Note 16. Income taxes

U.S. GAAP requires that the interim period tax provision be determined as follows:

At the end of each quarter, Woodward estimates the tax that will be provided for the current fiscal year stated as a percentage of estimated “ordinary income.” The term ordinary income refers to earnings from continuing operations before income taxes, excluding significant unusual or infrequently occurring items.

The estimated annual effective rate is applied to the year-to-date ordinary income at the end of each quarter to compute the estimated year-to-date tax applicable to ordinary income. The tax expense or benefit related to ordinary income in each quarter is the difference between the most recent year-to-date and the prior quarter year-to-date computations.

The tax effects of significant unusual or infrequently occurring items are recognized as discrete items in the interim period in which the events occur. The impact of changes in tax laws or rates on deferred tax amounts, the effects of changes in judgment about beginning of the year valuation allowances, and changes in tax reserves resulting from the finalization of tax audits or reviews are examples of significant unusual or infrequently occurring items that are recognized as discrete items in the interim period in which the event occurs.

The determination of the annual effective tax rate is based upon a number of significant estimates and judgments, including the estimated annual pretax income of Woodward in each tax jurisdiction in which it operates, and the development of tax planning strategies during the year. In addition, as a global commercial enterprise, Woodward’s tax expense can be impacted by changes in tax rates or laws, the finalization of tax audits and reviews, changes in the estimate of the amount of undistributed foreign earnings that Woodward considers indefinitely reinvested, as well as other factors that cannot be predicted with certainty. As such, there can be significant volatility in interim tax provisions.

The following table sets forth the tax expense and the effective tax rate for Woodward’s income from operations:



	Three-Months Ended				Six-Months Ended
	March 31,				March 31,
	2015		2014		2015		2014
Earnings before income taxes	$	57,591	$	56,756	$	114,663	$	89,700
Income tax expense		13,736		11,958		27,024		21,519
Effective tax rate		23.9%		21.1%		23.6%		24.0%

The increase in the year-over-year effective tax rate for the three-months ended March 31, 2015, is primarily attributable to smaller net favorable resolutions of tax matters in the current year compared to the prior year, partially offset by a more favorable tax rate on international activities in the current year. Additionally, it reflects the reversal of a valuation allowance in the amount of $3,348 that had been in place against a deferred tax asset. This net increase was offset in the six-months ended March 31, 2015 by the rate reduction due to the retroactive extension of the U.S. research and experimentation tax credit for calendar year 2014, which was enacted in December 2014. The portion related to the nine-months ended September 30, 2014 was $5,063 and was included in the results of the first half of fiscal year 2015. No similar retroactive benefit occurred during fiscal year 2014.

Gross unrecognized tax benefits were $23,037 as of March 31, 2015 and $22,687 as of September 30, 2014. Included in the balance of unrecognized tax benefits were $13,567 as of March 31, 2015 and $12,807 as of September 30, 2014, of tax benefits that, if recognized, would affect the effective tax rate. At this time, Woodward estimates that it is reasonably possible that the liability for unrecognized tax benefits will decrease by as much as $198 in the next twelve months due to the completion of reviews by tax authorities and the expiration of certain statutes of limitations. Woodward accrues for potential interest and penalties related to unrecognized tax benefits in tax expense. Woodward had accrued gross interest and penalties of $1,293 as of March 31, 2015 and $1,158 as of September 30, 2014.

Woodward’s tax returns are audited by U.S., state, and foreign tax authorities, and these audits are at various stages of completion at any given time. Reviews of tax matters by authorities and lapses of the applicable statutes of limitations may result in changes to tax expense. With a few exceptions, Woodward’s fiscal years remaining open to examination in the United States include fiscal years 2011 and thereafter, and fiscal years remaining open to examination in significant foreign jurisdictions include 2005 and thereafter.