Income Taxes

Provision for Income Taxes

On December 22, 2017, the President of the United States signed into law comprehensive tax legislation commonly referred to as the Tax Cuts and Jobs Act (the “Tax Act”). As a fiscal year taxpayer with an October 31 tax year-end, the Company was not subject to many of the tax law provisions until fiscal year 2019; however, GAAP principles required the Company to revalue its deferred tax assets and liabilities with resulting tax effects accounted for in the reporting period of enactment including retroactive effects during fiscal year 2018. Perspecta’s fiscal year ended March 31, 2019 contains multiple tax years, one of which began prior to the enactment of the Tax Act and ended upon the Spin-Off on May 31, 2018 and, therefore, the Company was required to blend its federal tax rate to take into account a differing applicable federal tax rate for the portion of the fiscal year preceding the Spin-Off and the portion thereafter. The Company’s net income before taxes for the fiscal year ended March 31, 2019 relating to the period prior to the Spin-Off is subject to federal tax on DXC’s tax return at an applicable federal tax rate of 23.3% under Section 15 of the Code. The Company computed a weighted federal tax rate based upon the number of days that the Company’s fiscal year would be taxed at 23.3% and the number of days that the Company’s federal tax rate was reduced to 21%. For fiscal year 2019, the Company has an estimated blended corporate U.S. federal income tax rate of approximately 21.4%.

Under SEC staff issued Staff Accounting Bulletin No 118, the Company made reasonable estimates and recorded provisional amounts during the Company’s fiscal year ended March 31, 2018. The Company has not made any adjustments to the provisional amounts recorded. As of December 22, 2018, we have completed the accounting for all the impacts of the Tax Act. Parent is still in the process of calculating return to provision adjustments for USPS for tax years ending prior to the enactment of the Tax Act. The Company will recognize the return to provision adjustments in the period in which they are finalized and provided by Parent.

The Tax Matters Agreement entered into with DXC in connection with the Spin-Off (the “TMA”) states each company’s rights and responsibilities with respect to payment of taxes, tax return filings and control of tax examinations. For certain of our tax years ending prior to the Spin-Off, we may have joint and several liability with DXC, HPE and/or HP Inc. to the Internal Revenue Service (“IRS”) for the consolidated U.S. federal income taxes of DXC or predecessor consolidated groups relating to the taxable periods in which we were part of that group. However, the TMA specifies the portion, if any, of this tax liability for which we would bear responsibility, and DXC agrees to indemnify us against any amounts for which we are not responsible. Except for Vencore HC and KGS HC, the Company is generally only responsible for tax assessments, penalties and interest allocable to periods (or portions of periods) beginning after the Spin-Off and Mergers. The TMA also provides special rules for allocating tax liabilities in the event the Spin-Off is determined not to be tax-free. Though valid as between the parties, the TMA is not binding on the IRS.

The Company has receivables for income tax refunds from the IRS and various state tax authorities of approximately $90 million at March 31, 2019, for which it must remit to DXC under the TMA and has a corresponding payable. These amounts are included in other receivables and the related indemnification is included in accrued expenses on our balance sheet. During the third quarter, the Company received a refund of $72 million that included interest in excess of the initial receivable amount. The corresponding TMA indemnification payable was adjusted for the additional interest, which was then immediately paid to DXC during the quarter.

The provision (benefit) for taxes were as follows:



	Successor					Predecessor
	Fiscal Years Ended					Five Months Ended			Fiscal Year Ended
(in millions)	March 31, 2019		March 31, 2018			March 31, 2017			October 31, 2016
U.S. federal taxes:
Current	$	13	$	16		$	(15	)	$	54
Deferred	8		(38		)	35			(12		)

State taxes:
Current	19		3			—			9
Deferred	—		10			3			(2		)
Total income tax expense (benefit)	$	40	$	(9	)	$	23		$	49

Our effective tax rate was 36%, (5)%, 39% and 38% for fiscal years ended March 31, 2019 and 2018, the five months ended March 31, 2017 and the fiscal year ended October 31, 2016, respectively. The Company’s effective tax rate for the fiscal year ended March 31, 2019 generally differs from the U.S. federal statutory rate primarily due to state income taxes, the remeasurement of state deferred income tax items, non-deductible transaction costs, and state valuation allowance. The differences between the U.S. federal statutory income tax rate and our effective tax rate were as follows:



	Successor				Predecessor
	Fiscal Years Ended				Five Months Ended		Fiscal Year Ended
	March 31, 2019		March 31, 2018		March 31, 2017		October 31, 2016
U.S. federal statutory rate	21	%	32	%	35	%	35	%
State income taxes, net of federal impact	5	%	4	%	4	%	4	%
Non-deductible transaction costs	3	%	4	%	—	%	—	%
Remeasurement of state deferred income tax items	5	%	—	%	—	%	—	%
State valuation allowance	3	%	—	%	—	%	—	%
Research and development credit	(3	)%	—	%	(1	)%	(1	)%
Unrecognized tax benefits	1	%	—	%	—	%	—	%
Interest on federal tax refund, net of tax expense	(2	)%	—	%	—	%	—	%
Impact of Tax Act	1	%	(44	)%	—	%	—	%
Other items, net	2	%	(1	)%	1	%	—	%
Effective tax rate	36	%	(5	)%	39	%	38	%

Deferred Income Taxes

Deferred income taxes result from temporary differences between the amount of assets and liabilities recognized for financial reporting and tax purposes. The significant components of deferred tax assets and deferred tax liabilities were as follows:



(in millions)	March 31, 2019			March 31, 2018
Deferred tax assets:
Loss carryovers	$	91		$	—
Employee and retiree benefits	54			1
Accrued liabilities	22			8
Capital lease obligations	16			41
Interest expense carryforward	11			—
Deferred service revenue	2			16
Restructuring	1			2
Other	1			—
Deferred tax assets, gross	198			68
Valuation allowance	(13		)	—
Deferred tax assets, net of valuation allowance	185			68
Deferred tax liabilities:
Purchased intangible assets	312			224
Fixed assets	30			12
Deferred service cost	1			4
Other receivables	—			4
Deferred tax liabilities	343			244
Net deferred tax liabilities	$	158		$	176

As of March 31, 2019, deferred tax assets of $13 million related to tax jurisdictions with net deferred tax assets are included in other assets on the accompanying balance sheet.

The Company has federal net operating loss (“NOL”) carryforwards of $308 million which will begin to expire in 2031 and state NOL carryforwards of $27 million which will begin to expire in 2020. There is no valuation allowance against the federal NOL.

Unrecognized Tax Benefits

The following table summarizes the activity related to the Company’s uncertain tax benefits (excluding interest and penalties and related tax attributes), included in other long-term liabilities on the accompanying balance sheets:



	Successor					Predecessor
	Fiscal Years Ended					Five Months Ended		Fiscal Year Ended
(in millions)	March 31, 2019			March 31, 2018		March 31, 2017		October 31, 2016
Balance at beginning of year	$	8		$	8	$	7	$	7
Decrease for transfers to Parent	(2		)	—		—		—
Increase for transfers from Parent	45			—		—		—
Increase for current year tax positions	1			—		1		—
Balance at end of year	$	52		$	8	$	8	$	7

Up to $52 million, $8 million, $8 million and $7 million of the Company’s unrecognized tax benefits as of March 31, 2019, March 31, 2018, March 31, 2017 and October 31, 2016, respectively, would affect our effective tax rate if realized.

The Company believes it is reasonably possible that certain liabilities for unrecognized tax benefits, all of which were transferred from Parent, may decrease by approximately $18 million during next year resulting from the settlement of appeals in fiscal year 2008 and 2009 related to the USPS entities. Any amounts that would be recognized are offset by indemnifications.

The Company recognizes interest accrued related to uncertain tax positions and penalties as a component of income tax expense. Any interest that has not already been accrued on all open tax exam years is fully indemnified under the TMA. The company recognized interest of approximately $9 million and $1 million for the fiscal years ended March 31, 2019 and 2018 (carve-out basis), respectively.

For the periods prior to the Spin-Off, the unrecognized tax benefits reflected in the financial statements were determined using the separate return method. As a result of the Spin-Off, the Company recognized $52 million of liabilities for unrecognized tax benefits determined on an asset and liability method that stay with the legal entities included in the Spin-Off of the USPS business from DXC, which were recorded through Parent company investment, net of corresponding indemnification assets.

The Company engages in continuous discussion and negotiation with taxing authorities regarding tax matters in various jurisdictions. The Company is subject to income tax in the U.S. at the federal and state level and is subject to routine corporate income tax audits in these jurisdictions. The Company’s 2008 to 2016 federal income tax returns remain open. With respect to major state tax jurisdictions, the Company is no longer subject to tax authority examination for years prior to 2005.

The Company believes it has provided adequate reserves for all tax deficiencies or reductions in tax benefits that could result from federal and state tax audits. We regularly assess the likely outcomes of these audits in consultation with the indemnifying parties to determine the appropriateness of unrecognized tax benefits. We adjust our unrecognized tax benefits to reflect the impact of negotiations, settlements, rulings, advice of legal counsel and other information and events pertaining to a specific audit. Income tax audits, however, are inherently unpredictable and the Company may not accurately predict the outcome of these audits. The amounts ultimately paid on resolution of an audit could be materially different from the amounts previously included in the provision (benefit) for taxes on the statements of operations and therefore the resolution of one or more of these uncertainties in any particular period could have a material impact on net earnings or cash flows.