Ecovyst, Inc. Annual report pursuant to Section 13 and 15(d)

Annual report pursuant to Section 13 and 15(d)

Income Taxes

Income Taxes

12 Months Ended

Dec. 31, 2017

18. Income Taxes:

The Tax Cuts and Jobs Act (“TCJA”) was enacted on December 22, 2017 and became effective January 1, 2018. The TCJA imposed significant changes to U.S. tax law, such as lowering U.S. corporate income tax rates, implementing a more territorial U.S. income tax system and levying a one-time transition tax on deemed repatriated earnings of foreign subsidiaries.

The TCJA reduces the U.S. corporate income tax rate from 35% to 21%, effective January 1, 2018. GAAP requires that deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to reverse in the future. As a result of the reduction in the U.S. corporate income tax rate from 35% to 21% under the TCJA, the Company was required to remeasure existing deferred tax balances using the new U.S. statutory tax rate. As a result of this remeasurement, the Company recorded a provisional net tax benefit from the rate reduction of $64,343.

The TCJA also provided for a one-time transition tax on the deemed repatriation of post-1986 undistributed foreign subsidiary earnings and profits (“E&P”) from controlled foreign corporations (“CFC”) at reduced tax rates of 8% or 15.5%. The Company has historically provided a deferred tax liability for certain foreign earnings. As a result of tax reform, the Company recorded a net provisional income tax benefit of $25,196, because the transition tax at the reduced rates was less than the amount previously provided at 35%. After provisionally electing to utilize current year tax losses to offset the impact of the transition tax, we expect to pay no U.S. federal cash taxes with respect to the deemed repatriation.

Due to having incurred approximately $43,000 of tax expense as of December 31, 2017 resulting from the one-time transition tax based on the cumulative E&P of our CFCs, all previously unremitted earnings for which no U.S. deferred tax liability had been accrued have now been subjected to U.S. federal income tax. Provisionally, the Company expects to offset the full impact of the $43,000 tax expense by utilizing tax net operating losses generated in the 2017 tax year against the deemed repatriation income inclusion. As such, no cash tax expense is expected with respect to the $43,000. To the extent we repatriate amounts related to these earnings to the United States, we estimate that the Company will not incur significant additional taxes related to such amounts, as they will have already been subject to U.S. federal income tax. However, our estimates are provisional and subject to further analysis.

The TCJA also includes a provision to tax global intangible low-taxed income (“GILTI”) of foreign subsidiaries and a base erosion anti-abuse tax (“BEAT”) measure that taxes certain payments between a U.S. corporation and its subsidiaries. Both of the GILTI and BEAT provisions are effective January 1, 2018. The Company is in the process of analyzing the impact of these two items. With respect to GILTI, the Company anticipates making a policy election to treat this tax as a period cost and will account for taxes on GILTI as they are incurred. With respect to BEAT, at this time the Company does not expect to be subject to that provision of the TCJA in a way that materially affects future tax provision amounts.

The SEC staff has issued Staff Accounting Bulletin No. 118 (“SAB 118”) to address the application of U.S. GAAP in situations when a registrant does not have the necessary information available, prepared, or analyzed (including computations) in reasonable detail to complete the accounting for certain income tax effects of the TCJA. As amounts are refined, SAB 118 allows the registrant to record provisional amounts during a measurement period not to extend beyond one year of the TCJA enactment date. We are in the process of analyzing the impact of the various provisions of the TCJA. The ultimate impact of TCJA to the Company’s financial statements may materially differ from these provisional amounts due to, among other things, additional analysis, changes in interpretations and assumptions we have made, additional regulatory guidance that may be issued, as well as any actions we may take as a result of the TCJA. We expect to complete our analysis within the allowed measurement period in accordance with SAB 118.

Income (loss) before income taxes and noncontrolling interest within or outside the United States are shown below:



	Years ended December 31,
	2017			2016			2015
Domestic	$	(137,147	)	$	(84,094	)	$	11,427
Foreign	76,513			14,977			—
Total	$	(60,634	)	$	(69,117	)	$	11,427

The provision (benefit) for income taxes as shown in the accompanying consolidated statements of operations consists of the following:



	Years ended December 31,
	2017			2016
Current:
Federal	$	—		$	—
State	806			91
Foreign	20,209			10,088
	21,015			10,179

Deferred:
Federal	(135,970		)	8,654
State	(1,817		)	292
Foreign	(2,425		)	(9,084		)
	(140,212		)	(138		)

Provision (benefit) for income taxes	$	(119,197	)	$	10,041

A reconciliation of income tax expense (benefit) at the U.S. federal statutory income tax rate of 35% to actual income tax expense is as follows:



	Years ended December 31,
	2017			2016
Tax at statutory rate	$	(21,222	)	$	(24,191	)
State income taxes, net of federal income tax benefit	(7,754		)	(4,110		)
Repatriation of non-US earnings inclusive of mandatory repatriation toll tax	(24,912		)	4,576
Change in Tax Status-Eco-Passthrough to C-Corp	—			33,891
Changes in uncertain tax positions	974			(2,383		)
Change in valuation allowances	6,771			2,577
Rate changes	(63,319		)	—
Change in state effective rates	(340		)	(290		)
Foreign withholding taxes	978			1,505
Foreign tax rate differential	(10,131		)	(1,354		)
Non-deductible transaction costs	1,679			667
Other, net	(1,921		)	(847		)
Provision (benefit) for income taxes	$	(119,197	)	$	10,041

The total tax (benefit) provision of $(119,197) and $10,041 for the years ended December 31, 2017 and 2016, respectively, on the Company’s consolidated pre-tax income (loss) for the period differs from the U.S. statutory tax rate of 35%. This difference is principally due to the impacts of U.S. tax reform, foreign income tax in jurisdictions with statutory rates different than the U.S. rate, state taxes, non-deductible transaction costs, foreign withholding taxes, changes in valuation allowance, and changes in uncertain tax positions.

Prior to the Business Combination on May 4, 2016, Eco Services was a single member limited liability company and taxed as a partnership for federal and state income tax purposes. As such, all income tax liabilities and/or benefits of Eco Services were passed through to their members. Because Eco Services was taxed as a partnership, it did not record deferred taxes on the basis difference on their financial statements. Following the Business Combination on May 4, 2016, Eco Services had a change in tax status and is now taxed as a C-Corporation subject to federal and state corporate level income taxes at prevailing corporate tax rates. As Eco Services had not previously recorded deferred taxes on the basis difference, the Company recognized net deferred tax liabilities of $33,891 for the year ended December 31, 2016 primarily related to basis differences in depreciable fixed assets and intangible assets based upon prevailing corporate tax rates.

Deferred tax assets (liabilities) are comprised of the following:



	December 31,
	2017			2016
Deferred tax assets:
Net operating loss carryforwards	$	144,267		$	157,811
Pension	16,255			21,454
Post retirement health	561			1,040
Transaction costs	1,183			2,896
Natural gas contracts	110			—
Interest rate swaps	115			—
Unrealized translation losses	5,065			6,046
Other	38,290			44,351
Valuation allowance	(64,945		)	(38,271		)
	$	140,901		$	195,327

Deferred tax liabilities:
Depreciation	$	(86,532	)	$	(114,749	)
Undistributed earnings of non-US subsidiaries	(8,334		)	(73,205		)
LIFO reserve	—			—
Inventory	(11,324		)	(20,159		)
Intangible assets	(184,937		)	(276,671		)
Natural gas contracts	—			(241		)
Other accruals	—			(1,621		)
Other	(36,810		)	(27,144		)
	$	(327,937	)	$	(513,790	)

Net deferred tax liabilities	$	(187,036	)	$	(318,463	)

Included in the 2017 and 2016 deferred tax asset and liability amounts for depreciation, intangible assets, inventory, natural gas contracts, unrealized transaction losses, and other above is $45,873 and $75,539, respectively, of a net deferred tax liability related to the Company’s investment in Potters, which is a partnership for federal income tax purposes. The Company and one of its subsidiaries own in aggregate 100% of Potters and the assets and liabilities of Potters are included in the consolidated financial statements of the Company.

The $187,036 in net deferred tax liabilities as of December 31, 2017 consists of $2,300 in non-current deferred tax assets and $189,336 in net non-current deferred tax liabilities. The $318,463 in net deferred tax liabilities as of December 31, 2016 consists of $195,327 in non-current deferred tax assets and $513,790 in net non-current deferred tax liabilities. Prior to the Business Combination, Eco Services was a single member LLC, treated as a partnership for federal and state tax purposes, with no deferred taxes provided.

The change in net deferred tax liabilities for the years ended December 31, 2017 and 2016 was primarily related to the decrease in deferred tax liabilities resulting from the revaluing of domestic deferred tax amounts, pursuant to U.S. tax reform lowering the statutory tax rate, as well as the change in book amortization of intangibles with no corresponding tax basis and an increase in valuation allowance with respect to acquired Sovitec entities.

The following are changes in the deferred tax valuation allowance during the years ended December 31, 2017 and 2016:



	Years ended December 31,
	2017			2016
Beginning Balance	$	38,271		$	—
Additions	34,863			46,347
Reductions	(8,189		)	(8,076		)
Ending Balance	$	64,945		$	38,271

The net change in the total valuation allowance was an increase of $26,674 in 2017. Prior to the Business Combination, Eco Services was a single member LLC, treated as a partnership for federal and state tax purposes. Any income tax liabilities and/or benefits of Eco Services were passed through to the member. As such, prior to May 4, 2016, the date of the Business Combination, the valuation allowance was $0. The valuation allowance at December 31, 2017 was primarily related to foreign and state net operating loss carryforwards and tax credits that, in the judgment of management, are not more likely than not to be realized. In assessing the ability to realize deferred tax assets, management considered 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. Management considered the scheduled reversal of deferred tax liabilities (including the impact of available carryback and carryforward periods), projected future taxable income, and tax-planning strategies that are prudent in making this assessment. In order to fully realize deferred tax assets, the Company will need to generate future taxable income prior to the expiration of the net operating loss and credit carryforwards. 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.

Management considered certain earnings in non-U.S. subsidiaries to be available for repatriation in the future. The tax cost associated with non-U.S. subsidiary earnings and distributions for the year ended December 31, 2017 has been recorded as tax expense for the period. In this regard the Company expects to deduct, rather than credit, foreign tax expense in computing the U.S. tax effects of repatriation from non-U.S. subsidiaries in 2017. The unremitted earnings of non-U.S. subsidiaries and affiliates that have not been reinvested abroad indefinitely amount to $210,979 and $190,586 as of December 31, 2017 and 2016, respectively. The deferred U.S. federal and state income tax liability and deferred foreign withholding tax liability on these undistributed earnings is estimated to be $8,334 and $73,205 as of December 31, 2017 and 2016, respectively. As a result of tax reform, the liability on unremitted earnings as of December 31, 2017 is only related to foreign withholding taxes, as all earnings and profits were deemed repatriated for U.S. income tax purposes as a result of U.S. Tax Reform.

As a result of the transition tax computed as part of U.S. tax reform, any earnings and profits permanently reinvested as of December 31, 2017 would have minimal taxes associated with them.

As of December 31, 2016, the cumulative unremitted earnings of foreign subsidiaries outside the United States, considered permanently reinvested, for which no income or withholding taxes have been provided approximated $194,444. Such earnings are expected to be reinvested indefinitely and, as a result, no deferred tax liability has been recognized with regard to such earnings. Determination of the deferred income tax liability on these unremitted earnings is not practicable, principally because such liability, if any, is dependent on circumstances existing if and when remittance occurs.

The following table summarizes the activity related to our gross unrecognized tax benefits:



	Years ended December 31,
	2017			2016
Balance at beginning of period	$	16,128		$	—
Increases related to prior year tax positions	68			19,419
Decreases related to prior year tax positions	(5,508		)	(68		)
Increases related to current year tax positions	743			691
Decreases related to current year tax positions	—			—
Decreases related to settlements with taxing authorities	—			(3,914		)
Decreases related to lapsing of statute of limitations	—			—
Balance at end of period	$	11,431		$	16,128

Included in the reduction of prior year positions is the impact of reducing the U.S. corporate tax rate from 35% to 21%, since the uncertain position that is recorded in the U.S. is recorded as a reduction in the net operating loss that is available. The net operating loss deferred tax balance was revalued along with the other domestic deferred tax assets and liabilities as of December 22, 2017.

Included in the balance of total unrecognized tax benefits are potential benefits of $11,431 and $16,128 arising from legacy PQ Corporation that if recognized, would affect the effective tax rate on income from continuing operations for the years ended December 31, 2017 and 2016, respectively.

Interest and penalties recognized related to uncertain tax positions amounted to $52 and $2,054 for the years ended December 31, 2017 and 2016, respectively. To the extent interest and penalties are not assessed with respect to uncertain tax positions, amounts accrued will be reduced and reflected as a reduction of the overall income tax provision in the period for which the event occurs requiring the adjustment. The $1,270 and $1,177 in accrued interest and penalties as of December 31, 2017 and 2016, respectively, is recorded in other long-term liabilities on the consolidated balance sheets.

Due to the Business Combination, the Company files numerous consolidated and separate income tax returns in the U.S. federal jurisdiction and in many state and foreign jurisdictions. The following describes the open tax years, by major tax jurisdiction, as of December 31, 2017:



Jurisdiction		Period
United States-Federal		2007-Present
United States-State		2008-Present
Canada⁽¹⁾		2009-Present
Germany		2007-Present
Netherlands		2012-Present
Mexico		2012-Present
United Kingdom		2010-Present
Brazil		2012-Present


⁽¹⁾	Includes federal as well as local jurisdictions

Given that certain U.S. companies have net operating loss carryforwards, the statute for examination by taxing authorities in the United States, and certain state jurisdictions, will remain open for a period following the use of such net operating loss carryforwards, extending the period for examination beyond the years indicated above.

The Company has subsidiaries in various states, provinces and countries that are currently under audit for years ranging from 2007 through 2016. To date, no material adjustments have been proposed as a result of these audits. As of December 31, 2017, the Company does not believe that there are any positions for which it is reasonably possible that the total amount of unrecognized tax benefits will significantly increase or decrease within the next 12 months.

The Company has a net operating loss carry-forward (“NOL”) available of $426,851 to reduce future federal taxes payable. The current federal NOL carry-forward period is 20 years. In light of tax reform, net operating losses incurred after December 31, 2017 will be allowed to carry forward indefinitely. As a result of the Business Combination, $332,376 of the $426,851 may be subject to the limitations of Section 382 of the Internal Revenue Code (“IRC”). Although potentially subject to the limitations of IRC §382, management believes it is more likely than not that the Company will realize the entire $332,376 in pre-transaction NOLs in future years. The remaining $94,475 relates to periods after the Business Combination and would not be subject to IRC §382.

For state income tax purposes, the Company incurred net operating losses of $119,742 for 2017 that may be carried forward at periods ranging from 5 to 20 years among the states in which the Company is subject to tax to reduce future state income taxes payable. Cumulative state net operating losses carrying forward into 2018 are $657,738. A valuation allowance of $16,318 has been applied against the total $31,389 of state net operating loss deferred tax assets, leaving losses of $15,071 that have been recognized for financial accounting purposes for the portion of those losses that the Company believes, on a more likely than not basis, will be realized.

Foreign net operating losses of $127,949, of which $4,880 will begin to expire in 2023, $2,932 will begin to expire in 2027, $2,441 will begin to expire in 2035, $1,604 will begin to expire in 2038 with the remaining $116,093 carrying forward indefinitely, are available to reduce future foreign income taxes payable. A valuation allowance of $29,728 has been applied to $31,294 of deferred tax assets related to foreign net operating loss carry-forwards, leaving a net deferred tax asset relating to foreign net operating losses of $1,566 that has been recognized for financial accounting purposes.

Cash payments for income taxes are as follows:



	Years ended December 31,
	2017		2016		2015
Domestic	$	1,647	$	373	$	8
Foreign	27,552		16,608		—
	$	29,199	$	16,981	$	8