05.5
Notes to Consolidated Financial Statements
16. INCOME TAXES
Income before income taxes and minority interest is attributable to the following geographic locations:
| Table 05.5.29 | INCOME BEFORE INCOME TAXES |
| $ in thousands | 2008 | 2007 |
|---|---|---|
| Germany | 372,174 |
281,633 |
| United States | 773,089 |
724,839 |
| Other | 190,427 |
202,603 |
| TOTAL | 1,335,690 |
1,209,075 |
Income tax expense (benefit) for the years ended December 31, 2008 and 2007 consisted of the following:
| Table 05.5.30 | EXPENSE (BENEFIT) FOR INCOME TAXES |
| $ in thousands | 2008 | 2007 |
|---|---|---|
| Current | ||
| Germany | 62,609 |
124,598 |
| United States | 211,889 |
283,350 |
| Other | 77,134 |
75,534 |
| TOTAL CURRENT | 351,632 |
483,482 |
| Deferred | ||
| Germany | 43,593 |
(11,377) |
| United States | 105,466 |
4,052 |
| Other | (11,549) |
(10,505) |
| TOTAL DEFERRED | 137,510 |
(17,830) |
| TOTAL | 489,142 |
465,652 |
In 2007 the Company was subject to German federal corporation income tax at a base rate of 25 % plus a solidarity surcharge of 5.5 % on federal corporation taxes payable.
A reconciliation between the expected and actual income tax expense is shown below. The expected corporate income tax expense is computed by applying the German corporation tax rate (including the solidarity surcharge) and the effective trade tax rate on income before income taxes and minority interest. The respective combined tax rates are 29.58 % and 38.47 % for the fiscal years ended December 31, 2008 and 2007.
| Table 05.5.31 | RECONCILIATION OF INCOME TAXES |
| $ in thousands | 2008 | 2007 |
|---|---|---|
| Expected corporate income tax expense | 395,097 |
465,131 |
| Tax free income | (49,309) |
(50,131) |
| Foreign tax rate differential | 93,877 |
(5,434) |
| Non-deductible expenses | 5,494 |
5,081 |
| Taxes for prior years | 21,371 |
41,868 |
| Change in valuation allowance | 4,168 |
3,627 |
| Change of German tax rate | – |
(4,257) |
| Other | 18,444 |
9,767 |
| ACTUAL INCOME TAX EXPENSE | 489,142 |
465,652 |
| EFFECTIVE TAX RATE | 36.6 % |
38.5 % |
The tax effects of the temporary differences that give rise to deferred tax assets and liabilities at December 31, 2008 and 2007, are presented below:
| Table 05.5.32 | DEFERRED INCOME TAX ASSETS AND LIABILITIES |
| $ in thousands | 2008 | 2007 |
|---|---|---|
| Deferred tax assets | ||
| Accounts receivable, primarily due to allowance for doubtful accounts | 37,431 |
37,572 |
| Inventory, primarily due to additional costs capitalized for tax purposes, and inventory reserve accounts |
35,029 |
42,301 |
| Plant, equipment, intangible assets and other non current assets, principally due to differences in depreciation and amortization |
41,103 |
50,829 |
| Accrued expenses and other liabilities for financial accounting purposes, not currently tax deductible |
305,898 |
320,518 |
| Net operating loss carryforwards, tax credit carryforwards and interest carryforwards |
79,389 |
64,792 |
| Derivatives | 67,800 |
22,260 |
| Stock-based compensation expense | 17,405 |
11,213 |
| Other | 10,679 |
11,497 |
| TOTAL DEFERRED TAX ASSETS | 594,734 |
560,983 |
| Less valuation allowance | (56,169) |
(51,326) |
| NET DEFERRED TAX ASSETS | 538,565 |
509,657 |
| Deferred tax liabilities | ||
| Accounts receivable | 11,015 |
13,630 |
| Inventory, primarily due to inventory reserve accounts for tax purposes | 4,615 |
6,306 |
| Accrued expenses and other liabilities deductible for tax prior to financial accounting recognition |
50,229 |
15,134 |
| Plant, equipment and intangible assets, principally due to differences in depreciation and amortization |
432,367 |
400,408 |
| Derivatives | 11,830 |
14,636 |
| Other | 66,532 |
20,587 |
| TOTAL DEFERRED TAX LIABILITIES | 576,588 |
470,701 |
| NET DEFERRED TAX ASSETS (LIABILITIES) | (38,023) |
38,956 |
The valuation allowance increased by $4,843 in 2008 and by $10,095 in 2007.
The expiration of net operating losses is as follows:
| Table 05.5.33 | NET OPERATING LOSS CARRYFORWARDS $ in thousands |
| 2009 | 2010 | 2011 | 2012 | 2013 | 2014 | 2015 | 2016 | 2017 | 2018 and thereafter |
Without expiration date |
Total | |
|---|---|---|---|---|---|---|---|---|---|---|---|---|
27,304 |
4,604 |
9,155 |
19,503 |
17,879 |
9,640 |
13,485 |
13,632 |
12,158 |
30,477 |
95,984 |
253,821 |
|
In assessing the realizability of deferred tax assets, management considers whether it is more-likely-than-not that some portion or all of the deferred tax assets will 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 considers the scheduled reversal of deferred tax liabilities and projected future taxable income 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, management believes it is more-likely-than-not the Company will realize the benefits of these deductible differences, net of the existing valuation allowances at December 31, 2008.
The Company provides for income taxes on the cumulative earnings of foreign subsidiaries that will not be reinvested. During the year 2008, the Company provided for $8,600 of deferred tax liabilities associated with earnings that are likely to be distributed in 2009 and the following years. Provision has not been made for additional taxes on $1,643,429 undistributed earnings of foreign subsidiaries as these earnings are considered permanently reinvested. The earnings could become subject to additional tax if remitted or deemed remitted as dividends; however calculation of such additional tax is not practical. These taxes would predominantly comprise foreign withholding tax on dividends of foreign subsidiaries, and German income tax of approx 1.5 percent on all dividends and capital gains.
FMC-AG & Co. KGaA companies are subject to tax audits in Germany and the U.S. on a regular basis and on-going tax audits in other jurisdictions. In Germany, the tax audit for the years 1998 until 2001 has been finalized. The Company recognized and recorded the results of the audit in 2006 and thereafter paid all amounts due to the tax authorities. Fiscal years 2002 through 2005 are currently under audit and fiscal years 2006, 2007 and 2008 are open to audit.
For the tax year 1997, the Company recognized an impairment of one of its subsidiaries which the German tax authorities have disallowed in the audit for the years 1996 and 1997. The Company disagrees with such conclusion and filed a complaint with the appropriate German court to challenge the tax authority’s decision. An adverse determination in this litigation could have a material adverse effect on the results of operations in the relevant reporting period. The Company has included the related unrecognized tax benefit in the total unrecognized tax benefit noted below.
In the U.S., the Company filed claims for refunds contesting the IRS’s disallowance of FMCH’s deductions of civil settlement payments in prior year tax returns. As a result of a settlement agreement with the IRS to resolve the appeal of the IRS’s disallowance of deductions for the civil settlement payments made to qui tam relators in connection with the resolution of the 2000 investigation, the Company received a refund in September 2008 of $37,000, inclusive of interest. The settlement agreement preserves the right to continue to pursue claims in the U.S. Federal courts for refund of all other disallowed deductions. The unrecognized tax benefit relating to these deductions is included in the total unrecognized tax benefit noted below.
The Federal tax audit for the years 2002 through 2004 has been completed and the IRS has issued its report. The audit report includes disallowance of a material amount of deductions taken during the audit period for interest expense related to intercompany mandatorily redeemable preferred securities. The Company has filed a protest over the disallowed deductions and will avail itself of all remedies. An adverse determination with respect to any of the disputed disallowances could have a material adverse effect on our cash flows, tax expenses, net income and earnings per share.
Fiscal years 2005 and 2006 are currently under audit, 2007 and 2008 are open to audit. There are a number of state audits in progress and various years are open to audit in various states. All expected results have been recognized in the financial statements.
Subsidiaries of FMC-AG & Co. KGaA in a number of countries outside of Germany and the U.S. are also subject to tax audits. The Company estimates that the effects of such tax audits are not material to these consolidated financial statements.
The following table shows the reconciliation of the beginning and ending amounts of unrecognized tax benefits:
| Table 05.5.34 | UNRECOGNIZED TAX BENEFITS (NET OF INTEREST) |
| $ in thousands | 2008 | 2007 |
|---|---|---|
| BALANCE AT JANUARY 1 | 354,050 |
302,552 |
| Increases in unrecognized tax benefits prior periods | 24,074 |
29,236 |
| Decreases in unrecognized tax benefits prior periods | (36,334) |
(9,965) |
| Increases in unrecognized tax benefits current period | 20,180 |
14,893 |
| Changes related to settlements with tax authorities | (2,042) |
(2,960) |
| Foreign currency translation | 19,399 |
20,294 |
| BALANCE AT DECEMBER 31 | 379,327 |
354,050 |
Included in the balance at December 31, 2008 are $363,188 of unrecognized tax benefits which would affect the effective tax rate if recognized. The Company is currently not in a position to forecast the timing and magnitude of changes in the unrecognized tax benefits.
During the year ended December 31, 2008 the Company recognized $17,982 in interest and penalties. The Company had a total accrual of $101,178 of tax related interest and penalties at December 31, 2008.
