Note 12. Income taxes

The Company and its Bermuda domiciled subsidiaries are not subject to Bermuda income tax under current Bermuda law. In the event there is a change in the current law such that taxes are imposed, the Company and its Bermuda domiciled subsidiaries would be exempt from such tax until March 31, 2035, pursuant to the Bermuda Exempted Undertakings Tax Protection Act of 1966. The Company has subsidiaries and branches that operate in various other jurisdictions around the world that are subject to tax in the jurisdictions in which they operate. The jurisdictions in which the Company’s subsidiaries and branches are subject to tax are Australia, Belgium, Canada, Denmark, Germany, Gibraltar, Hong Kong (China), Luxembourg, Malaysia, the Netherlands, Shanghai (China), Singapore, Spain, Sweden, Switzerland, the United Kingdom, and the United States.

Sirius Group’s net income (loss) before income taxes for the years ended December 31, 2018, 2017, and 2016 was generated in the following domestic and foreign jurisdictions:


(Millions)	2018		2017		2016
Domestic:
Bermuda	$	62.7	$	(95.0)	$	(4.9)
Foreign:
U.S.		(10.1)		(22.4)		(25.3)
U.K.		(14.9)		(27.0)		(7.0)
Sweden		(74.2)		(26.1)		(29.5)
Luxembourg		60.3		43.4		105.3
Netherlands		(0.1)		18.2		(0.1)
Other		—		(1.0)		(0.6)
Total income (loss) before income taxes	$	23.7	$	(109.9)	$	37.9

The total income tax (expense) benefit for the years ended December 31, 2018, 2017, and 2016 consisted of the following:


(Millions)	2018		2017		2016
Current tax (expense):
U.S. Federal	$	(7.0)	$	(0.9)	$	2.1
State		(2.2)		(2.0)		(1.7)
Non-U.S.		(19.8)		(3.6)		(11.4)
Total current tax (expense)		(29.0)		(6.5)		(11.0)
Deferred tax (expense) benefit:
U.S. Federal		14.5		(10.7)		16.0
State		—		—		—
Non-U.S.		(25.9)		(9.2)		2.3
Total deferred tax (expense) benefit		(11.4)		(19.9)		18.3
Total income tax (expense) benefit	$	(40.4)	$	(26.4)	$	7.3

Effective Rate Reconciliation

A reconciliation of taxes calculated using the 22% Swedish statutory rate (the rate at which the majority of Sirius Group’s worldwide operations are taxed) to the income tax (expense) benefit on pre-tax income follows:


(Millions)	2018		2017		2016
Tax (expense) benefit at the statutory rate	$	(5.2)	$	24.2	$	(8.3)
Differences in taxes resulting from:
Tax reserve adjustments		(42.0)		(0.7)		(6.0)
Tax rate change enacted in Sweden		15.4		—		—
Tax on Safety Reserve		(15.3)		—		—
Foreign tax credits		10.8		2.2		6.9
Section 197 Intangible as result of internal restructuring		6.9		—		—
Non-Sweden earnings		2.3		(18.4)		(6.9)
Gain on internal restructuring		(9.1)		—		—
State taxes expense		(2.9)		(0.7)		(1.1)
Change in valuation allowance		2.3		1.4		55.0
Withholding taxes		(1.9)		(0.8)		(1.4)
Tax rate change - other		0.1		(29.7)		—
Tax rate change enacted in Luxembourg		—		0.4		(30.6)
Other, net		(1.8)		(4.3)		(0.3)
Total income tax (expense) benefit on pre-tax earnings	$	(40.4)	$	(26.4)	$	7.3

The non-Sweden component of pre-tax (loss) income was $97.9 million, $(83.8) million, and $67.3 million for the years ended December 31, 2018, 2017, and 2016, respectively.

Effective January 1, 2019, Sweden enacted reductions in its corporate tax rate from 22% to 21.4% from 2019 and then to 20.6% from 2021. This resulted in a reduction in the net deferred tax liability for Sirius Group’s Swedish entities as of December 31, 2018 in the amount of $15.4 million. Further, as part of the same enacted tax legislation, Sweden introduced a standard taxable yield on property and casualty insurance companies’ safety reserves. Insurers recognizing a safety reserve must recognize an annual standard yield on safety reserve as taxable income. The standard income is equal to the government bond rate at the end of November the year before the year during which the insurers income year ends multiplied by the opening balance of the safety reserve for that year. In addition, an insurer with a safety reserve opening balance on January 1, 2021 is required to recognize notional taxable income equal to 6% of the safety reserve at the start of that income year. As a result of this newly enacted one-time tax determined by reference to the future safety reserve balance, Sirius Group has recorded a deferred tax expense of $15.3 million as of December 31, 2018.

The Company previously applied Staff Accounting Bulletin 118 (“SAB 118”), which provided guidance on accounting for the tax effects of the TCJA which was enacted into law in the U.S. in December 2017. SAB 118 addresses situations where accounting for certain income tax effects of the TCJA under ASC 740, Income Taxes (“ASC 740”), may be incomplete upon issuance of an entity’s financial statements and provides a one-year measurement period from the enactment date to complete the accounting under ASC 740. The Company has completed its accounting for all material tax effects of the TCJA and has recognized adjustments as of December 31, 2018 as described below.

The TCJA includes a new 21% corporate tax rate, the impacts of which (including on Sirius Group’s deferred tax assets) were already taken into account in Sirius Group’s financial results for the year ended December 31, 2017. The TCJA also includes a new BEAT provision, which is essentially a minimum tax that is potentially applicable to certain otherwise deductible payments made by U.S. entities to non-U.S. affiliates, including cross-border interest payments and reinsurance premiums. The statutory BEAT rate is 5% in 2018 and will rise to 10% in 2019-2025 and then 12.5% in 2026 and thereafter. The TCJA also includes provisions for GILTI under which taxes on foreign income are imposed on the excess of a deemed return on tangible assets of certain foreign subsidiaries. Consistent with accounting guidance, Sirius Group will treat BEAT as an in period tax charge when incurred in future periods for which no deferred taxes need to be provided and has made an accounting policy election to treat GILTI taxes in a similar manner. No provision for income taxes related to BEAT or GILTI was recorded as of December 31, 2018. Sirius Group has completed its accounting for loss reserves based on the new discounting methodology prescribed by the TCJA and recognized an adjustment of $3.5 million without a net impact on total taxes since an offsetting deferred tax asset would also be recorded.

Sirius Group has capital and liquidity in many of its subsidiaries, some of which may reflect undistributed earnings. If such capital or liquidity were to be paid or distributed to the Company or Sirius Group’s subsidiaries, as dividends or otherwise, they may be subject to income or withholding taxes. Sirius Group generally intends to operate, and manage its capital and liquidity, in a tax-efficient manner. However, the applicable tax laws in relevant countries are still evolving, including in response to guidance from the Organisation for Economic Cooperation and Development. Accordingly, such payments or earnings may be subject to income or withholding tax in jurisdictions where they are not currently taxed or at higher rates of tax than currently taxed, and the applicable tax authorities could attempt to apply income or withholding tax to past earnings or payments.

Tax Payments and Receipts

Net income tax payments to national, state, and local governments totaled $19.1 million, $16.7 million, and $8.3 million for the years ended December 31, 2018, 2017, and 2016, respectively.

Deferred Tax Inventory

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 tax purposes. An outline of the significant components of Sirius Group’s deferred tax assets and liabilities follows:


(Millions)	2018		2017
Deferred income tax assets related to:
Non-U.S. net operating loss carry forwards	$	249.8	$	305.1
U.S. federal net operating loss and capital carry forwards		33.8		34.7
Tax credit carry forwards		28.7		18.3
Loss reserve discount		7.3		8.9
Unearned premiums		3.1		1.5
Deferred interest		2.1		0.2
Incentive compensation and benefits accruals		1.9		2.0
Allowance for doubtful accounts		1.4		1.4
Foreign currency translations on investments and other assets		0.8		—
Net unrealized investment losses		—		1.8
Other items		2.7		3.6
Total gross deferred income tax assets		331.6		377.5
Valuation allowance		(64.3)		(71.8)
Total adjusted deferred tax asset		267.3		305.7
Deferred income tax liabilities related to:
Safety reserve (See Note 18)		261.1		286.6
Intangible assets		28.7		42.0
Deferred acquisition costs		3.1		1.2
Purchase accounting		3.0		2.4
Investment basis differences		2.4		1.1
Net unrealized investment gains		0.3		—
Foreign currency translations on investments and other assets		—		7.3
Other items		3.6		3.2
Total deferred income tax liabilities		302.2		343.8
Net deferred tax (liability) asset	$	(34.9)	$	(38.1)

Sirius Group’s deferred tax assets are net of U.S. federal and non-U.S. valuation allowances and, to the extent they relate to non-U.S. jurisdictions, they are shown at year-end exchange rates.

Of the $34.9 million net deferred tax liability as of December 31, 2018, $32.8 million relates to net deferred tax assets in U.S. subsidiaries, $155.8 million relates to net deferred tax assets in Luxembourg subsidiaries, $12.6 million relates to net deferred tax assets in United Kingdom subsidiaries and $236.1 million relates to net deferred tax liabilities in Sweden subsidiaries.

Net Operating Loss and Capital Loss Carryforwards

Net operating loss and capital loss carryforwards as of December 31, 2018, the expiration dates, and the deferred tax assets thereon are as follows:


(Millions)	2018
	United States		Luxembourg		Sweden		U.K.		Total
2019-2023	$	8.7	$	—	$	—	$	—	$	8.7
2024-2038		151.9		0.1		—		—		152.0
No expiration date		—		871.5		273.0		72.0		1,216.5
Total		160.6		871.6		273.0		72.0		1,377.2
Gross deferred tax asset		33.8		226.7		10.8		12.3		283.6
Valuation allowance		—		(64.6)		—		—		(64.6)
Net deferred tax asset	$	33.8	$	162.1	$	10.8	$	12.3	$	219.0

Sirius Group expects to utilize net operating loss carryforwards in Luxembourg of $668.9 million but does not expect to utilize the remainder as they belong to companies that are not expected to have sufficient taxable income in the future. Included in the U.S. net operating loss carryforwards are losses of $102.2 million subject to an annual limitation on utilization under Internal Revenue Code Section 382 and $11.0 million are subject to separately return limitation year (“SRLY”) provisions of the consolidated return regulations. Of the Section 382 limited loss carryforwards, $9.6 million will expire between 2022 and 2025 and $92.6 million will expire between 2030 and 2032. The SRLY limited losses will expire between 2036 and 2037. Sirius Group expects to utilize all of the U.S. net operating loss carryforwards.

As of December 31, 2018, there are U.S. foreign tax credits carryforwards available of $16.7 million, of which an insignificant amount expires in 2019, and the remaining, which Sirius Group expects to use, will begin to expire in 2022. As of December 31, 2018, there are alternative minimum tax credit carryforwards of $0.1 million which do not expire and are expected to become fully refundable beginning in the 2022 tax year under the TCJA. Further, there are Swedish foreign tax credits carryforwards available of $11.9 million, which Sirius Group expects to use, and will expire between 2021 and 2023.

Valuation Allowance

Sirius Group records a valuation allowance against deferred tax assets if it becomes more likely than not that all or a portion of a deferred tax asset will not be realized. Changes in valuation allowances from period to period are included in income tax expense in the period of change. In determining whether or not a valuation allowance, or change therein, is warranted, Sirius Group considers factors such as prior earnings history, expected future earnings, carryback and carryforward periods, and strategies that if executed would result in the realization of a deferred tax asset. It is possible that certain planning strategies or projected earnings in certain subsidiaries may not be feasible to utilize the entire deferred tax asset, which could result in material changes to Sirius Group’s deferred tax assets and tax expense.

Of the $64.6 million valuation allowance as of December 31, 2018, $64.6 million relates to net operating loss carryforwards in Luxembourg subsidiaries and an insignificant amount relates to other deferred tax assets in Swedish and United States subsidiaries.

Foreign Tax Credits

Sirius Re Holdings, Inc. (“SReHi”) has an immaterial valuation allowance on foreign tax credits, which will expire in 2019. SReHi has an additional $16.7 million of foreign tax credits that will expire between the years 2020 and 2027, which are expected to be fully utilized. Sirius International Insurance Corporation (publ.) has $11.9 million of foreign tax credits that will expire between 2021 and 2023 and are expected to be fully utilized.

Uncertain Tax Positions

Recognition of the benefit of a given tax position is based upon whether a company determines that it is more likely than not that a tax position will be sustained upon examination based upon the technical merits of the position. In evaluating the more likely than not recognition threshold, Sirius Group must presume that the tax position will be subject to examination by a taxing authority with full knowledge of all relevant information. If the recognition threshold is met, then the tax position is measured at the largest amount of benefit that is more than 50% likely of being realized upon ultimate settlement.

A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows:


	Permanent		Temporary		Interest and
(Millions)	differences(1)		differences(2)		penalties(3)		Total
Balance at January 1, 2016	$	19.8	$	6.6	$	—	$	26.4
Changes in prior year tax positions		—		—		—		—
Tax positions taken during the current year		4.4		(2.5)		0.2		2.1
Lapse in statute of limitations		—		—		—		—
Settlements with tax authorities		—		—		—		—
Balance at December 31, 2016	$	24.2	$	4.1	$	0.2	$	28.5
Changes in prior year tax positions		0.2		(0.1)		0.1		0.2
Tax positions taken during the current year		3.8		(2.2)		—		1.6
Lapse in statute of limitations		(0.5)		—		—		(0.5)
Settlements with tax authorities		(0.3)		—		(0.2)		(0.5)
Balance at December 31, 2017	$	27.4	$	1.8	$	0.1	$	29.3
Changes in prior year tax positions		1.4		—		0.1		1.5
Tax positions taken during the current year		36.2		(1.7)		—		34.5
Lapse in statute of limitations		—		—		—		—
Settlements with tax authorities		(0.1)		—		—		(0.1)
Balance at December 31, 2018	$	64.9	$	0.1	$	0.2	$	65.2

(1)

Represents the amount of unrecognized tax benefits that, if recognized, would impact the effective tax rate.

(2)

Represents the amount of unrecognized tax benefits that, if recognized, would create a temporary difference between the reported amount of an item in the Consolidated Balance Sheets and its tax basis.

(3)

Net of tax benefit.

If Sirius Group determines in the future that its reserves for unrecognized tax benefits on permanent differences and interest and penalties are not needed, the reversal of $64.9 million of such reserves as of December 31, 2018 would be recorded as an income tax benefit and would impact the effective tax rate. If Sirius Group determines in the future that its reserves for unrecognized tax benefits on temporary differences are not needed, the reversal of $0.1 million of such reserves as of December 31, 2018 would not impact the effective tax rate due to deferred tax accounting but would accelerate the payment of cash to the taxing authority. Most of Sirius Group’s reserves for unrecognized tax benefits on permanent differences relate to interest deductions denied by the Swedish Tax Authority ("STA"), as described further below.

Sirius Group classifies all interest and penalties on unrecognized tax benefits as part of income tax expense. During the years ended December 31, 2018, 2017, and 2016, Sirius Group recognized $0.1 million, $(0.1) million, and $0.2 million in interest income (expense), respectively, net of any tax benefit. The balance of accrued interest as of December 31, 2018 and 2017 is $0.2 million and $0.1 million, respectively, net of any tax benefit.

Tax Examinations

The STA has denied deductions claimed by two of the Company’s Swedish subsidiaries in certain tax years for interest paid on intra-group debt instruments. Sirius Group has challenged the STA's denial in court based on the technical merits. In October 2018, one of the Swedish subsidiaries received an adverse decision from Sweden's Administrative Court, which Sirius Group has appealed. Sirius Group has taken into account this and other relevant developments in applicable Swedish tax law and has established a reserve for this uncertain tax position. As of December 31, 2018, the total amount of such reserve was $62.2 million.

In connection with this matter, Sirius Group has also taken into account the SPA by which Sirius Group was sold to CMIG International in 2016 and has recorded an indemnification asset. Pursuant to the SPA, the seller agreed to indemnify the buyer and Sirius Group for, among other things, (1) any additional tax liability in excess of Sirius Group's accounting for uncertain tax positions for tax periods prior to the sale of Sirius Group to CMIG International, and (2) an impairment in Sirius Group's net deferred tax assets resulting from a final determination by a tax authority. While Sirius Group is continuing to challenge the STA's denial based on the technical merits by appealing the adverse court decision received in October 2018, the ultimate resolution of these tax disputes is uncertain and no assurance can be given that there will be no material changes to Sirius Group's operating results or balance sheet in connection with these uncertain tax positions or the related indemnification.

With few exceptions, Sirius Group is no longer subject to U.S. federal, state or non-U.S. income tax examinations by tax authorities for years before 2014.