Income Taxes

The geographical sources of income (loss) before income taxes were as follows (in millions):



	Year Ended December 31,
	2018			2017			2016
United States	$	(25	)	$	(152	)	$	(120	)
Outside United States	549			240			(9		)
Total	$	524		$	88		$	(129	)

Income tax expense (benefit) consisted of the following (in millions):



	Year Ended December 31,
	2018			2017			2016
Current:
Federal	$	20		$	10		$	14
State	3			8			6
Foreign	77			62			31
Total current	100			80			51
Deferred:
Federal	(11		)	20			(31		)
State	5			(10		)	(6		)
Foreign	9			(19		)	(6		)
Total deferred	3			(9		)	(43		)
Total	$	103		$	71		$	8

The Company’s effective tax rates were 19.7%, 80.7% and (6.2)% for the years ended December 31, 2018, 2017 and 2016 respectively.

The Company’s effective tax rate was lower than the federal statutory rate of 21% for the year ended December 31, 2018 primarily due to lower tax rates in foreign jurisdictions and the generation of tax credits. These benefits were partially offset by increases related to foreign earnings subject to U.S. taxation, the U.S. impact of the Enterprise acquisition and certain discrete items. The discrete items included the favorable impacts of reductions in valuation allowances and share-based compensation benefits, which were offset by audit settlements with the U.S. Internal Revenue Service for the fiscal years 2013, 2014, and 2015 and an increase in uncertain tax positions resulting from interpretive guidance issued during the year.

For the year ended December 31, 2017, the Company’s effective tax rate was higher than the federal statutory rate of 35%, primarily due to an increase in valuation allowance on foreign deferred tax assets, the one-time transition tax and remeasurement of net U.S. deferred tax assets under U.S. Tax Reform, the U.S. impact of the Enterprise acquisition, and an increase in uncertain tax benefits. These expenses were partially offset by remeasurement of foreign net deferred tax assets, the benefit of lower tax rates in foreign jurisdictions, the recognition of deferred tax assets on intercompany asset transfers, the generation of tax credits and share-based compensation benefits.

For the year ended December 31, 2016, the Company’s effective tax rate, applied to an overall pre-tax loss, was lower than the federal statutory rate of 35%, primarily due to the benefits of lower tax rates in foreign jurisdictions, the U.S. impact of the Enterprise acquisition as well as foreign earnings subject to U.S. taxation, partially offset by the generation of income tax credits.

A reconciliation of the U.S. federal statutory income tax rate to our actual income tax rate is provided below:



	Year Ended December 31,
	2018		2017		2016
Provision computed at statutory rate	21.0	%	35.0	%	35.0	%
U.S. Tax Reform - one-time transition tax	(0.6	)	41.8		0.0
Remeasurement of deferred taxes	0.7		(56.0	)	0.0
Change in valuation allowance	(4.5	)	96.4		(1.0	)
U.S. impact of Enterprise acquisition	1.1		12.9		(14.1	)
Change in contingent income tax reserves	3.2		14.0		(1.6	)
Foreign earnings subject to U.S. taxation	2.0		2.0		(6.6	)
Foreign rate differential	(2.0	)	(29.1	)	(16.0	)
Intra-entity transactions	0.0		(18.8	)	0.0
State income tax, net of federal tax benefit	0.8		(5.3	)	(1.0	)
Tax credits	(1.9	)	(5.7	)	9.5
Equity compensation deductions	(2.0	)	(5.6	)	(0.4	)
Return to provision and other true ups	1.1		(3.2	)	(3.7	)
Other	0.8		2.3		(6.3	)
Provision for income taxes	19.7	%	80.7	%	(6.2	)%

The Company earns a significant amount of its operating income outside of the U.S., primarily in the United Kingdom, Singapore, and Luxembourg, with statutory rates of 19%, 17%, and 27%, respectively. During 2017, the Company affirmed an incentivized tax rate of 10% with the Singapore Economic Development Board with the Company’s commitment to make increased investments in Singapore. During 2018, the Company applied for and was granted a second extension of its incentivized tax rate by the Singapore Economic Development Board. The incentive reduces the income tax rate to 10.5% from the statutory rate of 17% and is effective for calendar years 2019 to 2023. The Company has committed to making additional investments in Singapore over the period 2019 to 2022; should the Company not make these investments in accordance with the agreement, any incentive benefit would have to be repaid to the Singapore tax authorities.

Tax effects of temporary differences that resulted in deferred tax assets and liabilities are as follows (in millions):



	December 31,
	2018			2017
Deferred tax assets:
Capitalized research expenditures	$	28		$	32
Deferred revenue	21			21
Tax credits	28			31
Net operating loss carryforwards	394			338
Other accruals	20			20
Inventory items	20			20
Capitalized software costs	8			14
Sales return/rebate reserve	41			33
Share-based compensation expense	15			12
Accrued bonus	3			1
Unrealized gains and losses on securities and investments	—			8
Valuation allowance	(56		)	(134		)
Total deferred tax assets	522			396
Deferred tax liabilities:
Depreciation and amortization	411			275
Unrealized gains and losses on securities and investments	2			—
Undistributed earnings	3			2
Total deferred tax liabilities	$	416		$	277
Net deferred tax assets	$	106		$	119

At December 31, 2018, the Company has approximately $394 million (tax effected) of net operating losses (“NOLs”) and approximately $28 million of credit carryforwards. Approximately $39 million of NOLs will expire beginning in 2019 through 2032, and $14 million of credits will expire beginning in 2023 through 2032; $355 million of NOLs and $14 million of credit carryforwards have no expiration dates.

Impact of U.S. Tax Reform

Overview

Enacted on December 22, 2017, the Act reduced the U.S. federal corporate tax rate from 35% to 21%, required companies to pay a one-time transition tax on earnings of certain foreign subsidiaries that were previously tax deferred and created new taxes on certain foreign sourced earnings. Based on current operations, the Company is subject to the GILTI provisions of the Act. We are not currently subject to the new limitations which defer U.S. interest deductions in excess of 30% of adjusted taxable income or the Base Erosion Anti-Avoidance Tax (“BEAT”). However, the application of the interest limitations and BEAT regime may apply in the future, depending on changes in the Company’s business model or the level of taxable income in any given year. Additionally, the Company is no longer able to deduct performance-based compensation for its covered employees which exceeds the limitation under amended Internal Revenue Code Section 162(m). These impacts are included in the calculation of our effective tax rate.

Foreign Tax Effects

As part of the Act, the Company recognized a one-time transition tax based on its total post-1986 earnings and profits that were previously deferred from U.S. income taxes. The Company earns a significant amount of its operating income outside of the U.S. As of December 31, 2018, the Company is indefinitely reinvested with respect to its U.S. directly-owned subsidiary earnings. Under the Act, the Company has recorded a current provision related to deemed foreign inclusions through December 31, 2017 as a result of the transition tax. For periods after 2017, the Company is subject to U.S. income tax on substantially all foreign earnings under the GILTI provisions of the Act, while any remaining foreign earnings are eligible for the new dividends received deduction. As a result, future repatriation of earnings will no longer be subject to U.S. income tax, but may be subject to state and local income taxes, as well as currency translation gains or losses. Additionally, gains and losses on any future taxable dispositions of U.S.-owned foreign affiliates continue to be subject to U.S. income tax.

The Company has not recognized deferred tax liabilities in the U.S. with respect to its outside basis differences in its directly-owned foreign affiliates. It is not practicable to determine the amount of unrecognized deferred tax liabilities on these indefinitely reinvested earnings.

Certain foreign affiliate parent companies are not indefinitely reinvested, and thus, the Company has recorded a deferred tax liability for foreign withholdings taxes on those earnings.

Performance-Based Executive Compensation

The Act amends the rules related to the exclusion of performance-based compensation under Internal Revenue Code 162(m). The Company will no longer be able to claim a deduction for compensation accrued after January 1, 2018 for a covered employee which exceeds $1 million, unless the compensation is earned in respect of a binding contract in existence on November 2, 2017 (“Grandfathered Contracts”). The Company has remeasured the Section 162(m)-grandfathered deferred tax assets at 21% for its covered employees for equity award agreements issued and executed prior to November 2, 2017. Additionally, the Company has determined that its short-term bonus plan will not qualify for the grandfathered contract provisions, and thus any associated deferred tax assets have been derecognized.

Provisional and Final Effects

During 2017, the Company provisionally recognized an income tax expense of $72 million associated with the Act, including a one-time transition tax of $37 million and $35 million remeasurement of its net U.S. deferred tax assets based on a 21% rate.

During 2018, the Company finalized its analysis of the Act, including the one-time transition tax and measurement of net deferred tax assets, and recorded a $3 million income tax benefit for the year ended December 31, 2018 as a result of differences between its final analysis and provisional analysis from the prior year. The final analysis included both federal and state tax effects based on legislative pronouncements through December 31, 2018. The Company also utilized a total of $28 million of available net operating losses, research and development credits, alternative minimum tax credits, and foreign tax credits, in order to reduce its future cash payments for the one-time transition tax, resulting in a net liability for the one-time transition tax of $6 million, of which $1 million has been classified as a short term liability and $5 million as a long term liability. The final one-time transition tax installment payment will be made in 2024.

During 2018, the Company estimated and recognized an income tax expense of $10 million related to GILTI, based on current law and regulations; as guidance continues to be published, the estimate could result in filing positions significantly different than our current estimates.

Unrecognized tax benefits

A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows (in millions):



	Year ended December 31,
	2018			2017
Balance at beginning of year	$	51		$	42
Additions for tax positions related to the current year	1			0
Additions for tax positions related to prior years	22			11
Reductions for tax positions related to prior years	(11		)	(1		)
Settlements for tax positions	(13		)	(1		)
Balance at end of year	$	50		$	51

At December 31, 2018 and December 31, 2017, there are $48 million and $47 million of unrecognized tax benefits that if recognized would affect the annual effective tax rate. The Company continues to believe its positions are supportable, however, the Company anticipates that $20 million of uncertain tax benefits may be paid within the next twelve months and, as such, is reflected as a current liability within the Company’s Consolidated Balance Sheets. The Company is engaged in an inquiry from the UK Her Majesty’s Revenue and Customs (“HMRC”) for the years 2012 to 2016. The tax years 2004 through 2016 remain open to examination by multiple foreign and U.S. state taxing jurisdictions. Due to uncertainties in any tax audit outcome, the Company’s estimates of the ultimate settlement of uncertain tax positions may change and the actual tax benefits may differ significantly from the estimates.

The Company recognized $8 million, $2 million and $1 million of interest and/or penalties related to income tax matters as part of income tax expense for the years ended December 31, 2018, 2017 and 2016, respectively. The Company had $14 million and $6 million of interest and penalties reflected in the Consolidated Balance Sheets as of December 31, 2018 and 2017, respectively.