Income Taxes

6 Months Ended

Jun. 30, 2021

Note 13. Income Taxes

The Company calculates its interim income tax provision in accordance with ASC Topic 270, “Interim Reporting,” and ASC Topic 740, “Accounting for Income Taxes.” Historically, the Company calculated the provision for income taxes during the interim reporting periods by applying an estimate of the annual effective tax rate for the full fiscal year to “ordinary” income or loss (pretax income or loss excluding unusual or infrequently occurring discrete items) for the

reporting period. The Company determined that since small changes in estimated “ordinary” income would result in significant changes in the estimated annual effective tax rate, the historical method would not provide a reliable estimate for the three and six months ended June 30, 2021. Therefore, a discrete effective tax rate method was used to calculate taxes for the three and six months ended June 30, 2021.

In March 2021, the Company acquired Topgolf through a non-taxable stock acquisition in a share exchange. The purchase price of Topgolf at acquisition was approximately $3,014,174,000. The Company recorded a deferred tax liability of approximately $293,000,000 related to the acquired intangibles, offset by approximately $154,000,000 of other acquired deferred tax assets, after consideration of acquired valuation allowances.

In January 2019, the Company acquired Jack Wolfskin for approximately $521,201,000 (including cash acquired of $58,096,000). The Company recorded a deferred tax liability of $88,392,000 related to the intangibles upon acquisition in addition to $11,384,000 deferred tax assets acquired. In the second quarter of 2020, due to a decline in projected revenues caused by the COVID-19 pandemic, the Company recognized an impairment charge of $174,269,000 to write down the goodwill and trade name associated with Jack Wolfskin to its fair value (see Note 9). The impaired goodwill was comprised of book basis over tax basis with no corresponding deferred tax liability. The brand value impairment resulted in the reduction of approximately $7,900,000 of the deferred tax liability previously recorded as part of acquisition accounting.

The realization of deferred tax assets, including loss and credit carryforwards, is subject to the Company generating sufficient taxable income during the periods in which the deferred tax assets become realizable. As a result of the Topgolf merger and the fact that Topgolf’s losses exceed Callaway’s income in recent years, the Company recorded a valuation allowance in its income tax provision of approximately $38,927,000 against certain of its net operating losses and tax credit carryforwards during the three months ended March 31, 2021. In connection with the purchase accounting related to the merger with Topgolf, the Company also recorded a valuation allowance in goodwill of approximately $80,566,000 against certain Topgolf deferred tax assets acquired in the merger. For the three months ended June 30, 2021, the Company released acquired Topgolf valuation allowances of approximately $32,743,000 due to significant earnings in the period and as a consequence of using the discrete effective tax rate method described above. The Company will continue to assess this amount through the measurement period. With respect to Jack Wolfskin and previously existing non-U.S. entities, there continues to be sufficient positive evidence to conclude that realization of its deferred tax assets is more likely than not under applicable accounting rules, and therefore no significant valuation allowances have been established.

The Company recorded an income tax benefit of $15,853,000 and a tax provision of $31,890,000 for the three and six months ended June 30, 2021, respectively. As a percentage of pre-tax income, the Company's effective tax rate was (20.9)% and 8.1% for the three and six months ended June 30, 2021, respectively. In the three months ended June 30, 2021 the primary difference between the statutory rate and the effective rate relates to the tax effect of the valuation allowance release described above. In the six months ended June 30, 2021 the primary difference between the statutory rate and the effective rate relates to excluding the book gain on pre-merger Topgolf shares for tax purposes offset by the valuation allowances on the Company’s deferred tax assets discussed above.

At June 30, 2021, the gross liability for income taxes associated with uncertain tax positions was $27,028,000. Of this amount, $5,267,000 would benefit the Company’s consolidated condensed financial statements and effective income tax rate if favorably settled. The unrecognized tax liabilities are expected to decrease by approximately $470,000 during the next 12 months. The gross liability for uncertain tax positions decreased by $1,392,000 for the three months ended June 30, 2021. The decrease was primarily due to an increase in effectively settled tax positions taken in the current quarter. The gross liability for uncertain tax positions decreased by $1,274,000 for the six months ended June 30, 2021. The decrease was primarily due to an increase in effectively settled tax positions taken in the current year.

The Company recognizes interest and penalties related to income tax matters in income tax expense. For the three months ended June 30, 2021 and 2020, the Company's provision for income taxes includes a benefit of $49,000 and an expense of $25,000, respectively, related to the recognition of interest and/or penalties. For the six months ended June 30, 2021 and 2020, the Company's provision for income taxes includes a benefit of $282,000 and an expense of $54,000, respectively, related to the recognition of interest and/or penalties. As of June 30, 2021 and December 31, 2020, the gross amount of accrued interest and penalties included in income taxes payable in the accompanying consolidated condensed balance sheets was $950,000 and $1,232,000, respectively.

The Company files income tax returns in the U.S. federal jurisdiction and various state and foreign jurisdictions. The Company is generally no longer subject to income tax examinations by tax authorities in the following major jurisdictions:


Tax Jurisdiction						Years No Longer Subject to Audit
U.S. federal						2010 and prior
California (U.S.)						2008 and prior
Germany						2013 and prior
Japan						2015 and prior
South Korea						2015 and prior
United Kingdom						2016 and prior

Pursuant to Section 382 of the Internal Revenue Code, use of the Company's net operating losses and credit carry-forwards may be limited significantly if the Company were to experience a cumulative change in ownership of the Company's stock by “5-percent shareholders” that exceeds 50% over a rolling three-year period. The Company believes a cumulative change in ownership occurred as a result of the merger with Topgolf, for the Company and Topgolf. The resulting limitations are not expected to have an adverse impact on future combined earnings of the Company. The limitation on losses and credits could impact future cash flows but those impacts are not expected to be significant.

- Definition

The entire disclosure for income taxes. Disclosures may include net deferred tax liability or asset recognized in an enterprise's statement of financial position, net change during the year in the total valuation allowance, approximate tax effect of each type of temporary difference and carryforward that gives rise to a significant portion of deferred tax liabilities and deferred tax assets, utilization of a tax carryback, and tax uncertainties information.

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