Income Taxes

12 Months Ended

Sep. 30, 2021

Income Tax Disclosure [Abstract]

Income Taxes

INCOME TAXES

Components of income tax expense

Income tax expense consisted of the following for the years ended September 30:

(In millions)	2021		2020		2019
Current
Federal	$	36	$	16	$	10
State	14		11		5
Non-U.S.	25		15		19
	75		42		34
Deferred
Federal	42		62		24
State	8		26		—
Non-U.S.	(2)		4		(1)
	48		92		23
Income tax expense	$	123	$	134	$	57

The following presents pre-tax income and the principal components of the reconciliation between the effective tax rate and the U.S. federal statutory income tax rate in effect for the years ended September 30:

(In millions)	2021			2020			2019
Income before income taxes
United States	$	483		$	399		$	212
Non-U.S.	60			52			53
Total income before income taxes	$	543		$	451		$	265
U.S. statutory tax rate	21.0		%	21.0		%	21.0		%
Income taxes computed at U.S. statutory tax rate	$	114		$	95		$	56
(Decrease) increase in amount computed resulting from:
Unrecognized tax benefits	(5)			1			5
State taxes, net of federal benefit	19			16			9
International rate differential	3			2			2
Permanent items	(6)			(4)			(3)
Remeasurement of net deferred taxes	—			1			(4)
Return-to-provision adjustments	—			(2)			(6)
Change in valuation allowances	1			29			(4)
Tax Matters Agreement activity	(6)			(6)			1
Other	3			2			1
Income tax expense	$	123		$	134		$	57
Effective tax rate	22.7		%	29.7		%	21.5		%

The lower income tax expense and effective tax rate in fiscal 2021 from the prior year was principally driven by tax benefits recognized during the year as a result of audit settlements. This decrease in expense coupled with prior year income tax expense recognized to establish a $30 million valuation allowance on certain legacy tax attributes led to a lower effective tax rate in fiscal 2021.

Deferred taxes

A summary of the deferred tax assets and liabilities included in the Consolidated Balance Sheets follows as of September 30:

(In millions)	2021		2020
Deferred tax assets
Non-U.S. net operating loss carryforwards (a)	$	2	$	2
State net operating loss carryforwards (b)	18		18
Employee benefit obligations	46		79
Compensation accruals	29		26
Credit carryforwards (c)	12		11
Operating lease liabilities	98		69
Other	23		17
Valuation allowances (d)	(32)		(30)
Net deferred tax assets	196		192
Deferred tax liabilities
Goodwill and other intangibles	16		11
Property, plant and equipment	109		75
Operating lease assets	78		67
Undistributed earnings	5		6
Total deferred tax liabilities	208		159
Total net deferred tax (liabilities) assets (e)	$	(12)	$	33

(a)Gross non-U.S. net operating loss carryforwards of $7 million expire in fiscal years 2023 to 2040.

(b)Apportioned gross state net operating loss carryforwards of $361 million expire in fiscal years 2023 through 2034.

(c)Credit carryforwards consist primarily of U.S. tax credits that generally expire in fiscal years 2025 through 2036.

(d)Valuation allowances at September 30, 2021 primarily relate to state net operating loss carryforwards and certain other federal legacy tax attributes that are not expected to be realized or realizable.

(e)Balances are presented in the Consolidated Balance Sheets based on the net position of each tax jurisdiction.

Tax Matters Agreement

Background

Prior to its initial public offering (the "IPO") in September 2016, the Valvoline business operated as a wholly-owned subsidiary of Ashland Global Holdings Inc. (which together with its predecessors and consolidated subsidiaries is referred to herein as “Ashland”). In advance of the IPO, the Valvoline business and certain other legacy Ashland assets and liabilities were transferred from Ashland to Valvoline as a reorganization of entities under common Ashland control (the "Contribution"). In connection with the IPO, Ashland retained 83% of the total outstanding shares of Valvoline's common stock. On May 12, 2017, Ashland distributed its interest in Valvoline to Ashland stockholders through a pro rata dividend on shares of Ashland common stock outstanding (the "Distribution"), which marked the completion of Valvoline's separation from Ashland.

For the periods prior to the Distribution, Valvoline was included in Ashland’s consolidated U.S. and state income tax returns and in the income tax returns of certain Ashland international subsidiaries (collectively, the “Ashland Group Returns”). For the taxable periods that began on and after the Distribution, Valvoline files tax returns that include only Valvoline and its subsidiaries.

Key terms and conditions

An agreement (the "Tax Matters Agreement") was entered into in September 2016 between Valvoline and Ashland, that generally provides that Valvoline indemnify Ashland for the following items:

•The utilization of certain legacy tax attributes transferred from Ashland as the result of the Contribution;

•Taxes for the pre-IPO period that arise on audit or examination and are directly attributable to the Valvoline business;

•Certain U.S. federal, state or local taxes for the pre-IPO period of Ashland and/or its subsidiaries that arise on audit or examination and are not directly attributable to either the Valvoline business or the Ashland chemicals business;

•Taxes of Valvoline for the period between the IPO and Distribution that are not attributable to Ashland Group Returns (as defined above);

•Taxes of Valvoline for all taxable periods that begin on or after the day after the date of the Distribution; and

•Certain taxes and expenses resulting from the failure of the Contribution or Distribution to qualify for the intended tax-free treatment.

Summary of activity

Adjustments to the net obligations to Ashland under the Tax Matters Agreement are recorded within Net legacy and separation-related (income) expenses, with any resulting impacts to Valvoline's stand-alone income tax provision recorded in Income tax expense within the Consolidated Statements of Comprehensive Income. The Company reduced its indemnity obligations to Ashland under the Tax Matters Agreement by $33 million during fiscal 2021, principally due to settlement of the fiscal 2014 to 2016 federal audit examinations. This reduction resulted in pre-tax income of $27 million, and the remaining benefit of $6 million was recognized in income tax expense for matters attributable to the Valvoline stand-alone business.

During fiscal 2020, the Company determined it did not expect to utilize certain tax attributes that were transferred from Ashland as a result of the Contribution. Accordingly, the Company recognized income tax expense of $30 million to establish a valuation allowance for these tax attributes with an offsetting reduction in its indemnity obligation, the combined effects of which had no impact on net income in the fiscal year ended September 30, 2020.

Total liabilities related to obligations owed to Ashland under the Tax Matters Agreement are primarily recorded in Other noncurrent liabilities in the Consolidated Balance Sheets and were $1 million and $34 million as of September 30, 2021 and 2020, respectively. Given the indemnification of Ashland for periods in which Valvoline was included in Ashland Group Returns, a portion of the Company's liability for unrecognized tax benefits is included in the Tax Matters Agreement obligation. The periods under indemnity that currently remain open to examination include certain U.S. state jurisdictions from fiscal 2011.

Unrecognized tax benefits

The aggregate changes in the balance of gross unrecognized tax benefits were as follows for the years ended September 30:

(In millions)	2021		2020		2019
Gross unrecognized tax benefits as of October 1	$	15	$	14	$	10
Increases related to tax positions from prior years	2		1		5
Decreases related to tax positions from prior years	(1)		—		—
Increases related to tax positions taken during the current year	1		1		—
Settlements with tax authorities	(4)		—		—
Lapses of statutes of limitation	(1)		(1)		(1)
Gross unrecognized tax benefits as of September 30 (a)	$	12	$	15	$	14

(a)These unrecognized tax benefits would favorably impact the effective income tax rate, if recognized. Accruals for interest and penalties were $2 million as of September 30, 2021 and 2020.

The Company's U.S. federal income tax returns and certain U.S. state jurisdictions remain open to examination from fiscal 2017 forward. Fiscal years including and after 2010 remain open to examination by certain non-U.S. taxing authorities. Because Valvoline is routinely under examination by various taxing authorities, it is reasonably possible that the amount of unrecognized tax benefits will change during fiscal 2022. Due to the complexity and number of open years, it is not practical to estimate the amount or range of such change at this time. Based on current information available, management does not expect a material change to the Company's gross unrecognized tax benefits within fiscal 2022.