Income Taxes

On December 22, 2017, the United States enacted tax reform legislation that included a broad range of business tax provisions, including but not limited to a reduction in the U.S. federal tax rate from 35% to 21% as well as provisions that limit or eliminate various deductions or credits. The legislation also causes U.S. expenses, such as interest and general administrative expenses, to be taxed and imposes a new tax on U.S. cross-border payments.

In response to the enactment of U.S. tax reform, the SEC issued guidance (referred to as “SAB 118”) to address the complexity in accounting for this new legislation. When the initial accounting for items under the new legislation is incomplete, the guidance allows companies to recognize provisional amounts when reasonable estimates can be made or to continue to apply the prior tax law if a reasonable estimate of the impact cannot be made. The SEC has provided up to a one-year window for companies to finalize the accounting for the impacts of this new legislation and the Company finalized its accounting during 2018.

The 2017 provision for income taxes included a provisional one-time charge of $65 for the transition tax on accumulated foreign earnings and profits, which resulted in an associated one-time reduction estimated at $185 in the Company’s net operating loss carryforward. Upon filing the 2017 income tax return, the final transition tax calculated was $64 and the related net operating loss utilized was $181.

During 2018, the Company recognized income tax expense of $40, primarily as a result of income from certain foreign operations. In the United States, as a result of Tax Reform, disallowed interest expense resulted in current year taxable income which utilized a net operating loss carryforward. The disallowed interest expense carryforward of $283 generated a deferred tax asset. The decrease in the valuation allowance due to the net operating loss utilization was offset by an increase in the valuation allowance recorded on the interest expense carryforward deferred tax asset. Tax Reform also resulted in the inclusion of Global Intangible Low Tax Income (“GILTI”) of $21, which was fully offset by our net operating loss. This further reduced our valuation allowance.

Additionally, certain provisions of Tax Reform were not effective until 2018. The Company evaluated and recorded the impact of these provisions in the financial statements and the Company has made its accounting policy elections with respect to these items. The Company elected to account for GILTI as a current period expense in the reporting period in which the tax is incurred.

As a result of U.S. tax reform the Company recognized the earnings of non-U.S. operations in its 2017 U.S. consolidated income tax return under the transition tax. The previously taxed earnings are expected to be repatriated to the U.S. The Company has accrued the incremental tax expense expected to be incurred upon the repatriation of these earnings. In addition, the Company has certain intercompany arrangements that, if settled, may trigger taxable gains or losses based on foreign currency exchange rates in place at the time of settlement. As a result of the conditions related to the Company’s ability to continue as a going concern described in Note 1, in the fourth quarter of 2018, the Company is no longer able to assert permanent reinvestment with respect to certain intercompany arrangements previously considered indefinite, and the impact to deferred taxes on the associated foreign currency translation resulted in no tax expense.

During 2017, the Company recognized income tax expense of $18, primarily as a result of income from certain foreign operations. Losses in the United States created a deferred income tax benefit which was completely offset by an increase to the valuation allowance. The Company incurred a provisional income tax expense of $167 associated with revaluing its net U.S. deferred tax attributes to reflect the new U.S. corporate tax rate of 21%, as well as an additional $65 provisional income tax expense associated with the estimated transition tax. The Company’s valuation allowance was reduced by $234 as a result of the impact Tax Reform had on reducing its net deferred tax assets.

Due to the previously enacted U.S. tax rate change, estimated balances as of December 31, 2017 represented timing differences, which changed when those estimates were finalized with the filing of the 2017 income tax return. The Company updated its provisional estimate of the transition tax and assessed the impact on its valuation allowance during 2018.

During 2016, the Company recognized income tax expense of $38, primarily as a result of income from certain foreign operations. Losses in the United States created a deferred income tax benefit which was completely offset by an increase to the valuation allowance. Income tax expense detail for the Company for the years ended December 31, 2018, 2017 and 2016 is as follows:



	2018		2017			2016
Current:
State and local	$	2	$	2		$	2
Foreign	26		19			34
Total current	28		21			36
Deferred:
Federal	1		(5		)	—
State and local	—		—			(1		)
Foreign	11		2			3
Total deferred	12		(3		)	2
Income tax expense	$	40	$	18		$	38

A reconciliation of the Company’s combined differences between income taxes computed at the federal statutory tax rate of 21% and provisions for income taxes for the year ended December 31, 2018 and the federal statutory tax rate of 35% and provisions for income taxes for the years ended December 31, 2017 and 2016 is as follows:



	2018			2017			2016
Income tax benefit computed at federal statutory tax rate	$	(26	)	$	(77	)	$	(4	)
State tax provision, net of federal benefits	1			—			—
Foreign tax rate expense (benefit) differential	9			(2		)	(18		)
Foreign source income (loss) subject to U.S. taxation	2			(45		)	21
Losses (gains) and other expenses (income) not deductible (excluded) for tax	10			20			(4		)
Increase (decrease) in the taxes due to changes in valuation allowance	25			(129		)	42
Additional expense (benefit) on foreign unrepatriated earnings	1			—			(16		)
Additional expense (benefit) for uncertain tax positions	18			5			(3		)
Tax recognized in other comprehensive income	—			(3		)	—
Changes in enacted tax laws and tax rates	—			167			—
Transition tax expense	—			65			—
Write-off of deferred tax assets	—			17			20
Income tax expense	$	40		$	18		$	38

In December 2017, the United States enacted tax reform legislation. As a result, in 2017 the Company incurred a provisional income tax expense of $167 associated with revaluing its net U.S. deferred tax attributes to reflect the new U.S. corporate tax rate of 21%, as well as an additional $65 provisional income tax expense associated with the estimated transition tax. The Company’s valuation allowance was reduced by $234 as a result of the impact Tax Reform had on reducing its net deferred tax assets.

The domestic and foreign components of the Company’s loss before income taxes for the years ended December 31, 2018, 2017 and 2016 is as follows:



	2018			2017			2016
Domestic	$	(195	)	$	(143	)	$	(115	)
Foreign	69			(77		)	104
Total	$	(126	)	$	(220	)	$	(11	)

The tax effects of significant temporary differences and net operating loss, interest expense limitation, and credit carryforwards, which comprise the Company’s deferred tax assets and liabilities at December 31, 2018 and 2017 is as follows:



	2018			2017
Assets:
Non-pension post-employment	$	5		$	5
Accrued and other expenses	56			53
Property, plant and equipment	4			1
Loss, expense, and credit carryforwards	488			477
Intangibles	5			6
Pension and postretirement benefit liabilities	37			47
Gross deferred tax assets	595			589
Valuation allowance	(547		)	(522		)
Net deferred tax asset	48			67
Liabilities:
Property, plant and equipment	(47		)	(52		)
Unrepatriated earnings of foreign subsidiaries	(10		)	(9		)
Intangible assets	(6		)	(9		)
Gross deferred tax liabilities	(63		)	(70		)
Net deferred tax liability	$	(15	)	$	(3	)

The following table summarizes the presentation of the Company’s net deferred tax liability in the Consolidated Balance Sheets at December 31, 2018 and 2017:



	2018			2017
Assets:
Long-term deferred income taxes	$	—		$	8
Liabilities:
Long-term deferred income taxes	(15		)	(11		)
Net deferred tax liability	$	(15	)	$	(3	)

Hexion LLC, the Company’s parent, is not a member of the registrant. Hexion LLC and its eligible subsidiaries file a consolidated U.S. Federal income tax return. Therefore, the Company can utilize Hexion LLC's tax attributes or vice versa. Cumulative income at Hexion LLC has reduced the amount of net operating loss carryforwards otherwise available to the Company by $26. However, since the Company accounts for Hexion LLC under the separate return method, the utilization is not reflected in the above gross deferred tax asset - loss, expense, and credit carryforwards. Further, the valuation allowance above does not reflect the related $26 offset.

As of December 31, 2018, the Company had a $547 valuation allowance for its net deferred tax assets that management believes, more likely than not, will not be realized. The Company’s deferred tax assets include federal, state and foreign net operating loss carryforwards as well as an interest expense carryforward. The federal net operating loss carryforwards available are $1,048, which excludes the cumulative income from Hexion LLC, as described above. The federal net operating loss carryforwards expire beginning in 2027. The interest expense carryforward available is $283. A full valuation allowance has been recorded against these loss and expense carryforwards. The Company has provided a full valuation allowance against its state deferred tax assets, primarily related to state net operating loss carryforwards of $77. A valuation allowance of $115 has been recorded against a portion of foreign net operating loss carryforwards, primarily in Germany and the Netherlands.

The Company continues to not assert indefinite reinvestment of undistributed earnings of its foreign subsidiaries outside of the United States. Accordingly, a related deferred tax liability of $10 is recorded.

The following table summarizes the changes in the valuation allowance for the years ended December 31, 2018, 2017, and 2016:



	Balance at Beginning of Period		Changes in Related Gross Deferred Tax Assets/Liabilities			Charge			Balance at End of Period
Valuation allowance on Deferred tax assets:
Year ended December 31, 2016	$	611	$	(2	)	$	42		$	651
Year ended December 31, 2017	651		—			(129		)	522
Year ended December 31, 2018	522		—			25			547

For 2018, previous losses in the U.S. and previous and current losses in certain foreign operations for recent periods continue to provide sufficient negative evidence requiring a full valuation allowance against the net federal, state, and foreign deferred tax assets. The Company’s risk of not being able to continue as a going concern further supports the maintenance of a full valuation allowance.

Examination of Tax Returns

The Company conducts business globally and, as a result, certain of its subsidiaries file income tax returns in the U.S. federal jurisdiction and various state and foreign jurisdictions. In the normal course of business, the Company is subject to examinations by taxing authorities throughout the world, including major jurisdictions such as the United States, Brazil, Canada, China, Germany, Italy, Netherlands and the United Kingdom.

With minor exceptions, the Company’s closed tax years for major jurisdictions are years prior to: 2014 for United States, 2012 for Brazil, 2010 for Canada, 2013 for China, 2014 for Germany, 2007 for Italy, 2010 for Netherlands and 2014 for the United Kingdom.

The Company continuously reviews issues that are raised from ongoing examinations and open tax years to evaluate the adequacy of its liabilities. As the various taxing authorities continue with their audit/examination process, the Company will adjust its reserves accordingly to reflect the current status and settlements.

Unrecognized Tax Benefits

A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows:



	2018			2017
Balance at beginning of year	$	80		$	73
Additions based on tax positions related to the current year	4			2
Additions for tax positions of prior years	16			1
Reductions for tax positions of prior years	(2		)	(1		)
Settlements	—			—
Foreign currency translation	(4		)	5
Balance at end of year	$	94		$	80

During the year ended December 31, 2018, the Company increased the amount of its unrecognized tax benefits, including its accrual for interest and penalties, by $16, primarily as a result of increases in the unrecognized tax benefit for various intercompany transactions, offset by releases of unrecognized tax benefits from negotiations with foreign jurisdictions and lapses of statute of limitations. During the years ended December 31, 2018, 2017, and 2016, the Company recognized approximately $3, $5 and $6, respectively, in interest and penalties. The Company had approximately $51 and $49 accrued for the payment of interest and penalties at December 31, 2018 and 2017, respectively.

$94 of unrecognized tax benefits, if recognized, would affect the effective tax rate; however, a portion of the unrecognized tax benefit would be in the form of a net operating loss carryforward, which would be subject to a full valuation allowance. The Company anticipates recognizing less than $25 of the total amount of unrecognized tax benefits within the next 12 months as a result of lapses of statute of limitations, negotiations with foreign jurisdictions, settlements, and completion of audit examinations.