Income Taxes

Income tax expense (benefit) was calculated based upon the following components of income from continuing operations before income taxes:



	Fiscal
	2014		2013			2012
Income from continuing operations before income taxes:
United States	$	9.2	$	(78.9	)	$	(146.5	)
Outside the United States	204.0		197.2			171.9
Total income from continuing operations before taxes	$	213.2	$	118.3		$	25.4

The components of income tax expense (benefit) were as follows:



	Fiscal
	2014			2013			2012
Current:
Federal	$	64.2		$	(32.5	)	$	74.4
Foreign	46.6			47.7			38.1
State	6.2			1.4			(0.4		)
Total current	117.0			16.6			112.1
Deferred:
Federal	12.4			169.0			(199.2		)
Foreign	(8.3		)	2.1			5.2
State	(9.6		)	(0.4		)	(3.4		)
Total deferred	(5.5		)	170.7			(197.4		)
Income tax expense (benefit)	$	111.5		$	187.3		$	(85.3	)

The differences between income taxes expected at the U.S. Federal statutory income tax rate of 35.0% and reported income tax expense (benefit) are summarized as follows:



	Fiscal
	2014			2013			2012
Expected income tax expense at Federal statutory rate	$	74.6		$	41.4		$	8.9
Valuation allowance for deferred tax assets	(47.4		)	151.8			(139.6		)
Preferred stock equity conversion feature	4.4			35.6			54.8
Residual tax on foreign earnings	90.9			(7.0		)	29.8
Foreign rate differential	(23.1		)	(18.8		)	(14.1		)
Foreign tax law changes	(7.7		)	—			—
Gain on contingent purchase price reduction	—			—			(14.3		)
Permanent items	6.5			5.7			9.5
Non-deductible stock based compensation	1.4			1.7			—
Exempt foreign income	(5.7		)	(5.9		)	(5.8		)
Unrecognized tax benefits	2.2			4.1			(4.4		)
State and local income taxes	0.8			(32.2		)	(8.5		)
Dividends received deduction	—			1.4			(0.9		)
Inflationary adjustments	(0.5		)	(0.2		)	(0.8		)
Capitalized transaction costs	1.0			5.6			0.3
Other	14.1			4.1			(0.2		)
Reported income tax expense (benefit)	$	111.5		$	187.3		$	(85.3	)
Effective tax rate	52.3		%	158.3		%	(335.9		)%

For Fiscal 2014, the Company’s effective tax rate of 52.3% was negatively impacted by the following: (i) the profitability of FGL’s life insurance subsidiaries, which files its own consolidated Federal income tax return; and (ii) pretax losses in the U.S. and some foreign jurisdictions for which the Company concluded that the tax benefits are not more likely-than-not realizable, resulting in valuation allowances. Partially offsetting these factors in Fiscal 2014 were: (i) income earned outside the U.S. that is subject to statutory rates lower than 35.0%; and (ii) the partial release of U.S. valuation allowances by FGL’s life insurance subsidiaries, totaling $40.1, attributable to a tax planning strategy that will allow for the utilization of capital loss carryforwards, that management previously concluded were more-likely-than-not unrealizable.

For Fiscal 2013, the Company’s effective tax rate of 158.3% was negatively impacted by the following: (i) the profitability of FGL’s life insurance subsidiaries which files its own consolidated Federal income tax return; (ii) pretax losses in the U.S. and some foreign jurisdictions for which the Company concluded that the tax benefits are not more-likely-than-not realizable, resulting in valuation allowances; (iii) book expense for the increase in the fair value of the equity conversion feature of Preferred Stock, for which no tax benefit is available; (iv) tax amortization of certain indefinite lived intangibles; and (v) tax expense on income in certain foreign jurisdictions that will not be creditable in the U.S. due to the Company’s U.S. taxable loss position. In addition, the Company is not permanently reinvesting income from its foreign operations, thereby subjecting unremitted foreign earnings to the U.S. Federal statutory income tax rate of 35.0%. The Company’s effective tax rate was favorably impacted by a partial release of U.S. valuation allowances against deferred tax assets that are more-likely-than-not realizable as a result of a recent acquisition by Spectrum Brands and a change in the realizability of deferred tax assets related to FGL’s life insurance subsidiaries.

For Fiscal 2012, the Company’s effective tax rate of (335.9)% representing a tax benefit despite pretax income, was positively impacted by the net release of valuation allowance attributed to the Company’s determination that certain of its deferred tax assets are more likely than not realizable and a contingent purchase price reduction. The Company’s effective tax rate was negatively impacted by the following: (i) an expense for the increase in fair value of the equity conversion feature of Preferred Stock, for which no tax benefit is available, and (ii) deferred tax provision related to the change in book versus tax basis of indefinite lived intangibles, which are amortized for tax purposes, but not for book purposes. In addition, for Fiscal 2012 and forward, the Company has asserted that it is no longer permanently reinvesting the income from its foreign operations, thereby subjecting non-U.S. unremitted earnings to the U.S. Federal statutory income tax rate of 35.0%.

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



	September 30,
	2014			2013
Current deferred tax assets:
Employee benefits	$	22.9		$	15.4
Restructuring	6.3			7.1
Inventories and receivables	25.6			24.3
Employee compensation	6.4			5.4
Marketing and promotional accruals	16.0			14.1
Capitalized transaction costs	—			0.1
Unrealized losses on mark-to-market securities	14.7			12.6
Other	17.2			23.9
Valuation allowance	(66.1		)	(55.0		)
Total current deferred tax assets	43.0			47.9
Current deferred tax liabilities:
Inventories and receivables	(0.7		)	(2.7		)
Unrealized gains	(1.2		)	(0.4		)
Other	(6.0		)	(11.7		)
Total current deferred tax liabilities	(7.9		)	(14.8		)
Noncurrent deferred tax assets:
Employee benefits	$	61.4		$	49.5
Restructuring and purchase accounting	0.7			0.3
Net operating loss, credit and capital loss carryforwards	930.6			1,029.5
Prepaid royalty	6.6			7.0
Properties	9.0			9.7
Capitalized transaction costs	0.6			0.6
Unrealized losses on mark-to-market securities	0.3			2.1
Long-term debt	—			0.7
Intangibles	8.5			3.9
Deferred acquisition costs	0.4			0.4
Insurance reserves and claim related adjustments	483.8			477.7
Outside basis differences on partnership interests	43.8			21.3
Other	76.6			32.8
Valuation allowance	(712.4		)	(762.2		)
Total noncurrent deferred tax assets	909.9			873.3
Noncurrent deferred tax liabilities:
Properties	(22.6		)	(27.5		)
Unrealized gains	(20.0		)	(13.1		)
Intangibles	(744.1		)	(735.5		)
Value of business acquired	(20.8		)	(67.3		)
Deferred acquisition costs	(104.2		)	(63.7		)
Tax on unremitted foreign earnings	(2.6		)	(18.6		)
Investments	(338.3		)	(156.5		)
Funds withheld receivables	(9.7		)	—
Long-term debt	(10.0		)	—
Other	(19.3		)	(23.4		)
Total noncurrent deferred tax liabilities	(1,291.6		)	(1,105.6		)
Total gross deferred tax assets	$	952.9		$	921.2
Total gross deferred tax liabilities	$	(1,299.5	)	$	(1,120.4	)

In accordance with ASC Topic 740, the Company establishes valuation allowances for deferred tax assets that, in its judgment, are not more-likely-than-not realizable. These judgments are based on projections of future income, including tax-planning strategies, by individual tax jurisdiction. Changes in industry and economic conditions and the competitive environment may impact the accuracy of these projections. In accordance with ASC Topic 740, during each reporting period, the Company assesses the likelihood that its deferred tax assets will be realized and determines if adjustments to its valuation allowances are appropriate. As a result of this assessment, for Fiscal 2014, 2013, and 2012, the Company had a net (release) charge of valuation allowance to earnings totaling $(47.4), $151.8 and $(139.6), respectively, as more fully described below.

HGI

As a result of HGI’s cumulative losses over the past three years, management concluded at September 30, 2014, that a valuation allowance was required for its entire net deferred tax asset balance. HGI’s valuation allowance at September 30, 2014, totaled $279.9. This resulted from the Company’s conclusion that tax benefits on its pretax losses are not more-likely-than-not realizable. HGI has approximately $497.3 of U.S. Federal net operating loss (“NOL”) carryforwards which, if unused, will expire in years 2029 through 2034. HGI has approximately $35.5 of U.S. Federal capital loss carryforwards which, if unused, will expire through 2016 and 2019. HGI has approximately $16.3 of tax benefits related to U.S. state NOL carryforwards which, if unused, will expire in years 2029 through 2034.

On September 27, 2013, HGI triggered a change of ownership, as defined under Internal Revenue Code (the “IRC”) Section 382 which limits the utilization of HGI’s U.S. Federal and state net operating losses and other tax attributes. The amount of the limitation is based on a number of factors, including the value of HGI’s stock (as defined for tax purposes) on the date of the ownership change, its net unrealized gain position on that date (as defined for tax purposes), the occurrence of realized gains in years subsequent to the ownership change, and the effects of subsequent changes in ownership, if any. Such factors, including the recognition of unrealized gains, may not be relied upon when assessing the realizability of HGI’s deferred tax assets on its U.S. Federal and state net operating losses. As a result, Management has concluded that its deferred tax assets on U.S. Federal and state NOL's are not more-likely-than-not realizable. The Company also concluded that a valuation allowance was required for HGI’s entire net deferred tax asset balance at September 30, 2013, in the amount of $204.0.

Spectrum Brands

At September 30, 2014, Spectrum Brands had U.S. Federal NOL carryforwards of $1,087.8 and tax benefits related to state NOLs of $70.3. Spectrum Brands has an additional $45.5 of Federal and state NOLs for which benefits will be recorded to Additional paid-in capital when those carryforwards are used. If unused, they will expire through 2034. Spectrum Brands has foreign loss carryforwards totaling $106.5 which will expire beginning in 2015. Certain of the foreign net operating losses have indefinite carryforward periods. Spectrum Brands is subject to an annual limitation on use of its NOL carryforwards that arose prior to its emergence from bankruptcy. Spectrum Brands has had multiple changes of ownership, as defined under IRC Section 382, that limit the utilization of Spectrum Brands’ U.S. Federal and state net operating losses and other tax attributes. The annual limitation is based on a number of factors, including the value of the Spectrum Brands’ stock (as defined for tax purposes), on the date of the ownership change, its net unrealized gain position on that date, the occurrence of realized gains in years subsequent to the ownership change, and the effects of subsequent ownership changes (as defined for tax purposes), if any. Due to these limitations, Spectrum Brands estimates, as of September 30, 2014, that $301.7 of U.S. Federal NOLs and $16.8 of the tax benefit related to state NOLs will expire unused even if Spectrum Brands generates sufficient income to otherwise use all of its NOLs. In addition, separate return year limitations apply to limit Spectrum Brands’ utilization of the acquired Russell Hobbs U.S. Federal and state NOLs to future income of the Russell Hobbs subgroup. Spectrum Brands also projects, as of September 30, 2014, that $88.8 of its foreign NOLs will not be used. Spectrum Brands has provided a full valuation allowance against these deferred tax assets.

As of September 30, 2014 and 2013, Spectrum Brands’ valuation allowances totaled approximately $333.1 and $454.6, respectively. These valuation allowances were recorded on: (i) U.S. net deferred tax assets totaling $299.1 and $421.7, respectively; and (ii) foreign net deferred tax assets totaling $34.0 and $32.8, respectively. The net decrease in Spectrum Brands’ valuation allowance during Fiscal 2014 totaled $121.5, of which $122.6 relates to U.S. net deferred tax assets, and an increase of $1.1 relates to foreign net deferred tax assets. In addition, as a result of an acquisition, Spectrum Brands was able to release $62.6 of its U.S. valuation allowance during Fiscal 2014. Spectrum Brands was able to release $49.8 of its U.S. valuation allowance resulting from an acquisition during Fiscal 2013. The release was attributable to $49.8 of net deferred tax liabilities recorded on the acquiree's opening balance sheet that are available to offset other U.S. net deferred tax assets.

Effective October 1, 2012, Spectrum Brands began recording residual U.S. and foreign taxes on current foreign earnings in accordance with its change in policy not to permanently reinvest current and future foreign earnings. To the extent necessary, Spectrum Brands intends to utilize earnings of foreign subsidiaries generated after September 30, 2011, to support the plans of Spectrum Brands to voluntarily accelerate its pay down of U.S. debt, fund distributions to shareholders, fund U.S. acquisitions and satisfy ongoing U.S. operational cash flow requirements. As a result, earnings of Spectrum Brands’ non-U.S. subsidiaries after September 30, 2011 are not considered permanently reinvested, except in jurisdictions where repatriation is either precluded or restricted by law. Accordingly, Spectrum Brands is providing residual U.S. and foreign deferred taxes to these earnings to the extent they cannot be repatriated in a tax-free manner. As a result for Fiscal 2014, Spectrum Brands recorded residual taxes on approximately $190.5 of distributions of foreign earnings and $3.1 of earnings not yet taxed in the U.S., which had no impact to income tax expense due to a corresponding adjustment to Spectrum Brands’ domestic valuation allowance. For Fiscal 2013, Spectrum Brands recorded residual U.S. and foreign taxes on approximately $12.5 of distributions of foreign earnings and $45.7 of earnings not yet taxed in the U.S., which had no impact to income tax expense due to a corresponding adjustment to Spectrum Brands’ domestic valuation allowance. During Fiscal 2014, $178.7 of the distributions related to one-time internal restructuring and external debt refinancing activities. Due to the U.S. valuation allowance, these activities did not result in a Fiscal 2014 tax increase. Fiscal 2013 and 2012 distributions were primarily non-cash deemed distributions under U.S. tax law.

Remaining undistributed earnings of Spectrum Brands’ foreign operations totaled approximately $351.5 at September 30, 2014, and are permanently reinvested. Spectrum Brands has determined that it is not practical to calculate the residual U.S. income tax on the foregoing permanently reinvested unremitted foreign earnings.

FGL

At September 30, 2014, FGL’s deferred tax assets were primarily the result of U.S. NOL, capital loss and tax credit carryforwards and insurance reserves. FGL’s net deferred tax asset position at September 30, 2014 and 2013, before consideration of its recorded valuation allowance, totaled $256.2 and $399.2, respectively. Valuation allowances of $118.8 and $158.7 were recorded against its gross deferred tax asset balance at September 30, 2014 and 2013, respectively. FGL’s net deferred tax asset position at September 30, 2014 and 2013, after taking into account the valuation allowance, was $137.4 and $240.5, respectively. For Fiscal 2014 and 2013, FGL recorded a net valuation allowance release of $40.1 (comprised of a full year valuation release of $43.0 related to FGL’s operating insurance subsidiaries, partially offset by an increase to valuation allowance of $2.9 related to the non-life companies) and $18.9 (comprised of a full year valuation release of $20.7 related to the life insurance companies, partially offset by an increase to valuation allowance of $1.8 related to FGL’s non-life companies), respectively, based on management’s reassessment of the amount of its deferred tax assets that are more-likely-than-not realizable.

At September 30, 2014, FGL’s valuation allowance of $118.8 consisted of a partial valuation allowance of $78.0 on capital loss carryforwards and a full valuation allowance of $40.8 on non-life insurance net deferred taxes. At September 30, 2013, FGL’s valuation allowance of $158.7 consisted of a partial valuation allowance of $118.8 on capital loss carryforwards and a full valuation allowance of $39.9 on non-life insurance net deferred taxes.

As a consequence of FGL’s acquisition on April 6, 2011, utilization of certain tax attributes (carryforwards) became limited at the FGH Acquisition date under IRC sections 382 and 383. On September 27, 2013, FGL triggered a subsequent change of ownership, as defined under IRC Section 382; the resulting limitation is higher than the original limitation calculated on April 6, 2011. Consequently, this limitation is not expected to impact FGL’s utilization of its tax attributes. In addition, FGL experienced cumulative losses during the three-year period preceding its acquisition. These are among the factors the Company considered in establishing a valuation allowance against FGL’s deferred tax asset position at the FGH Acquisition Date.

FGL maintains a valuation allowance against certain IRC section 382 limited capital loss carryforwards and the deferred tax assets of its non-life insurance company subsidiaries. A valuation allowance has been recorded against capital loss carryforwards limited under Section IRC 382 to reduce the associated deferred tax assets to an amount that is more-likely than not realizable. The non-life insurance company subsidiaries have a history of losses and insufficient sources of future income in order to recognize any portion of their deferred tax assets.

During Fiscal 2014, market conditions changed sufficiently that FGL determined it was prudent and feasible to adopt a new tax planning strategy. The strategy involves repositioning a portion of the investment portfolio to trigger $100.0 in net unrealized built-in gains (“NUBIG”). The sale of these assets will result in an increase to FGL’s Section 382 limit (i.e. the “adjusted limit”), enabling FGL to utilize capital loss carryforwards that will offset NUBIG-related gains. This strategy makes it more likely than not that the amount of capital loss carryforwards needed to offset those gains will be utilized. Therefore, FGL released a portion of the valuation allowance previously recorded against its deferred tax asset related to capital loss carryforwards. FGL intends to execute the transactions prior to the expiration of Section 382-limited capital loss carryforwards. As of September 30, 2014, approximately $67.8 of NUBIG has been recognized, resulting in $23.7 of tax benefits. FGL currently has capital loss carryforwards of $255.0 that will expire on December 31, 2015.

Key considerations in FGL’s decision supporting adoption of the planning strategy include wider spreads in specific credit markets, increased range of executable reinvestment opportunities, and an enhanced focus on managing and increasing FGL’s Statutory Interest Maintenance Reserve (“IMR”) balance and capital position providing increased flexibility in volatile interest rate and credit spread markets.

At September 30, 2014 and 2013, FGL had NOL carryforwards of $92.5 and $92.7, respectively, which, if unused, will expire in years 2026 through 2034. FGL had capital loss carryforwards totaling $259.1 and $350.4 at September 30, 2014 and 2013, respectively, which if unused, will expire in years 2015 through 2019. In addition, at September 30, 2014 and 2013, FGL had low income housing tax credit carryforwards totaling $54.3 and $54.2, respectively, which, if unused, will expire in years 2017 through 2034 and alternative minimum tax credits of $6.3 and $6.3, respectively, that may be carried forward indefinitely. Certain tax attributes are subject to an annual limitation as a result of the acquisition of FGL by the Company, which constitutes a change of ownership, as defined under IRC Sections 382 and 383.

Uncertain Tax Positions

The total amount of unrecognized tax benefits (“UTBs”) at September 30, 2014 and 2013 were $12.6 and $13.8, respectively. If recognized in the future, $9.3 of UTBs would impact the effective tax rate and $3.3 of UTBs would create deferred tax assets against which the Company would record a full valuation allowance. The Company records interest and penalties related to uncertain tax positions in income tax expense. At September 30, 2014 and 2013, the Company’s accrued balances of interest and penalties on uncertain tax positions totaled $4.1 and $3.7, respectively. For Fiscal 2014, 2013 and 2012, interest and penalties increased (decreased) income tax expense by $1.8, $0.0 and $(1.2), respectively.

At September 30, 2014, filed income tax returns for certain of the Company’s legal entities in various jurisdictions were undergoing income tax audits. The Company cannot predict the ultimate outcome of these examinations. However, it is reasonably possible that during the next 12 months some portion of previously unrecognized tax benefits could be recognized.

The Company believes its income tax reserves for UTBs are adequate, consistent with the principles of ASC Topic 740. The Company regularly assesses the likelihood of additional tax assessments by jurisdiction and, if necessary, adjusts its tax reserves based on new information or developments.

The following table summarizes changes to the Company’s UTB reserves, excluding related interest and penalties:



	Amount
Unrecognized tax benefits at September 30, 2011	$	9.0
Gross increase — tax positions in prior period	0.7
Gross decrease — tax positions in prior period	(1.3		)
Gross increase — tax positions in current period	0.8
Settlements	(1.7		)
Lapse of statutes of limitations	(1.6		)
Unrecognized tax benefits at September 30, 2012	5.9
Gross increase — tax positions in prior period	9.1
Gross decrease — tax positions in prior period	(0.3		)
Gross increase — tax positions in current period	0.5
Settlements	(0.1		)
Lapse of statutes of limitations	(1.3		)
Unrecognized tax benefits at September 30, 2013	13.8
Gross increase — tax positions in prior period	2.7
Gross decrease — tax positions in prior period	(1.4		)
Gross increase — tax positions in current period	0.8
Settlements	(2.5		)
Lapse of statutes of limitations	(0.8		)
Unrecognized tax benefits at September 30, 2014	$	12.6

HGI files U.S. Federal consolidated and state and local combined and separate income tax returns. HGI’s consolidated and combined returns do not include Spectrum Brands or FGL (life insurance subsidiaries), each of which files their own consolidated Federal, and combined and separate state and local income tax returns. HGI’s U.S. Federal income tax returns for years prior to and including 2010 are no longer subject to audit by the taxing authorities. Except for certain immaterial jurisdictions, HGI’s state and local income tax returns are no longer subject to audit for years prior to 2008. HGI’s U.S. Federal NOL carryforwards from the fiscal years ended September 30, 2010 and prior, will continue to be subject to Internal Revenue Service examination until the Statute of Limitations expires for the years in which these NOL carryforwards are ultimately utilized.

Spectrum Brands files U.S. Federal consolidated and state and local combined and separate income tax returns as well as foreign income tax returns in various jurisdictions. They are subject to ongoing examination by various taxing authorities. Spectrum Brand’s major taxing jurisdictions are the U.S., United Kingdom and Germany.

U.S. Federal income tax returns of Spectrum Brands and Russell Hobbs are no longer subject to audit for fiscal years prior to 2010. However, Federal NOL carryforwards from the fiscal years ended September 30, 2010 and prior, will continue to be subject to Internal Revenue Service examination until the Statute of Limitations expires for the years in which these NOL carryforwards are ultimately utilized. Filings in various U.S. state and local jurisdictions are also subject to audit; to date, no significant audit matters have arisen.

U.S. Federal income tax returns of FGL for years prior to 2009 are no longer subject to examination by the taxing authorities. Except for certain immaterial jurisdictions, FGL is no longer subject to state and local income tax audits for years prior to 2010. However, Federal NOL carryforwards from tax years ended June 30, 2006 and December 31, 2006, respectively, continue to be subject to Internal Revenue Service examination until the Statute of Limitations expires for the years in which these NOL carryforwards are ultimately utilized.