Income Taxes

12 Months Ended

Dec. 31, 2016

Note 11 – Income Taxes

Credco’s results of operations are included in the consolidated U.S. federal income tax return of American Express. Under an agreement with American Express, provision for income taxes is recognized on a separate company basis. If benefits for net operating losses, future tax deductions and foreign tax credits cannot be recognized on a separate company basis, such benefits are then recognized based upon a share, derived by formula, of those deductions and credits that are recognizable on an American Express consolidated reporting basis.

The components of income tax expense (benefit) for the years ended December 31 included in Credco’s Consolidated Statements of Income were as follows:

(Millions)				2016		2015		2014
Current income tax expense (benefit):
	U.S. federal		$	(4)	$	15	$	(22)
	U.S. state and local			(6)		(4)		(23)
	Non-U.S.			11		20		22
		Total current income tax expense (benefit)		1		31		(23)
Deferred income tax expense (benefit) :
	U.S. federal			10		(5)		―
	U.S. state and local			1		―		―
	Non-U.S.			3		12		(12)
		Total deferred income tax expense (benefit)		14		7		(12)
Total income tax expense (benefit)			$	15	$	38	$	(35)

A reconciliation of the U.S. federal statutory rate of 35 percent to Credco’s actual income tax rate for the years ended December 31 was as follows:

		2016		2015		2014
U.S. statutory federal income tax rate		35.0	%	35.0	%	35.0	%
(Decrease) increase in taxes resulting from:
	State and local income taxes, net of federal benefit	(0.5)		―		(0.3)
	Non-U.S. subsidiaries earnings^(a)	(25.1)		(25.5)		(38.4)
	Tax Settlements^(b)	(1.4)		(0.4)		(4.4)
	Other^(c)	(0.9)		6.0		(3.0)
Actual tax rate		7.1	%	15.1	%	(11.1)	%

Results for all years include recurring permanent tax benefits in relation to the level of pretax income. Expenses in the United States are attracting a 35 percent statutory benefit whereas foreign earnings are taxed at lower rates and are indefinitely reinvested. Credco’s effective tax rate reflects the favorable impact of the tax benefit related to its ongoing funding activities outside of the United States.
The tax rate reflects favorable resolution of certain prior years’ tax items.
Results for all years include the impact of prior year tax returns filed in the current year.

The results for the year ended December 31, 2015 reflect out-of-period corrections that increased tax expense by $11 million and the effective tax rate by approximately 4.4 percent. The corrections relate to tax calculations of foreign exchange gains/losses in one jurisdiction reflected in the 2014 results. None of the current or prior period financial statements were materially misstated from these corrections.

Credco records a deferred income tax provision (benefit) when there are differences between assets and liabilities measured for financial reporting and for income tax return purposes. These temporary differences result in taxable or deductible amounts in future years and are measured using the tax rates and laws that will be in effect when such differences are expected to reverse. A valuation allowance is established when management determines that it is more likely than not that all or some portion of the benefit of the deferred tax assets will not be realized.

The significant components of deferred tax assets and liabilities as of December 31 are reflected in the following table:

(Millions)				2016		2015
Deferred tax assets:
	Reserves not yet deducted for tax purposes		$	23	$	28
	State income taxes			9		11
	Other			1		2
		Gross deferred tax assets		33		41
Deferred tax liabilities:
	Investment in foreign subsidiaries			―		1
	Foreign exchange gain			8		―
		Gross deferred tax liabilities		8		1
Net deferred tax assets			$	25	$	40

Accumulated earnings of certain non-U.S. subsidiaries, which totaled approximately $4.9 billion as of December 31, 2016, are intended to be permanently reinvested outside the United States. Credco does not provide for federal income taxes on foreign earnings intended to be permanently reinvested outside the United States. Accordingly, federal taxes, which would have aggregated approximately $1.7 billion as of December 31, 2016, have not been provided on such earnings.

Credco is subject to the income tax laws of the United States, its states and municipalities and those of the foreign jurisdictions in which American Express operates. These tax laws are complex, and the manner in which they apply to the taxpayer’s facts is sometimes open to interpretation. Given these inherent complexities, Credco must make judgments in assessing the likelihood that a tax position will be sustained upon examination by the taxing authorities based on the technical merits of the tax position. A tax position is recognized only when, based on management’s judgment regarding the application of income tax laws, it is more likely than not that the tax position will be sustained upon examination. The amount of benefit recognized for financial reporting purposes is based on management’s best judgment of the largest amount of benefit that is more likely than not to be realized on ultimate settlement with the taxing authority given the facts, circumstances and information available at the reporting date. Credco adjusts the level of unrecognized tax benefits when there is new information available to assess the likelihood of the outcome.

American Express is under continuous examination by the Internal Revenue Service (IRS) and tax authorities in other countries and states in which American Express has significant business operations. The tax years under examination and open for examination vary by jurisdiction. The IRS has completed its field examination of American Express’ federal tax returns for years through 2007; however, refund claims for certain years continue to be reviewed by the IRS. In addition, American Express is currently under examination by the IRS for the years 2008 through 2014.

The following table presents changes in unrecognized tax benefits:

(Millions)				2016		2015		2014
Balance, January 1			$	211	$	364	$	481
	Increases:
		Current year tax positions		79		2		2
		Tax positions related to prior years		24		1		1
	Decreases:
		Tax positions related to prior years		(1)		(152)		(113)
		Settlements with tax authorities		(1)		―		(7)
		Lapse of statute of limitations		(4)		(4)		―
Balance, December 31			$	308	$	211	$	364

Included in the unrecognized tax benefits of $308 million, $211 million and $364 million for December 31, 2016, 2015 and 2014, respectively, are approximately $12 million, $14 million and $16 million, respectively that if recognized, would favorably affect the effective tax rate in a future period.

Credco believes it is reasonably possible that its unrecognized tax benefits could decrease within the next 12 months by as much as $293 million principally as a result of potential resolutions of prior years’ tax items with various taxing authorities. The prior years’ tax items include unrecognized tax benefits relating to the deductibility of certain expenses or losses and the attribution of taxable income to a particular jurisdiction or jurisdictions. Of the $293 million of unrecognized tax benefits, approximately $289 million relates to amounts that, if recognized, would be recorded as an increase to shareholders’ equity and would not impact Credco’s results of operations or its effective tax rate. In January 2017, American Express reached resolution with the IRS on this item and as a result, $289 million will be recognized as an increase to shareholder’s equity in the first quarter of 2017.

Interest and penalties relating to unrecognized tax benefits are reported in the income tax provision. During the years ended December 31, 2016, 2015 and 2014, Credco recognized tax benefits of approximately $2 million, $1 million and $10 million, respectively, related to interest and penalties. Credco has approximately $48 million and $42 million accrued for the payment of interest and penalties as of December 31, 2016 and 2015, respectively.

Current taxes due (to)/from American Express or affiliates as of December 31, 2016 and 2015 were $ (18) million and $44 million, respectively.

Net income taxes paid by Credco during 2016 and 2015 were approximately $45 million and $332 million, respectively.