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, general administrative, and certain executive officer compensation expenses, to be taxed and imposes a new tax on U.S. cross-border payments.

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.

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. For the year ended December 31, 2017, the Company accrued the incremental tax expense expected to be incurred upon the repatriation of the previously taxed earnings.

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 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. During 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.

During the Predecessor period January 1, 2019 through July 1, 2019, the Predecessor Company recorded income tax expense of $40 for reorganization adjustments, primarily consisting of tax expense of $50 for the gain recognized between fair value and tax basis (the gain in Predecessor Company will be substantially offset by the Predecessor Company’s tax attributes, including net operating losses and previously disallowed interest expense). A tax benefit of $10 was recorded for the removal of a valuation allowance for certain foreign jurisdictions. Pursuant to the Plan, the Successor Company is obligated to indemnify the Predecessor Company for any tax related liabilities. The Predecessor Company recorded income tax expense of $222 in the Predecessor period, primarily related to the increase in deferred tax liabilities resulting from fresh start accounting.

The Predecessor Company’s U.S. net operating loss carryforward of $1,053 and certain state net operating loss carryforwards, along with other tax attributes, have been utilized or forfeited as a result of the taxable gain realized upon Emergence. Certain foreign net operating losses and other carryforwards of the Predecessor Company were forfeited upon Emergence.

Upon the Emergence, the Successor Company applied fresh start accounting (see Note 4 for more information regarding fresh start accounting) and therefore the deferred tax assets and liabilities were adjusted based on the revised U.S. GAAP financial statements. As a result of the step-up in U.S. GAAP basis in the Successor Company’s foreign assets without a corresponding step-up in the tax basis of the foreign assets, the Successor Company’s deferred tax liability increased. An Internal Revenue Code §338(h)(10) election is expected to be made to treat the Emergence as an asset sale for U.S. income tax purposes. As a result, the Emergence is expected to be treated as a deemed sale of assets of the Predecessor Company while the Successor Company receives a step-up in U.S. tax basis to fair value. The Successor Company anticipates electing bonus depreciation (as currently permitted under Tax Reform) on the stepped-up U.S. eligible fixed assets. The Successor Company also anticipates amortizing the stepped-up basis of intangibles over a 15-year period and the Successor Company’s depreciation and amortization expense is expected to generate a U.S. net operating loss for the tax year ended December 31, 2019. The U.S. net operating loss will be carried forward indefinitely but will be subject to an 80% limitation on U.S. taxable income.

During the Successor period July 2, 2019 through December 31, 2019, the Successor Company recognized income tax benefit of $9, primarily as a result of losses from certain foreign operations of which the deferred tax asset created is not offset by a valuation allowance. Losses in the United States created a deferred tax asset which was completely offset by an increase to the valuation allowance. The disallowed interest expense carryforward of $34 generated a deferred tax asset which offset the decrease in the valuation allowance on the net operating loss deferred tax asset. The Successor Company anticipates a GILTI inclusion of $15, which will be fully offset by our net operating loss and further reduces our valuation allowance. As previously discussed above, the Successor Company anticipates electing bonus depreciation.

Income tax expense detail for the Company for the Successor period July 2, 2019 through December 31, 2019, and the Predecessor periods January 1, 2019 through July 1, 2019 and the years ended December 31, 2018 and 2017 is as follows:



	Successor			Predecessor
	July 2, 2019 through December 31, 2019			January 1, 2019 through July 1, 2019			Year Ended December 31,
	July 2, 2019 through December 31, 2019			January 1, 2019 through July 1, 2019			2018		2017
Current:
Federal	$	—		$	38		$	—	$	—
State and local	3			13			2		2
Foreign	—			14			26		19
Total current	3			65			28		21
Deferred:
Federal	11			(1		)	1		(5		)
State and local	1			—			—		—
Foreign	(24		)	158			11		2
Total deferred	(12		)	157			12		(3		)
Income tax (benefit) expense	$	(9	)	$	222		$	40	$	18

A reconciliation of the Company’s combined differences between income taxes computed at the federal statutory tax rate of 21% and the provisions for income taxes for the Successor period July 2, 2019 through December 31, 2019, the Predecessor periods January 1, 2019 through July 1, 2019 and the year ended December 31, 2018 and the federal statutory tax rate of 35% and provision for income taxes for the year ended December 31, 2017 is as follows:



	Successor			Predecessor
	July 2, 2019 through December 31, 2019			January 1, 2019 through July 1, 2019			Year Ended December 31,
	July 2, 2019 through December 31, 2019			January 1, 2019 through July 1, 2019			2018			2017
Income tax (benefit) expense computed at federal statutory tax rate	$	(21	)	$	654		$	(26	)	$	(77	)
State tax (benefit) expense, net of federal benefit	(2		)	10			1			—
Foreign tax rate (benefit) expense differential	(1		)	2			9			(2		)
Foreign source income (loss) subject to U.S. taxation	3			1			2			(45		)
Non-deductible losses and other expenses	—			14			10			20
Increase (decrease) in the taxes due to changes in valuation allowance	20			(427		)	25			(129		)
Additional expense on foreign unrepatriated earnings	—			—			1			—
Additional expense for uncertain tax positions	1			46			18			5
Tax recognized in other comprehensive income	(1		)	—			—			(3		)
Changes in enacted tax laws and tax rates	—			—			—			167
Transition tax expense	—			—			—			65
Tax benefit for fresh start accounting and reorganization adjustments	—			(87		)	—			—
Other (increase) decrease of deferred tax assets	(8		)	9			—			17
Income tax (benefit) expense	$	(9	)	$	222		$	40		$	18

The domestic and foreign components of the Company’s loss before income taxes for the Successor period July 2, 2019 through December 31, 2019, the Predecessor periods January 1, 2019 through July 1, 2019 and the years ended December 31, 2018 and 2017 is as follows:



	Successor			Predecessor
	July 2, 2019 through December 31, 2019			January 1, 2019 through July 1, 2019		Year Ended December 31,
	July 2, 2019 through December 31, 2019			January 1, 2019 through July 1, 2019		2018			2017
Domestic	$	(44	)	$	2,892	$	(195	)	$	(143	)
Foreign	(55		)	223		69			(77		)
Total	$	(99	)	$	3,115	$	(126	)	$	(220	)

The tax effects of significant temporary differences, net operating losses, interest expense limitation, and credit carryforwards, which comprise the Company’s deferred tax assets and liabilities at December 31, 2019 and 2018 are as follows:



	Successor			Predecessor
	2019			2018
Assets:
Non-pension post-employment	$	4		$	5
Accrued and other expenses	100			56
Property, plant and equipment	4			4
Loss, expense, and credit carryforwards	165			488
Intangible assets	—			5
Pension and postretirement benefit liabilities	47			37
Gross deferred tax assets	320			595
Valuation allowance	(140		)	(547		)
Net deferred tax asset	180			48
Liabilities:
Property, plant and equipment	(263		)	(47		)
Unrepatriated earnings of foreign subsidiaries	(10		)	(10		)
Intangible assets	(65		)	(6		)
Gross deferred tax liabilities	(338		)	(63		)
Net deferred tax liability	$	(158	)	$	(15	)

The following table summarizes the presentation of the Company’s net deferred tax liability in the Consolidated Balance Sheets at December 31, 2019 and 2018:



	Successor			Predecessor
	2019			2018
Assets:
Long-term deferred income taxes	$	6		$	—
Liabilities:
Long-term deferred income taxes	(164		)	(15		)
Net deferred tax liability	$	(158	)	$	(15	)

Hexion Holdings, and its direct subsidiary Hexion Intermediate Holding 1, Inc. and its direct subsidiary Hexion Intermediate Holding 2, Inc. (the “Eligible Subsidiaries”) are not members of the registrant. Hexion Holdings and its Eligible Subsidiaries file a consolidated U.S. Federal income tax return. Therefore, the Company can utilize Hexion Holdings and its Eligible Subsidiaries’ tax attributes or vice versa.

As of December 31, 2019, the Company had a $140 valuation allowance against 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 $319, which excludes the cumulative income from Hexion Holdings and its Eligible Subsidiaries, as described above. The federal net operating loss will be carried forward indefinitely but will be subject to an 80% limitation on U.S. taxable income. The interest expense carryforward available is $34. A valuation allowance has been recorded against these loss and expense carryforwards. The Company has provided a valuation allowance against its state deferred tax assets, primarily related to state net operating loss carryforwards of $6. A valuation allowance of $58 has been recorded against a portion of foreign net operating loss carryforwards, primarily in 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 Successor period July 2, 2019 through December 31, 2019, the Predecessor periods January 1, 2019 through July 1, 2019 and the years ended December 31, 2018 and 2017:



	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:
Predecessor
Year ended December 31, 2017	$	651	$	—	$	(129	)	$	522
Year ended December 31, 2018	522		—		25			547
January 1, 2019 through July 1, 2019	547		—		(427		)	120
Successor
July 2, 2019 through December 31, 2019	120		—		20			140

For 2019, previous and current losses in the U.S. and in certain foreign operations for recent periods continue to provide sufficient negative evidence requiring a valuation allowance against the net federal, state, and certain foreign deferred tax assets.

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: 2015 for United States, 2012 for Brazil, 2010 for Canada, 2014 for China, 2015 for Germany, 2016 for Italy, 2010 for Netherlands and 2016 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:



	Successor			Predecessor
	July 2, 2019 through December 31, 2019			January 1, 2019 through July 1, 2019			Year Ended December 31, 2018
Balance at beginning of period	$	133		$	94		$	80
Additions based on tax positions related to the current year	2			41			4
Additions for tax positions of prior years	—			5			16
Reductions for tax positions of prior years	(3		)	(6		)	(2		)
Settlements	(4		)	—			—
Foreign currency translation	2			(1		)	(4		)
Balance at end of period	$	130		$	133		$	94

During the period July 2, 2019 through December 31, 2019, the Successor Company decreased the amount of its unrecognized tax benefits, including its accrual for interest and penalties, by $1, primarily as a result of decreases in the unrecognized tax benefit from negotiations with foreign jurisdictions, lapses of statute of limitations and settlements, offset by increases of unrecognized tax benefits for various intercompany transactions. During the periods July 2, 2019 through December 31, 2019, January 1, 2019 through July 1, 2019 and the years ended December 31, 2018 and 2017 the Company recognized approximately $2, $3, $3 and $5, respectively, in interest and penalties. The Company had approximately $56, $54, and $51 accrued for the payment of interest and penalties at December 31, 2019, July 1, 2019, and December 31, 2018, respectively.

$130 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 $22 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.