4. INCOME TAXES

For periods ended on or prior to the Separation Date, we were a member of Conagra’s consolidated group and our U.S. taxable income will be included in the consolidated U.S. federal income tax return of Conagra as well as in returns to be filed by Conagra with certain state and local taxing jurisdictions. Our foreign income tax returns are filed on a separate company basis. For periods prior to the Separation Date, our income tax liability was computed and presented herein under the “separate return method” as if we were a separate tax paying entity.

In connection with the Separation, we entered into a tax matters agreement. Under the tax matters agreement, Conagra is generally responsible for all taxes associated with consolidated federal and state filings (and will be entitled to all related refunds of taxes) imposed on Conagra and its subsidiaries (including subsidiaries that were transferred to Lamb Weston at Separation) with respect to the taxable periods (or portions thereof) ended on or prior to November 9, 2016. Also, pursuant to this agreement, Lamb Weston is generally responsible for all taxes associated with separately filed foreign, state, and local tax filings (and will be entitled to all related refunds of taxes) imposed on Lamb Weston and its subsidiaries ended on or prior to November 9, 2016.

Pre-tax income (loss) consisted of the following (dollars in millions):


	For the Fiscal Years Ended May
	2017		2016		2015
United States	$	467.5	$	384.7	$	382.7
Foreign		42.9		54.4		35.3
	$	510.4	$	439.1	$	418.0

The provision for income taxes included the following (dollars in millions):


	For the Fiscal Years Ended May
	2017		2016		2015
Current
U.S. Federal	$	132.0	$	100.0	$	92.3
State and local		13.9		12.0		13.1
Foreign		9.5		11.8		11.3
Total current provision for taxes		155.4		123.8		116.7

Deferred
U.S. Federal		9.7		17.6		23.8
State and local		3.2		(1.3)		2.3
Foreign		1.9		4.4		(2.4)
Total deferred provision for taxes	$	14.8	$	20.7	$	23.7
Total provision for taxes	$	170.2	$	144.5	$	140.4

Income taxes computed by applying the U.S. Federal statutory rates to income from continuing operations before income taxes are reconciled to the provision for income taxes set forth in the Combined and Consolidated Statements of Earnings as follows (dollars in millions):


	For the Fiscal Years Ended May
	2017		2016		2015
Provision computed at U.S. Federal statutory rate of 35%	$	178.6	$	153.7	$	146.3
Increase (reduction) in rate resulting from:
State and local taxes, net of federal benefit		11.4		7.1		10.2
Tax credits and domestic manufacturers deduction		(11.0)		(9.5)		(9.2)
Effect of taxes on foreign operations		(7.8)		(2.8)		(3.0)
Other		(1.0)		(4.0)		(3.9)
	$	170.2	$	144.5	$	140.4
Effective income tax rate (a)		33%		33%		34%

(a)

The effective income tax rate is calculated as the ratio of income tax expense to pre-tax income, inclusive of equity method investment earnings.

Income taxes paid, net of refunds, were $170.0 million, $124.7 million, and $115.1 million in fiscal 2017, 2016, and 2015, respectively.

Deferred and Current Income Taxes

Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts for income tax purposes. Deferred income tax assets and liabilities at May 28, 2017 and May 29, 2016 are summarized as follows (dollars in millions):


	May 28, 2017				May 29, 2016
	Assets		Liabilities		Assets		Liabilities
Property, plant and equipment	$	—	$	159.8	$	—	$	155.5
Goodwill and other intangible assets (a)		125.0		—		—		23.0
Compensation and benefit related liabilities		20.3		—		11.7		—
Accrued expenses and other liabilities		22.5		—		23.4		—
Deferred revenue previously recognized for tax		8.2		—		7.2		—
Net operating loss carryforwards (b)		17.0		—		12.6		—
Debt issuance cost		—		8.3		—		—
Other		0.9		17.4		8.0		13.9
		193.9		185.5		62.9		192.4
Less: Valuation allowance (a) (c)		(98.4)		—		(12.3)		—
Net deferred taxes (d)	$	95.5	$	185.5	$	50.6	$	192.4

(a)

In connection with the Separation, Lamb Weston recognized a step-up in tax basis in certain assets, which resulted in a $75.0 million net decrease in deferred tax liabilities (a deferred tax asset of $155.0 million, offset by a valuation allowance of $80.0 million) and a corresponding increase in equity. The step-up in tax basis is related to a deferred intercompany transaction arising in 2008, which until the Separation Date, was eliminated within Conagra’s consolidated financial statements and federal tax filings.

(b)

Lamb Weston has approximately $46.9 million of gross ($11.1 million after-tax) foreign net operating loss carryforwards, of which the majority expire by fiscal 2021. Lamb Weston also has approximately $102.2 million of gross ($5.9 million after-tax) state capital loss carryovers which will expire in fiscal 2021.

(c)

The valuation allowance also includes the portion of the net operating loss carryforwards that we do not believe we are not more likely than not to realize. The net impact on income tax expense related to changes in the valuation allowance, including net operating loss carryforwards were charges of $2.8 million and $3.4 million in fiscal 2017 and 2016, respectively.

(d)

Deferred tax assets of $0.5 million and $2.2 million, as of May 28, 2017 and May 29, 2016, respectively, were presented in “Other assets”. Deferred tax liabilities of $90.5 million and $144.0 million, as of May 28, 2017 and May 29, 2016, respectively, were presented in “Deferred income taxes” as a long-term liability. The deferred tax asset and liability net position is determined by tax jurisdiction.

As of May 28, 2017, we had not recognized U.S. deferred income taxes on a cumulative total of approximately $118 million of undistributed earnings and other basis differences for certain non-U.S. subsidiaries. Determining the unrecognized deferred tax liability in these non-U.S. subsidiaries that are indefinitely reinvested is not practicable. We currently intend to indefinitely reinvest those earnings and other basis differences in operations outside the U.S.

Uncertain Tax Positions

The aggregate changes in the gross amount of unrecognized tax benefits, excluding interest and penalties consisted of the following (dollars in millions):


	For the Fiscal Years Ended May
	2017			2016
Beginning Balance	$	3.8	$	4.3
Decreases from positions established during prior fiscal years		—		(0.5)
Increases from positions established during current and prior fiscal years		2.2		0.6
Decreases relating to settlements with taxing authorities		—		(0.2)
Reductions resulting from lapse of applicable statute of limitations		(0.9)		(0.3)
Other adjustments to liability resulting from the Separation		1.8		(0.1)
Ending Balance (a)	$	6.9	$	3.8

(a)

If the $6.9 million and $3.8 million of unrecognized tax benefits as of May 28, 2017 and May 29, 2016, were recognized in a future period, it would result in a tax benefit of $6.2 million and $2.4 million, respectively, and a reduction in the effective tax rate. The ending balance excludes $2.8 million of gross interest and penalties at both May 28, 2017 and May 29, 2016. Lamb Weston accrues interest and penalties associated with uncertain tax positions as part of income tax expense.

Lamb Weston conducts business and files tax returns in numerous countries, states, and local jurisdictions. While Lamb Weston has little history of audits on a standalone basis, Conagra has completed its U.S. federal income tax audit for tax years through fiscal 2015 and all resulting significant items for fiscal 2015 and prior years have been settled with the U.S. Internal Revenue Service. Other major jurisdictions where we conduct business generally have statutes of limitations ranging from three to five years.

Although the timing of the resolutions and/or closures of audits is highly uncertain, it is reasonably possible that certain U.S. federal and non-U.S. tax audits may be concluded within the next 12 months, which could increase or decrease the balance of our gross unrecognized tax benefits. The estimated impact of income tax expense and net income is not expected to be significant.