Note 8—Income Taxes

Pacific Drilling S.A., a holding company and Luxembourg resident, is subject to Luxembourg corporate income tax and municipal business tax at a combined rate of 24.9% for the year ended December 31, 2019, 26.0% for the year ended December 31, 2018, and 27.1% for the year ended December 31, 2017. Qualifying dividend income and capital gains on the sale of qualifying investments in subsidiaries are exempt from Luxembourg corporate income tax and municipal business tax. Consequently, the Company expects dividends from its subsidiaries and capital gains from sales of investments in its subsidiaries to be exempt from Luxembourg corporate income tax and municipal business tax.

Under the Plan of Reorganization, the Term Loan B, 2020 Notes, and 2017 Notes were cancelled and extinguished in exchange for common shares of Pacific Drilling S.A., resulting in cancellation of debt income (“CODI”) for Pacific Drilling S.A. of $863.1 million as calculated under Luxembourg accounting and tax principles. Article 52 of Luxembourg Income Tax Law generally provides for an exemption from income tax for CODI that remains after the utilization of net operating losses. As part of the Plan of Reorganization, certain intercompany debt was extinguished, resulting in bad debt losses for Pacific Drilling S.A., which together with its available net operating losses, is sufficient to fully offset CODI of Pacific Drilling S.A. that resulted from the Plan of Reorganization.

Income taxes have been provided based on the laws and rates in effect in the countries in which our operations are conducted or in which our subsidiaries are considered residents for income tax purposes. Our income tax expense or benefit arises from our mix of pretax earnings or losses, respectively, in the international tax jurisdictions in which we operate. Because the countries in which we operate have different statutory tax rates and tax regimes with respect to one another, there is no expected relationship between the provision for income taxes and our income or loss before income taxes.

Loss before income taxes consists of the following:


	Successor				Predecessor
			Period From		Period From
			November 20, 2018		January 1, 2018
	Year Ended		through		through		Year Ended
	December 31, 2019		December 31, 2018		November 19, 2018		December 31, 2017
(in thousands)
Luxembourg	$	(83,322)	$	(9,738)	$	(500,317)	$	349
United States		(933)		3,558		(10,467)		1,301
Other jurisdictions		(459,794)		(28,073)		(1,646,401)		(513,953)
Loss before income taxes	$	(544,049)	$	(34,253)	$	(2,157,185)	$	(512,303)

The components of income tax provision (benefit) consist of the following:


	Successor				Predecessor
			Period From		Period From
			November 20, 2018		January 1, 2018
	Year Ended		through		through		Year Ended
	December 31, 2019		December 31, 2018		November 19, 2018		December 31, 2017
(in thousands)
Current income tax expense (benefit):
Luxembourg	$	1,906	$	(292)	$	866	$	2,287
United States		1,323		90		641		3,202
Other foreign		404		(60)		288		(35)
Total current	$	3,633	$	(262)	$	1,795	$	5,454
Deferred tax expense (benefit):
Luxembourg	$	7,914	$	(6,454)	$	(6,924)	$	(321)
United States		(274)		15		1,902		6,145
Other foreign		1,143		(68)		919		1,585
Total deferred	$	8,783	$	(6,507)	$	(4,103)	$	7,409
Income tax expense (benefit)	$	12,416	$	(6,769)	$	(2,308)	$	12,863

A reconciliation between the Luxembourg statutory rate of 24.9% for the year ended December 31, 2019, 26.0% for the year ended December 31, 2018 and 27.1% for the year ended December 31, 2017 and our effective tax rate is as follows:


	Successor						Predecessor
				Period From			Period From
				November 20, 2018			January 1, 2018
	Year Ended			through			through			Year Ended
	December 31, 2019			December 31, 2018			November 19, 2018			December 31, 2017
Statutory rate		24.9	%		26.0	%		26.0	%	27.1	%
Effect of tax rates different from the Luxembourg statutory tax rate		(22.1)	%		(25.3)	%		(18.7)	%	(19.2)	%
Change in valuation allowance		(1.1)	%		18.7	%		(4.3)	%	(8.0)	%
Changes in unrecognized tax benefits		(0.2)	%		(1.0)	%		(0.2)	%	(0.8)	%
Equity based compensation shortfall		—	%		—	%		(0.1)	%	(1.2)	%
Change in enacted statutory tax rates		(3.9)	%		—	%		—	%	(0.5)	%
Adjustments related to prior years		0.1	%		1.3	%		—	%	0.1	%
Fresh start accounting		—	%		—	%		(2.6)	%	—	%
Effective tax rate		(2.3)	%		19.7	%		0.1	%	(2.5)	%

The components of deferred tax assets and liabilities consist of the following:


	December 31,
	2019		2018
	(in thousands)
Deferred tax assets:
Net operating loss carryforwards	$	550,119	$	549,107
Depreciation and amortization		187,288		188,161
Accrued payroll expenses		3,073		2,307
Deferred revenue		981		42
Interest expense limitation carryforward		2,033		—
Other		336		307
Deferred tax assets		743,830		739,924
Less: valuation allowance		(733,047)		(701,727)
Total deferred tax assets	$	10,783	$	38,197

Deferred tax liabilities:
Depreciation and amortization	$	—	$	(22,134)
Deferred expenses		(2,433)		—
Other		(47)		(5)
Total deferred tax liabilities	$	(2,480)	$	(22,139)

Net deferred tax assets	$	8,303	$	16,058

As of December 31, 2019 and 2018, the Company had gross deferred tax assets of $550.1 million and $549.1 million, respectively, related to loss carry forwards in various worldwide tax jurisdictions. The majority of the loss carry forwards are in Luxembourg and have a related gross deferred tax asset of $501.6 million that expire starting in 2034. The remaining loss carry forwards have no expiration.

A valuation allowance for deferred tax assets is established when it is more likely than not that some portion or all of the deferred tax assets will not be realized. As of December 31, 2019 and 2018, the valuation allowance for deferred tax assets was $733.0 million and $701.7 million, respectively.

We consider the earnings of certain of our subsidiaries to be indefinitely reinvested. Accordingly, we have not provided for taxes on these unremitted earnings. Should we make distributions from the unremitted earnings of these subsidiaries, we would be subject to taxes payable in certain jurisdictions. As of December 31, 2019, the amount of indefinitely reinvested earnings was approximately $22.2 million, and if all of these indefinitely reinvested earnings were distributed, we would be subject to estimated taxes of approximately $1.1 million.

We recognize tax benefits from an uncertain tax position only if it is more likely than not that the position will be sustained upon examination by taxing authorities based on the technical merits of the position. The amount recognized is the largest benefit that we believe has greater than a 50% likelihood of being realized upon settlement. As of December 31, 2019, we had $43.5 million of unrecognized tax benefits which were included in other long-term liabilities on our consolidated balance sheets and would impact our consolidated effective tax rate if realized. To the extent we have income tax receivable balances available to utilize against amounts payable for unrecognized tax benefits, we have presented such receivable balances as a reduction to other long-term liabilities on our consolidated balance sheets. A reconciliation of the beginning and ending amounts of unrecognized tax benefits for the Successor periods in 2019 and 2018 and for the Predecessor period in 2018 is as follows:


	Successor				Predecessor
			Period From		Period From
			November 20, 2018		January 1, 2018
	Year Ended		through		through
	December 31, 2019		December 31, 2018		November 19, 2018
(in thousands)
Balance, beginning of period	$	42,457	$	41,831	$	38,860
Increases in unrecognized tax benefits as a result of tax positions taken during current year		1,028		626		2,971
Balance, end of period	$	43,485	$	42,457	$	41,831

As of December 31, 2019 and 2018, we have no accrued interest and penalties related to uncertain tax positions on our balance sheet as such payments would not be required by law.

The Company is subject to taxation in various U.S., foreign, and state jurisdictions in which it conducts business. Tax years as early as 2011 remain subject to examination. As of December 31, 2019, the Company has ongoing tax audits in Nigeria and Brazil.