease) from expiration of statute of limitations	(2.8		)
Balance at October 31, 2017	59.9
Increase from prior year's UTB's	4.2
Increase from current year's UTB's	9.4
UTB (decrease) from expiration of statute of limitations	(4.6		)
Balance at October 31, 2018	$	68.9

As of October 31, 2018, 2017, and 2016 we had unrecognized tax benefits of $68.9 million, $59.9 million, and $39.9 million, respectively. If recognized, these tax benefits would affect our effective tax rates for 2018, 2017, and 2016, by $46.6 million, $38.1 million, and $24.8 million, respectively. It is our policy to recognize interest and penalties directly related to incomes tax as additional income tax expense. As of October 31, 2018, 2017, and 2016, we had accrued gross interest and penalties related to uncertain tax positions of $4.4 million, $3.6 million, and $3.7 million, respectively.

Included in the balance of unrecognized tax benefits at October 31, 2018, is $26 million related to tax positions for which it is reasonably possible that the total amounts could significantly change during the next twelve months.

We are required to file income tax returns in the U.S. federal jurisdiction, various state and local jurisdictions, and many foreign jurisdictions. As of October 31, 2018, the tax years for which we remain subject to U.S. federal income tax assessment upon examination are 2015 through 2017, as well as other major tax jurisdictions including the United Kingdom, Japan and France. We remain subject to income tax examinations in Australia for the tax years 2014 through 2017. The Company is currently under audit in the U.S. and the U.K. for 2015 and 2016. These audits are in the early stages and the tax authorities are issuing requests for information.