Income Taxes

12 Months Ended

Sep. 30, 2019

Note 18. Income taxes

Income taxes consisted of the following:



		Year Ended September 30,
		2019		2018		2017
Current:
	Federal	$	40,173	$	39,979	$	17,872
	State		2,402		3,697		1,379
	Foreign		34,660		25,968		15,118
Deferred:
	Federal		(2,015)		(10,519)		16,907
	State		(2,948)		(3,784)		(2,561)
	Foreign		(11,262)		(16,141)		3,525
		$	61,010	$	39,200	$	52,240

Earnings before income taxes by geographical area consisted of the following:



	Year Ended September 30,
	2019		2018		2017
United States	$	211,267	$	181,671	$	192,220
Other countries		109,345		37,907		60,527
	$	320,612	$	219,578	$	252,747

Significant components of deferred income taxes presented in the Consolidated Balance Sheets are related to the following:



		At September 30,
		2019		2018
Deferred tax assets:
	Defined benefit plans, other postretirement	$	6,535	$	6,844
	Foreign net operating loss carryforwards		6,836		6,071
	Inventory		51,740		23,549
	Stock-based and other compensation		45,839		39,903
	Defined benefit plans, pension		11,399		2,187
	Deferred revenue net of unbilled receivables		32,310		60,177
	Other reserves		11,571		10,154
	Tax credits and incentives		13,580		12,512
	Other		5,611		9,887
	Valuation allowance		(3,638)		(4,522)
	Total deferred tax assets, net of valuation allowance		181,783		166,762
Deferred tax liabilities:
	Goodwill and intangibles - net		(212,926)		(231,223)
	Property, plant and equipment		(97,469)		(85,459)
	Other		(4,589)		(4,425)
	Total deferred tax liabilities		(314,984)		(321,107)
Net deferred tax liabilities		$	(133,201)	$	(154,345)

Woodward has recorded a net operating loss (“NOL”) deferred tax asset of $6,836 as of September 30, 2019 and $6,071 as of September 30, 2018. A portion of these NOL carryforwards started to expire in 2019 and are currently offset by a valuation allowance. Woodward has placed valuation allowances against all other NOL carryforwards that are less than 50 percent likely to be realized.

Deferred tax assets are reduced by a valuation allowance if, based on the weight of available evidence, it is more likely than not that some portion or all of the deferred tax assets will not be realized. Both positive and negative evidence are considered in forming Woodward’s judgment as to whether a valuation allowance is appropriate, and more weight is given to evidence that can be objectively verified. Valuation allowances are reassessed whenever there are changes in circumstances that may cause a change in judgment. The change in the valuation allowance was primarily the result of the expiration of net operating losses at a wholly owned subsidiary.

At September 30, 2019, Woodward has not provided for taxes on undistributed foreign earnings of $293,538 that it considered indefinitely reinvested. These earnings could become subject to income taxes if they are remitted as dividends, are loaned to Woodward or any of Woodward’s subsidiaries located in the United States, or if Woodward sells its stock in the foreign subsidiaries. Any additional U.S. taxes could be offset, in part or in whole, by foreign tax credits. The amount of such taxes and application of tax credits would be dependent on the income tax laws and other circumstances at the time these amounts are repatriated. Based on these variables, it is impractical to determine the income tax liability that might be incurred if these funds were to be repatriated.

On December 22, 2017 the U.S. enacted the Tax Act. The Tax Act included significant changes to prior tax law, including a permanent reduction to the U.S federal corporate income tax rate of 35% to 21%, a one-time repatriation tax on deferred foreign income (“Transition Tax”), deemed inclusions of foreign low tax earnings, limitations on certain deductions, adjusted foreign tax credits, and business-related exclusions.

Enactment of the Tax Act during December 2017 resulted in a net change to Woodward’s income tax expense in the amount of $14,778, which was recorded in the three-months ended December 31, 2017. After adjustments to amounts made throughout fiscal year 2018, the net impact of the enactment of the Tax Act was $10,860. Woodward finalized its assessment of the income tax effects of the Tax Act in the first quarter of fiscal year 2019.

On June 14, 2019, the Internal Revenue Service (“IRS”) issued final regulations that modified the Transition Tax computation required by the Tax Act. As a result, in the three-months ended June 30, 2019, Woodward recognized additional income tax expense related to the Transition Tax of $10,588.

The permanent reduction to the U.S. federal corporate income tax rate from 35% to 21% was effective January 1, 2018 (the “Effective Date”). When a U.S. federal tax rate change occurs during a taxpayer’s fiscal year, taxpayers are required to compute a weighted daily average rate for the fiscal year of enactment. As a result of the Tax Act, Woodward calculated a U.S. federal statutory corporate income tax rate of 24.5% for the fiscal year ending September 30, 2018 and applied this rate

in computing the income tax provision for the fiscal year ended September 30, 2018. The U.S. federal statutory corporate income tax rate of 24.5% is the weighted daily average rate between the pre-enactment U.S. federal statutory tax rate of 35% applicable to Woodward’s 2018 fiscal year prior to the Effective Date and the post-enactment U.S. federal statutory tax rate of 21% applicable to the 2018 fiscal year after the Effective Date. The U.S. federal statutory rate is 21% for the fiscal year ended September 30, 2019.

The following is a reconciliation of the U.S. Federal statutory tax 21.0% in the fiscal year ended September 30, 2019, 24.5% in fiscal year ended September 30, 2018 and 35% in the fiscal year ended September 30, 2017 to Woodward’s effective income tax rate:



	Year Ending September 30,
	2019		2018		2017
Percent of pretax earnings
Statutory tax rate	21.0	%	24.5	%	35.0	%
State income taxes, net of federal tax benefit	(0.1)		(0.5)		(0.3)
Taxes on international activities	0.2		(1.8)		(7.6)
Research credit	(3.3)		(4.8)		(3.2)
Net excess income tax benefit from stock-based compensation	(3.5)		(1.4)		(1.4)
Domestic production activities deduction	-		(1.6)		(1.5)
Adjustments of prior period tax items	0.9		(5.0)		(0.9)
Effect of U.S. federal corporate rate reduction on net beginning U.S. deferred tax liability	-		(5.0)		-
Transition Tax	3.3		6.2		-
Increased deferred tax liability associated with anticipated repatriation taxes	-		3.7		-
Effect of U.S. federal corporate rate reduction on net current year U.S. deferred tax activity	-		2.0		-
Other items, net	0.5		1.6		0.6
Effective tax rate	19.0	%	17.9	%	20.7	%

In determining the tax amounts in Woodward’s financial statements, estimates are sometimes used that are subsequently adjusted in the actual filing of tax returns or by updated calculations. In addition, Woodward occasionally has resolutions of tax items with tax authorities related to prior years due to the conclusion of audits and the lapse of applicable statutes of limitations. Such adjustments are included in the “Adjustments of prior period tax items” line in the above table. The majority of these adjustments are related to the conclusion of audits, effective settlement, and lapse of applicable statutes of limitations in various tax jurisdictions.

The increase in the effective tax rate for fiscal year 2019 compared to fiscal year 2018 is primarily attributable to favorable resolutions of tax matters in the prior fiscal year that did not repeat in the current fiscal year, an increase in the U.S. federal corporate income tax on current year foreign earnings, the loss of the domestic production activities deduction in the year and a decrease in the current year of the U.S. research and experimentation credit as a percent of pretax earnings. Partially offsetting these increases were the decrease in the U.S federal corporate income tax rate from 24.5% for fiscal year 2018 to 21.0% in the current fiscal year and the related impact on fiscal year 2018 deferred tax activity that did not repeat in the current fiscal year. Additionally, the fiscal year 2018 net tax expense increase related to the Tax Act was larger than the current fiscal year increase. Finally, the current fiscal year had a larger favorable increase in the net excess income tax benefits from stock-based compensation compared to fiscal year 2018.

A reconciliation of the beginning and ending amounts of gross unrecognized tax benefits follows:



	Year Ending September 30,
	2019		2018		2017
Beginning balance	$	8,364	$	20,132	$	23,526
Additions to current year tax positions		1,930		2,675		2,560
Reductions to prior year tax positions		-		(14,458)		(5,753)
Additions to prior year tax positions		11		15		3,501
Lapse of applicable statute of limitations		-		-		(3,702)
Ending balance	$	10,305	$	8,364	$	20,132

Included in the balance of unrecognized tax benefits were $4,411 as of September 30, 2019 and $3,288 as of September 30, 2018 of tax benefits that, if recognized, would affect the effective tax rate. At this time, Woodward does not estimate it is reasonably possible that the liability for unrecognized tax benefits will decrease in the next twelve months. Woodward accrues for potential interest and penalties related to unrecognized tax benefits and all other interest and penalties related to

tax payments in tax expense. Woodward had accrued gross interest and penalties of $437 as of September 30, 2019 and $279 as of September 30, 2018.

Woodward’s tax returns are subject to audits by U.S. federal, 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 limitation may result in changes to tax expense. Woodward’s fiscal years remaining open to examination for U.S. Federal income taxes include fiscal years 2017 and thereafter. Woodward is currently under examination by the Internal Revenue Service for fiscal year 2017, which included a foreign tax carryback to fiscal year 2016. Woodward’s fiscal years remaining open to examination for significant U.S. state income tax jurisdictions include fiscal years 2015 and thereafter. Woodward closed various audits in foreign jurisdictions in the second and third quarters of fiscal year 2019. Consequently, fiscal years remaining open to examination in significant foreign jurisdictions include 2016 and thereafter.