Income Taxes

3 Months Ended

Mar. 31, 2022

Income Tax Disclosure [Abstract]

Income Taxes

Note 10. Income Taxes

As a result of the IPO, Clearwater Analytics Holdings, Inc. owns a portion of CWAN Holdings, which contains all operations of the business and is treated as a partnership for U.S. federal and most applicable state and local income tax purposes. As a partnership, CWAN Holdings is generally not subject to U.S. federal, state, and local income taxes. Any taxable income or loss generated by CWAN Holdings is passed through to and included in the taxable income or loss of its members in accordance with the terms of the operating agreement of CWAN Holdings. Before the IPO, the majority of CWAN Holdings’ income was passed through to its members and nontaxable to the entity. CWAN Holdings’ international wholly-owned subsidiaries are subject to taxes in foreign jurisdictions.

Clearwater Analytics Holdings, Inc. is taxed as a corporation and pays corporate federal, state, and local taxes on income allocated to it from CWAN Holdings based on Clearwater Analytics Holdings, Inc.’s economic interest held in CWAN Holdings. While the Company consolidates CWAN Holdings for financial reporting purposes, the Company will not be taxed on the earnings attributed to the non-controlling interests. As a result, the income tax burden on the earnings taxed to the non-controlling interests is not reported by the Company in its consolidated financial statements.

Our tax provision for interim periods is determined using an estimated annual effective tax rate, adjusted for discrete items arising in the applicable quarter. In each quarter, we update the estimated annual effective tax rate and make a year-to-date adjustment to the provision. The estimated annual effective tax rate may be subject to significant volatility due to several factors, including our ability to accurately predict the proportion of our pretax income in multiple jurisdictions, certain book-tax differences, and exchanges from non-controlling interests.

The following table provides details of the provision for income taxes:

	Three Months Ended March 31,
	2022			2021
Income before provision for income taxes	$	765		$	3,455
Provision for income taxes		237			44
Effective tax rate		31	%		1.3	%

For the three months ended March 31, 2022, the Company’s effective tax rate was more than the statutory rate primarily because of foreign tax expense, equity-based compensation and the valuation allowance on the U.S. deferred tax assets. In addition, the Company is not liable for income taxes on the portion of CWAN Holdings earnings that are attributable to non-controlling interests.

For the three months ended March 31, 2021, CWAN Holdings' effective tax rate was less than the statutory rate primarily because its earnings were exempt from federal corporate income taxation due to its status as a partnership.

The Company regularly monitors its uncertain tax benefits, and as of March 31, 2022, there were no material uncertain tax benefits that, if realized, would affect the estimated annual effective tax rate, nor do we expect any significant changes within the next 12 months.

We recognize deferred tax assets to the extent that we believe that these assets are more likely than not to be realized. The realization of tax benefits of net deferred tax assets is dependent upon future levels of taxable income, of an appropriate character, in the periods the items are expected to be deductible or taxable. Based on the available objective evidence as of March 31, 2022, we believe that it is more likely than not that the tax benefits of the U.S. losses incurred may not be realized. Accordingly, we have recorded a full valuation allowance against the tax benefits of the U.S. losses incurred. We intend to maintain the full valuation allowance on the U.S. net deferred tax assets until sufficient positive evidence exists to support a reversal of, or decrease in, the valuation allowance.

On March 16, 2022, Idaho enacted legislation that amended portions of relevant tax laws. Due to our valuation allowance in the U.S., this legislation did not have a significant impact on the provision for income taxes for the three months ended March 31, 2022. However, we expect our blended state tax rate to decrease due to the new law.

Tax Receivable Agreement Liability

Pursuant to our election under Section 754 of the Internal Revenue Code (the “Code”), we expect to obtain an increase in our share of the tax basis in the net assets of CWAN Holdings when its units are redeemed or exchanged. We intend to treat any redemptions and exchanges of CWAN Holdings units as direct purchases of the units for U.S. federal income tax purposes. These increases in tax basis may reduce the amounts that we would otherwise pay in the future to various tax authorities. They may also decrease gains (or increase losses) on future dispositions of certain capital assets to the extent the tax basis is allocated to those capital assets.

In connection with the IPO and related transactions, we entered into a TRA that provides for the payment by us of 85% of the amount of any tax benefits that we actually realize, or in some cases are deemed to realize, as a result of (i) increases in our share of the tax basis in the net assets of CWAN Holdings resulting from any redemptions or exchanges of CWAN Holdings units, (ii) tax basis increases attributable to payments made under the TRA, and (iii) deductions attributable to imputed interest and TRA bonus payments pursuant to the TRA (the “TRA Payments”). We expect to benefit from the remaining 15% of any tax benefits that we may actually realize. The TRA Payments are not conditioned upon any continued ownership interest in CWAN Holdings or the Company. The rights of each member of CWAN Holdings, that is a party to the TRA, are assignable to transferees of their respective CWAN Holdings units.

The estimation of a liability under the TRA is, by its nature, imprecise and subject to significant assumptions regarding a number of factors, including (but not limited to) the amount and timing of taxable income generated by the Company each year as well as the tax rate then applicable. The future tax benefits related to ownership exchanges as of March 31, 2022 are estimated to be $362 million, of which $308 million is estimated to be the associated TRA liability.

As noted above, the Company evaluated the realizability of its U.S. deferred tax assets and has recorded a full valuation against those benefits. As a result, the Company determined that payments to TRA holders are not probable and no TRA liability has been recorded as of March 31, 2022.

As non-controlling interest holders exercise their right to exchange their units in CWAN Holdings, a TRA liability may be recorded based on 85% of the estimated future tax benefits that the Company may realize as a result of increases in the tax basis of CWAN Holdings. The amount of the increase in the tax basis, the related estimated tax benefits, and the related TRA liability to be recorded will depend (among other things) on the price of the Company’s Class A stock at the time of the relevant redemption or exchange.

TRA Bonus Agreements

In connection with the execution of the TRA agreement, the Company also entered into the “TRA Bonus Agreements” with certain executive officers. Under the terms of TRA Bonus Agreements, certain executive officers are eligible to receive a cash bonus payment (the “TRA Bonus”) pursuant to payments under the TRA agreement. As the Company has determined that payments to TRA holders are not probable and no TRA liability has been recorded as of March 31, 2022, no liability has been recorded for the TRA Bonus.