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, 2018

19. Income Taxes:

The Tax Cuts and Jobs Act (the “TCJA”) was enacted on December 22, 2017 and certain provisions 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 territorial tax system and levying a one-time transition tax on deemed repatriated earnings of foreign subsidiaries.

In response to the TCJA, the SEC staff issued Staff Accounting Bulletin No. 118 (“SAB 118”) to address the application of U.S. GAAP in situations when a registrant did 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 were refined, SAB 118 allowed registrants to record provisional adjustments during a measurement period that extended beyond one year of the TCJA enactment date. In accordance with SAB 118, the Company has finalized the impacts of the transition tax as of December 31, 2018 and has recorded a measurement period adjustment of $2,102 as a benefit to tax expense. There was no cash tax outlay associated with the final transition tax amount, as the Company elected to utilize NOL carryforwards to offset the associated taxable income.

The TCJA also established other new provisions that became effective in 2018. These include, but are not limited to, (1) a new provision designed to tax low-taxed income of foreign subsidiaries (i.e., “GILTI”), which allows for the possibility of using foreign tax credits ("FTCs") and a deduction of up to 50% to offset any resulting income tax liability (subject to some limitations); (2) limitations on the deductibility of certain executive compensation (“162(m)”); (3) limitations on the deductibility of interest expense (“163(j)”); and (4) limitations on the use of FTCs to reduce the U.S. income tax liability. While many of these provisions are expected to have an impact on the Company’s tax expense and deferred taxes for the year ended December 31, 2018 and future periods, the Company expects the GILTI provisions and 163(j) to have the most significant impact. While significant additional guidance regarding U.S. tax reform has been put forth during the year ended December 31, 2018, at this time the overall impact of the TCJA on the Company’s future income tax provision continues to remain uncertain.

With respect to GILTI, the Company has experienced significant impact to tax expense for the year ended December 31, 2018 because of its substantial U.S. NOL balance and being unable to avail itself of both U.S. foreign tax credits and the GILTI special deduction (“Section 250 Deduction”). The December 31, 2018 impact to tax expense with respect to GILTI is $15,444. Based on FASB guidance, the Company is permitted to make an accounting policy election to either (1) treat the taxes incurred as a result of the GILTI provision as a current-period expense when incurred or (2) factor such amounts into its measurement of deferred taxes. The Company has elected to treat any expense incurred as a current-period expense.

With respect to 163(j), the Company has experienced a significant disallowance with respect to its current year interest expense. The Company’s 163(j) interest disallowance is $57,705 for the year ended December 31, 2018. This disallowance has no impact to overall tax expense, given that any disallowed interest deductions are permitted to be carried forward indefinitely and, as such, are set up as deferred tax assets. The Company has evaluated the realizability of this deferred tax asset, and believes it is more-likely-than-not that it will be realized, using reversal of existing taxable temporary differences.

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



	Years ended December 31,
	2018		2017			2016
Domestic	$	3,935	$	(137,147	)	$	(84,094	)
Foreign	84,681		76,513			14,977
Total	$	88,616	$	(60,634	)	$	(69,117	)

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



	Years ended December 31,
	2018			2017			2016
Current:
Federal	$	—		$	—		$	—
State	2,470			806			91
Foreign	23,080			20,209			10,088
	25,550			21,015			10,179

Deferred:
Federal	12,854			(135,970		)	8,654
State	(784		)	(1,817		)	292
Foreign	(8,625		)	(2,425		)	(9,084		)
	3,445			(140,212		)	(138		)

Provision (benefit) for income taxes	$	28,995		$	(119,197	)	$	10,041

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



	Years ended December 31,
	2018			2017			2016
Tax at statutory rate	$	18,610		$	(21,222	)	$	(24,191	)
State income taxes, net of federal income tax benefit	1,203			(7,754		)	(4,110		)
Repatriation of non-US earnings	14,187			(24,912		)	4,576
Change in tax status-Eco Services-Passthrough to C-Corporation	—			—			33,891
Changes in uncertain tax positions	(996		)	974			(2,383		)
Change in valuation allowances	5,075			6,771			2,577
Rate changes	(4,016		)	(63,319		)	—
Change in state effective rates	691			(340		)	(290		)
Foreign withholding taxes	1,828			978			1,505
Foreign tax rate differential	2,191			(13,634		)	(3,040		)
Non-deductible transaction costs	84			1,679			667
Permanent difference created by foreign exchange gain or loss	(7,550		)	3,503			1,686
Research and development tax credits	(1,173		)	—			—
Other, net	(1,139		)	(1,921		)	(847		)
Provision (benefit) for income taxes	$	28,995		$	(119,197	)	$	10,041

The total tax provision (benefit) of $28,995, $(119,197) and $10,041 for the years ended December 31, 2018, 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 21%. This difference is principally due to the impacts of U.S. tax reform (including GILTI), the effect of permanent differences related to foreign currency exchange gain or loss, 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 incomes taxes reflect the net tax effects of temporary differences between the financial statement carrying amounts of assets and liabilities and the amounts recognized for income tax purposes. U.S. GAAP requires that deferred tax assets and liabilities are measured using enacted tax rates expected to be applied 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%, the Company was required to remeasure existing deferred tax balances using the new U.S. statutory tax rate in 2017.

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



	December 31,
	2018			2017
Deferred tax assets:
Net operating loss carryforwards	$	116,607		$	144,267
Section 163j interest disallowance carryforward	13,387			—
Pension	16,397			16,255
Post retirement health	1,385			561
Transaction costs	708			1,183
Natural gas contracts and interest rate swaps	335			225
Unrealized translation losses	3,737			5,065
US research and development credits	1,173			—
Other	38,855			38,290
Valuation allowance	(48,711		)	(64,945		)
	$	143,873		$	140,901

Deferred tax liabilities:
Depreciation	$	(92,911	)	$	(86,532	)
Undistributed earnings of non-US subsidiaries	(6,648		)	(8,334		)
Inventory	(10,432		)	(11,324		)
Intangible assets	(174,327		)	(184,937		)
Cross currency swaps	(4,654		)	—
Other	(32,230		)	(36,810		)
	$	(321,202	)	$	(327,937	)

Net deferred tax liabilities	$	(177,329	)	$	(187,036	)

Included in the 2018 and 2017 deferred tax asset and liability amounts for depreciation, intangible assets, inventory, natural gas contracts, unrealized transaction losses, and other above is $45,251 and $45,873, 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 $177,329 in net deferred tax liabilities as of December 31, 2018 consists of $18,795 in non-current deferred tax assets and $196,124 in net non-current deferred tax liabilities. 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 change in net deferred tax liabilities for the years ended December 31, 2018 and 2017 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, establishing a deferred tax asset with respect to 163(j), as well as the change in book amortization of intangibles with no corresponding tax basis and movement in valuation allowances with respect to acquired Sovitec entities.

The following are changes in the deferred tax valuation allowance during the years ended December 31, 2018 and 2017:



	Years ended December 31,
	2018			2017
Beginning Balance	$	64,945		$	38,271
Additions	5,314			34,863
Reductions	(21,548		)	(8,189		)
Ending Balance	$	48,711		$	64,945

Included in the additions line above is $20,753 related to fair value adjustments recorded to goodwill as part of the initial Acquisition purchase accounting analysis for the year ended December 31, 2017. Included in the reductions line above is $20,038 related to fair value adjustments recorded to goodwill as part of the finalization of the Acquisition purchase accounting for the year ended December 31, 2018.

The net change in the total valuation allowance was a decrease of $16,234 in 2018. The valuation allowance at December 31, 2018 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, 2018 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 2018. The unremitted earnings of non-U.S. subsidiaries and affiliates that have not been permanently reinvested amount to $168,304 and $210,979 as of December 31, 2018 and 2017, respectively. The deferred foreign withholding tax liability on these undistributed earnings is estimated to be $6,648 and $8,334 as of December 31, 2018 and 2017, respectively. As a result of U.S. tax reform, the liability on unremitted earnings as of December 31, 2018 is only related to foreign withholding taxes, as all earnings and profits were deemed to be repatriated for U.S. income tax purposes as a result of U.S. Tax Reform.

The cumulative unremitted earnings of foreign subsidiaries outside the United States in excess of the $168,304 are considered permanently reinvested, for which no withholding taxes have been provided. 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 withholding 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 the Company’s gross unrecognized tax benefits:



	Years ended December 31,
	2018			2017
Balance at beginning of period	$	11,431		$	16,128
Increases related to prior year tax positions	—			68
Decreases related to prior year tax positions	(1,538		)	(5,508		)
Increases related to current year tax positions	282			743
Balance at end of period	$	10,175		$	11,431

The total unrecognized tax benefits of $10,175 and $11,431 were generated from legacy PQ Corporation. If these amounts are recognized in future periods, it would affect the effective tax rate on income from continuing operations for the years in which they are recognized.

Interest and penalties recognized related to uncertain tax positions amounted to $42 and $52 for the years ended December 31, 2018 and 2017, 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 $1,088 and $1,270 in accrued interest and penalties as of December 31, 2018 and 2017, 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, 2018:



Jurisdiction		Period
United States-Federal		2007-Present
United States-State		2007-Present
Canada⁽¹⁾		2010-Present
Germany		2015-Present
Netherlands		2012-Present
Mexico		2014-Present
United Kingdom		2012-Present
Brazil		2014-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 2017. To date, no material adjustments have been proposed as a result of these audits. As of December 31, 2018, 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 NOL available of $284,237 to reduce future federal taxes payable. The current federal carry-forward period for those NOL’s is 20 years because they were generated prior to U.S. tax reform being enacted. In light of tax reform, any net operating losses incurred after December 31, 2017 will be allowed to carry forward indefinitely. As a result of the 2014 change in control, $144,357 of the $284,237 are subject to the limitations of Section 382 of the Internal Revenue Code (“IRC”). Although subject to the limitations of IRC §382, management believes it is more likely than not that the Company will realize the entire $144,357 in pre-transaction NOLs in future years. The remaining $139,880 relates to periods after the 2014 change in control and would not be subject to limitation under IRC §382.

For state income tax purposes, the Company incurred net operating losses of $21,594 for 2018 that may be carried forward at a minimum period of 5 years, and in certain circumstances indefinitely, 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 2019 are $681,010. A valuation allowance of $17,718 has been applied against the total $33,179 of state net operating loss deferred tax assets, leaving losses of $15,461 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 $131,453, of which $586 will begin to expire in 2019, $2,205 will begin to expire in 2026, $92 will begin to expire in 2028, $7,616 will begin to expire in 2029 with the remaining $120,954 carrying forward indefinitely, are available to reduce future foreign income taxes payable. A valuation allowance of $11,940 has been applied to $31,431 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 $19,491 that has been recognized for financial accounting purposes.

Cash payments for income taxes, net of refunds, are as follows:



	Years ended December 31,
	2018		2017		2016
Domestic	$	2,160	$	1,647	$	373
Foreign	21,682		27,552		16,608
	$	23,842	$	29,199	$	16,981