Income Taxes

9 Months Ended

Sep. 25, 2020

Income Tax Disclosure [Abstract]

Income Tax Disclosure

4. Income Taxes

On March 27, 2020, the U.S. government enacted the Coronavirus Aid, Relief, and Economic Security ("CARES") Act. The CARES Act was a response to the market volatility and instability resulting from the novel coronavirus ("COVID-19") pandemic. It includes provisions to support individuals and businesses in the form of loans, grants, and tax changes among other types of relief. Estimates of the effects of the changes to the U.S. tax code have been incorporated into the Company’s nine months ended September 25, 2020 provision for income taxes, as applicable.

The CARES Act income tax provisions applicable to the Company include, but are not limited to (1) carrybacks of certain net operating losses ("NOL(s)") generated in tax years beginning after December 31, 2017 and before January 1, 2021 to the preceding five taxable years, (2) suspension of the 80.0% taxable income limitation for NOLs generated in tax years beginning after December 31, 2017 and before January 1, 2021, (3) increase in the limitation of the interest expense deduction under Internal Revenue Code ("IRC") §163(j) from 30.0% to 50.0% of adjusted taxable income for any taxable year beginning in 2019 or 2020, (4) expansion of the charitable contribution deduction limit to 25.0% of taxable income versus the previous 10.0% limitation for contributions made during

2020, and (5) acceleration of alternative minimum tax credits being refunded incrementally in tax years 2018, 2019, 2020 and 2021 to recover the entire remaining balance in either the 2018 or 2019 tax year.

As a result of the CARES Act, the Company is able to carryback a portion of its prior year and estimated current year U.S. Federal NOLs resulting in anticipated cash tax refunds of $201.0 million and $117.4 million, respectively. A tax benefit of $285.3 million has been recognized during the nine months ended September 25, 2020. The carryback of the U.S. Federal NOLs has an ancillary effect on the Company’s unrecognized tax benefits, as disclosed below.

As further discussed in Note 1, the Company concluded that there is substantial doubt about its ability to continue as a going concern within one year from the date of issuance of the unaudited condensed consolidated financial statements. The Company considered this in determining that certain net deferred tax assets were no longer more likely than not realizable. As a result, an increase in valuation allowance of $341.6 million on the Company’s net deferred tax assets was recorded for the three months ended June 26, 2020. Approximately $202.7 million of this increase was a valuation allowance placed on prior year deferred tax assets predominantly related to U.S. Federal NOLs and the Opioid-Related Litigation Settlement charge (as defined in Note 11). The remaining $138.9 million increase was placed on the Company's net deferred tax assets resulting from current year activity predominantly related to the Acthar Gel Medicaid Retrospective Rebate (as defined in Note 11) accrual. As a result, all of the Company's net deferred tax assets as of the nine months ended September 25, 2020 are fully offset by a valuation allowance.

The Company recognized an income tax benefit of $211.6 million on a loss from continuing operations before income taxes of $19.8 million for the three months ended September 25, 2020, and an income tax benefit of $27.6 million on a loss from continuing operations before income taxes of $28.5 million for the three months ended September 27, 2019. This resulted in effective tax rates of 1,068.7% and 96.8% for the three months ended September 25, 2020 and September 27, 2019, respectively. The income tax benefit for the three months ended September 25, 2020 was comprised of $201.4 million of current tax benefit and $10.2 million of deferred tax benefit. The current tax benefit was primarily the result of the CARES Act and unrecognized tax benefits, partially offset by the fiscal 2020 reorganization of the Company's intercompany financing and associated legal entity ownership. The deferred tax benefit was predominantly related to the fiscal 2020 reorganization of the Company's intercompany financing and associated legal entity ownership. The income tax benefit for the three months ended September 27, 2019 was comprised of $3.3 million of current tax expense and $30.9 million of deferred tax benefit. The deferred tax benefit was predominantly related to previously acquired intangibles and the generation of tax loss and credit carryforwards net of valuation allowances.

The Company recognized an income tax benefit of $69.2 million on a loss from continuing operations before income taxes of $884.7 million for the nine months ended September 25, 2020, and an income tax benefit of $256.6 million on a loss from continuing operations before income taxes of $102.8 million for the nine months ended September 27, 2019. This resulted in effective tax rates of 7.8% and 249.6% for the nine months ended September 25, 2020 and September 27, 2019, respectively. The income tax expense for the nine months ended September 25, 2020 was comprised of $370.3 million of current tax benefit and $301.1 million of deferred tax expense. The current tax benefit was primarily the result of the CARES Act and unrecognized tax benefits, partially offset by the fiscal 2020 reorganization of the Company's intercompany financing and associated legal entity ownership. The deferred tax expense was predominantly related to the valuation allowance noted above, recorded against the Company's net deferred tax assets, and unrecognized tax benefits, partially offset by a tax benefit predominantly related to the fiscal 2020 reorganization of the Company's intercompany financing and associated legal entity ownership. The income tax benefit for the nine months ended September 27, 2019 was comprised of $47.4 million of current tax expense and $304.0 million of deferred tax benefit. The deferred tax benefit was predominantly related to previously acquired intangibles, the generation of tax loss and credit carryforwards net of valuation allowances, the non-restructuring impairment charges, as well as the 2019 reorganization of the Company's intercompany financing and associated legal entity ownership, which eliminated the interest bearing deferred tax obligation.

The income tax benefit was $211.6 million for the three months ended September 25, 2020, compared with an income tax benefit of $27.6 million for the three months ended September 27, 2019. The $184.0 million net increase in the tax benefit included an increase of $235.7 million attributed to the CARES Act, and an increase of $1.2 million attributed to the fiscal 2019 gain on debt repurchased partially offset by a decrease of $32.0 million attributed to the fiscal 2020 reorganization of the Company's intercompany financing and associated legal entity ownership, a decrease of $12.3 million attributed to changes in the timing, amount and jurisdictional mix of income, a decrease of $6.5 million attributed to separation costs and a decrease of $2.1 million attributed to net restructuring.

The income tax benefit was $69.2 million for the nine months ended September 25, 2020, compared with an income tax benefit of $256.6 million for the nine months ended September 27, 2019. The $187.4 million net decrease in the tax benefit included a decrease of $229.1 million predominantly attributed to the fiscal 2019 reorganization of the Company's intercompany financing and associated legal entity ownership including related adjustments to elections on the fiscal 2019 U.S. tax return primarily as a result of changes to the NOL carryback provisions in the CARES Act, a decrease of $202.7 million attributed to a valuation allowance recorded against the Company's net deferred tax assets, a decrease of $30.0 million attributed to changes in the timing, amount and jurisdictional mix of income, a decrease of $9.9 million attributed to separation costs, a decrease of $8.5 million attributed to non-restructuring impairment charges, a decrease of $2.6 million attributed to net restructuring, partially offset by an increase of $285.3 million attributed to the CARES Act and an increase of $10.1 million attributed to the fiscal 2019 gain on debt repurchased.

During the nine months ended September 25, 2020, and fiscal 2019, the net cash payments for income taxes were $42.9 million and $30.7 million, respectively.

On July 15, 2020, the activities of the Company's principal executive offices were relocated from the United Kingdom ("U.K.") to Ireland, which resulted in a change in the Company's tax residence to Ireland. Mallinckrodt plc has always been and remains incorporated in Ireland. Relocation of Mallinckrodt plc’s tax residence to Ireland allows the Company to mitigate the potential impacts of the U.K.’s departure from the European Union and align with the Company's commercial activity in Ireland. The Company continues to be subject to taxation in various tax jurisdictions worldwide. Accordingly, in fiscal 2020 the Company will report the Irish tax jurisdiction as the Company's domestic jurisdiction using an Irish statutory tax rate of 12.5% versus the U.K. statutory rate of 19.0%, and the International jurisdiction will represent areas outside the Irish tax jurisdiction. There is no material financial impact to this change.

In August 2020, a settlement was reached with the Internal Revenue Service ("IRS") related to the audit of Mallinckrodt Hospital Products Inc.'s ("MHP") (formerly known as Cadence Pharmaceuticals, Inc. ("Cadence")) tax year ended September 26, 2014. Cadence was acquired as a U.S. subsidiary on March 19, 2014. Following the acquisition of Cadence, the Company transferred certain rights and risks in Ofirmev intellectual property ("Transferred IP") to one of the Company's wholly owned non-U.S. subsidiaries. The transfer occurred at a price determined in conjunction with external advisors, in accordance with applicable Treasury Regulations and with reference to the $1,329.0 million taxable consideration the Company paid to the shareholders of Cadence. The IRS asserted the transfer price of the Transferred IP was understated. The settlement increased the transfer price of the Transferred IP, resulting in an increase to taxable income of $356.5 million and underpayment interest of $11.8 million. The increase to taxable income was satisfied through a noncash offset against the Company's U.S. Federal NOLs and interest expense for the tax year ended September 25, 2020, while the underpayment interest was satisfied through a cash payment of $11.8 million. The Company was adequately reserved for this; therefore there were no impacts to the unaudited condensed consolidated statement of operations for the three months ended September 25, 2020.

During the three months ended September 25, 2020, the Company commenced the fiscal 2020 reorganization of its intercompany financing and associated legal entity ownership to align its Specialty Brands and Specialty Generics businesses in preparation for the Chapter 11 bankruptcy filing, described in Note 14. As a result, for the three months ended September 25, 2020, the Company recognized current income tax expense of $44.2 million and a deferred income tax benefit of $12.2 million with a corresponding reduction to net deferred tax liabilities. In addition, a current tax benefit of $234.7 million was recognized due to the impact of the CARES Act on the fiscal 2020 reorganization, as described above. Finally, the fiscal 2020 reorganization substantially contributed to a deferred tax asset of $312.2 million for the portion of the Company's estimated fiscal 2020 U.S. Federal NOL that is not impacted by the CARES Act, which is fully offset with a valuation allowance.

The Company's unrecognized tax benefits, excluding interest, totaled $336.9 million and $398.6 million as of September 25, 2020 and December 27, 2019, respectively. The net decrease of $61.7 million primarily resulted from settlements of $80.3 million, a lapse of statute of limitations of $35.7 million, and a net decrease of prior period tax positions of $4.3 million, offset by an increase to current period tax positions of $58.6 million. If favorably settled, $77.0 million of unrecognized tax benefits as of September 25, 2020 would benefit the effective tax rate. The total amount of accrued interest and penalties related to these obligations was $15.7 million and $32.9 million as of September 25, 2020 and December 27, 2019, respectively. Due to a lapse of the statute of limitations noted above, $18.1 million of tax and interest on unrecognized tax benefits related to the Nuclear Imaging business were eliminated, and a benefit of $17.3 million was recorded in discontinued operations within the unaudited condensed consolidated statement of operations for the nine months ended September 25, 2020.

It is reasonably possible that within the next twelve months the unrecognized tax benefits could decrease by up to $25.0 million and the amount of related interest and penalties could decrease by up to $6.0 million as a result of payments or releases due to the resolution of examinations, appeals and litigation and the expiration of various statutes of limitation.