Kontoor Brands, 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. 28, 2019

As discussed in Note 1 to the Company's financial statements, income taxes for periods prior to the Separation were prepared on a carve-out basis of accounting.

The following table presents income before income taxes for which the provision for income taxes was computed:



	Year Ended December

(In thousands)		2019		2018		2017
Domestic		$	61,691	$	159,716	$	169,160
Foreign		73,503		180,362		189,993
Income before income taxes		$	135,194	$	340,078	$	359,153

The following table presents components of the provision for income taxes:



	Year Ended December

(In thousands)		2019			2018			2017
Current:
Federal		$	14,831		$	29,670		$	161,482
Foreign		23,017			32,501			31,444
State		4,866			12,303			13,546
Total current income taxes		42,714			74,474			206,472
Deferred:
Federal and state		(5,912		)	4,067			36,009
Foreign		1,738			(1,536		)	481
Total deferred income taxes		(4,174		)	2,531			36,490
Total provision for income taxes		$	38,540		$	77,005		$	242,962

On December 22, 2017, the U.S. government enacted comprehensive tax legislation commonly referred to as the Tax Act. The Tax Act included a broad range of complex provisions impacting the taxation of multi-national companies. Generally, accounting for the impacts of newly enacted tax legislation is required to be recorded in the period of enactment; however, in response to the complexities and ambiguity surrounding the Tax Act, the Securities and Exchange Commission ("SEC") released Staff Accounting Bulletin ("SAB 118") to provide companies with relief around the initial accounting for the Tax Act. Pursuant to SAB 118, the SEC provided a one-year measurement period for companies to analyze and finalize the accounting for the Tax Act. During the one-year measurement period, SAB 118 allowed companies to recognize provisional amounts when reasonable estimates could be made for the impacts resulting from the Tax Act. The Company finalized the accounting for the Tax Act as detailed below.

During 2017, the Company recognized a provisional charge of $136.7 million, primarily comprised of $110.6 million related to the transition tax and $19.4 million of tax expense related to revaluing U.S. deferred tax assets and liabilities using the new U.S. corporate tax rate of 21%. The transition tax payable was not transferred from the former parent to the Company with the Separation. This treatment is consistent with other taxes payable for which the Company is not liable under relevant tax laws and the Tax Matters Agreement. Other provisional charges of $6.7 million were recorded in 2017, primarily related to establishing a deferred tax liability for foreign withholding and state taxes related to unremitted foreign earnings.

The Company finalized its accounting for the Tax Act during the one-year measurement period provided by SAB 118, and recognized additional net charges of $5.5 million in 2018, primarily comprised of $5.7 million of charges related to the transition tax, additional tax benefits of $1.5 million related to revaluing U.S. deferred tax assets and liabilities using the new U.S. corporate tax rate of 21%, and other charges of $1.3 million related to establishing a deferred tax liability for foreign withholding taxes.

In accordance with GAAP, companies may make an accounting policy election to either treat taxes resulting from global intangible low-tax income ("GILTI") as a current-period expense when they are incurred or factor such amounts into the measurement of deferred taxes. The Company completed its analysis related to this accounting policy election and decided to treat the taxes resulting from GILTI as a component of current income tax expense, consistent with the treatment prior to the accounting policy election.

The following table presents a reconciliation of the differences between income taxes computed by applying the statutory federal income tax rate and income tax expense reported in the financial statements:



	Year Ended December

(In thousands)		2019			2018			2017
Tax at federal statutory rate		$	28,391		$	71,416		$	125,703
State income taxes, net of federal tax benefit		2,476			10,532			5,788
Foreign rate differences		(8,983		)	(5,125		)	(28,077		)
Tax reform		258			5,526			136,722
Stock-based compensation - federal		(3,169		)	(2,692		)	(2,929		)
Adjustments to opening balances		1,928			—			—
Change in valuation allowance		17,025			(2,707		)	5,120
GILTI		2,437			—			—
Change in indefinite reinvestment assertions		(3,914		)	—			—
Other		2,091			55			635
Income taxes		$	38,540		$	77,005		$	242,962

Income tax expense includes tax benefits of $0.6 million, $5.8 million and $4.7 million in 2019, 2018 and 2017, respectively, from favorable audit outcomes on certain tax matters and from expiration of statutes of limitations.

The following table presents the components of deferred income tax assets and liabilities:



(In thousands)	December 2019			December 2018
Deferred income tax assets:
Inventories	$	7,811		$	7,676
Deferred compensation	13,816			11,701
Other employee benefits	10,125			3,297
Stock-based compensation	8,076			6,243
Other accrued expenses	27,369			19,266
Intangible assets	21,356			7,541
Leases	20,219			—
Operating loss carryforwards	9,779			23,702
Gross deferred income tax assets	118,551			79,426
Less: valuation allowance	(16,699		)	(24,175		)
Net deferred income tax assets	101,852			55,251
Deferred income tax liabilities:
Leases	19,417			—
Depreciation	2,959			4,142
Taxes on unremitted earnings	2,163			9,702
Other deferred tax liabilities	221			1,195
Deferred income tax liabilities	24,760			15,039
Total net deferred income tax assets	$	77,092		$	40,212
Amounts included in the balance sheets:
Deferred income taxes - assets	$	79,551		$	42,891
Deferred income taxes - liabilities	(2,459		)	(2,679		)
	$	77,092		$	40,212

At the end of 2019, the Company is not asserting indefinite reinvestment with regards to foreign short-term liquid assets, except for certain jurisdictions with foreign earnings totaling $19.7 million that are considered indefinitely reinvested. The Company has determined the unrecorded deferred tax liability associated with the $19.7 million basis difference is approximately $1.1 million, primarily related to withholding taxes.

The Company has $2.2 million of potential tax benefits for foreign operating loss carryforwards, none of which have an unlimited carryforward life. In addition, there are $7.6 million of potential tax benefits for state operating loss and credit carryforwards that expire between 2020 and 2039.

A valuation allowance has been provided where it is more likely than not that deferred tax assets related to operating loss carryforwards will not be realized. Valuation allowances totaled $1.8 million for available foreign operating loss carryforwards, $7.6 million for available state operating loss and credit carryforwards, $6.7 million for other foreign deferred income tax assets, and $0.6 million for other state deferred income tax assets. During 2019, the Company recorded tax expense for a net increase in valuation allowances of $0.6 million related to state operating loss and credit carryforwards as well as other state deferred income tax assets, a net increase in valuation allowances of $6.0 million related to a change in judgement about the realizability of certain foreign deferred tax balances transferred from former parent with the Separation, and $10.4 million related to current year foreign operating losses and other deferred tax assets, inclusive of foreign currency effects. As a result of the Separation, a $24.5 million decrease in valuation allowances was recorded within "former parent investment" in the financial statements, since the corresponding tax attributes reported by the Company on a carve-out basis were not transferred to the Company, as discussed in Note 1 to the Company's financial statements.

The following table presents a reconciliation of the change in the accrual for unrecognized income tax benefits:



(In thousands)	Unrecognized Income Tax Benefits			Accrued Interest and Penalties			Unrecognized Income Tax Benefits Including Interest and Penalties
Balance, December 2016	$	48,842		$	1,411		$	50,253
Additions for current year tax positions	7,419			—			7,419
Additions for prior year tax positions	75			1,458			1,533
Reductions for prior year tax positions	(418		)	(1		)	(419		)
Reductions due to statute expirations	(4,655		)	(380		)	(5,035		)
Balance, December 2017	51,263			2,488			53,751
Additions for current year tax positions	2,458			8			2,466
Additions for prior year tax positions	6,286			2,870			9,156
Reductions for prior year tax positions	(191		)	—			(191		)
Reductions due to statute expirations	(5,735		)	(427		)	(6,162		)
Balance, December 2018	54,081			4,939			59,020
Additions for current year tax positions	1,260			—			1,260
Additions for prior year tax positions	4,881			2,632			7,513
Reductions for prior year tax positions	(3,680		)	(318		)	(3,998		)
Reductions due to statute expirations	(674		)	(127		)	(801		)
Payments in settlement	(205		)	(183		)	(388		)
Amounts transferred to former parent	(41,986		)	(2,728		)	(44,714		)
Balance, December 2019	$	13,677		$	4,215		$	17,892



(In thousands)	December 2019			December 2018
Amounts included in the balance sheets:
Unrecognized income tax benefits, including interest and penalties	$	17,892		$	59,020
Less: deferred tax benefits	(3,626		)	(7,724		)
Total unrecognized tax benefits	$	14,266		$	51,296

The unrecognized tax benefits of $14.3 million at the end of 2019, if recognized, would reduce the annual effective tax rate.

The Company will file a consolidated U.S. federal income tax return, as well as separate and combined income tax returns in numerous state and international jurisdictions. The Company has not filed its initial consolidated U.S. federal income tax return; therefore, there are no open IRS examinations. However, the Company is currently subject to examination by various U.S. state and international tax authorities. Management regularly assesses the potential outcomes of both ongoing and future examinations for the current and prior years and has concluded that the Company’s provision for income taxes is adequate. The outcome of any one examination is not expected to have a material impact on the Company’s financial statements. Management believes that some of these audits and negotiations will conclude during the next 12 months. Management also believes that it is reasonably possible that the amount of unrecognized tax benefits may decrease by $0.9 million within the next 12 months due to settlement of audits and expiration of statutes of limitations, $0.7 million of which would reduce income tax expense.