Note 17. 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				Nine-Months Ended
	June 30,				June 30,
	2015		2014		2015		2014
Earnings before income taxes	$	57,559	$	62,468	$	172,222	$	152,168
Income tax expense		13,806		16,467		40,830		37,986
Effective tax rate		24.0%		26.4%		23.7%		25.0%

The decrease in the year-over-year effective tax rate for the three-months ended June 30, 2015, is primarily attributable to a favorable net valuation increase in deferred tax assets in the current quarter that was partially offset by smaller net favorable resolutions of foreign tax matters in the current quarter compared to the prior year’s quarter. The decrease in the effective tax rate for the nine-months ended June 30, 2015 included both the quarterly decrease and the retroactive extension of the U.S. research and experimentation tax credit for calendar year 2014, which was enacted in December 2014, and was partially offset by smaller net favorable resolutions of foreign tax matters in the current year compared to the prior year.

Gross unrecognized tax benefits were $23,769 as of June 30, 2015 and $22,687 as of September 30, 2014. Included in the balance of unrecognized tax benefits were $14,249 as of June 30, 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 $3,105 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 $1,468 as of June 30, 2015 and $1,158 as of September 30, 2014.

Woodward’s tax returns are subject to audits 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 2012 and thereafter, and fiscal years remaining open to examination in significant foreign jurisdictions include 2005 and thereafter.