Note 18. Income taxes

U.S. GAAP requires the interim tax provision be determined as follows:

At the end of each quarter, Woodward estimates the tax that will be provided for the current fiscal year stated as a percentage of estimated “ordinary income.” The term ordinary income refers to earnings from continuing operations before income taxes, excluding significant unusual or infrequently occurring items.

The estimated annual effective rate is applied to the year-to-date ordinary income at the end of each quarter to compute the estimated year-to-date tax applicable to ordinary income. The tax expense or benefit related to ordinary income in each quarter is equal to the difference between the most recent year-to-date and the prior quarter year-to-date computations.

The tax effects of significant unusual or infrequently occurring items are recognized as discrete items in the interim period in which the events occur. The impact of changes in tax laws or rates on deferred tax amounts, the effects of changes in judgment about beginning of the year valuation allowances, and changes in tax reserves resulting from the finalization of tax audits or reviews are examples of significant unusual or infrequently occurring items that are recognized as discrete items in the interim period in which the events occur.

The determination of the annual effective tax rate is based upon a number of significant estimates and judgments. In addition, as a global commercial enterprise, Woodward’s tax expense can be impacted by changes in tax rates or laws, the finalization of tax audits and reviews, changes in the estimate of the amount of undistributed foreign earnings that Woodward considers indefinitely reinvested, and other factors that cannot be predicted with certainty. As such, there can be significant volatility in interim tax provisions.

On December 22, 2017, the United States (“U.S.”) enacted significant changes to the U.S. tax law following the passage and signing of the Tax Act. The Tax Act included significant changes to existing tax law, including a permanent reduction to the U.S. federal corporate income tax rate from 35% to 21%, a one-time repatriation tax on deferred foreign income (“Transition Tax”), deductions, credits and business-related exclusions.

Enactment of the Tax Act during December 2017 resulted in a discrete net charge to Woodward’s income tax expense in the amount of $14,778, which was recorded in the first quarter of fiscal year 2018. After adjustments to amounts made throughout fiscal year 2018, the net impact of the enactment of the Tax Act was $10,860. Woodward finalized its assessment of the income tax effects of the Tax Act in the first quarter of fiscal year 2019.

Within the calculation of Woodward’s annual effective tax rate, Woodward has used assumptions and estimates that may change as a result of future guidance, interpretation, and rule-making from the Internal Revenue Service (“IRS”), the SEC, and the FASB and/or various other tax jurisdictions. Changes in corporate tax rates, the net deferred tax assets and/or liabilities relating to Woodward’s U.S. operations, the taxation of foreign earnings, and the deductibility of expenses contained in the Tax Act or other future tax reform legislation could have a material impact on Woodward’s future income tax expense. Additionally, Woodward anticipates the IRS will issue additional regulations related to the Tax Act which may have an impact on Woodward’s future income tax expense.

The following table sets forth the tax expense and the effective tax rate for Woodward’s earnings before income taxes:



	Three-Months Ended				Six-Months Ended
	March 31,				March 31,
	2019		2018		2019		2018
Earnings before income taxes	$	90,168	$	48,647	$	151,683	$	86,134
Income tax expense		12,589		10,158		24,984		29,385
Effective tax rate		14.0%		20.9%		16.5%		34.1%

The decrease in the year-over-year effective tax rate for the three-months ended March 31, 2019 is primarily attributable to a higher favorable adjustment for the net excess income tax benefits from stock-based compensation, as compared to the prior fiscal year quarter, and the reduction in the U.S. federal corporate income tax rate provided by the Tax Act. This decrease was partially offset by the loss of the domestic production activities deduction in the current quarter, and an increase in the U.S. federal corporate income tax on estimated current year foreign earnings in the current quarter compared to the same quarter last year, both of which were a result of the Tax Act.

The decrease in the year-over-year effective tax rate for the six-months ended March 31, 2019 is primarily attributable to the income tax expense resulting from the Tax Act that was recognized in the prior fiscal year with no such charge recognized in the current fiscal year, a higher favorable adjustment for the net excess income tax benefits from stock-based compensation in the first six-months of fiscal year 2019 compared to the first six-months of the prior fiscal year, and the reduction in the U.S. federal corporate income tax rate in the six-months ended March 31, 2019, as provided by the Tax Act. This decrease was partially offset by an increase in the U.S. federal corporate income tax on estimated current year foreign earnings in the first six-months of this year compared to the same six-month period last year, the resolution of prior year tax matters, which did not repeat in the first six-months of the current fiscal year, and the loss of the domestic production activities deduction in the six-months ended March 31, 2019.

Gross unrecognized tax benefits were $9,431 as of March 31, 2019, and $8,364 as of September 30, 2018. Included in the balance of unrecognized tax benefits were $3,722 as of March 31, 2019 and $3,288 as of September 30, 2018 of tax benefits that, if recognized, would affect the effective tax rate. At this time, Woodward does not believe it is reasonably possible that the liability for unrecognized tax benefits will decrease in the next twelve months. Woodward accrues for potential interest and penalties related to unrecognized tax benefits and all other interest and penalties related to tax payments in tax expense. Woodward had accrued gross interest and penalties of $345 as of March 31, 2019 and $279 as of September 30, 2018.

Woodward’s tax returns are subject to audits by U.S. federal, state, and foreign tax authorities, and these audits are at various stages of completion at any given time. Reviews of tax matters by authorities and lapses of the applicable statutes of limitations may result in changes to tax expense. Woodward’s fiscal years remaining open to examination for U.S. Federal income taxes include fiscal years 2017 and thereafter. In fiscal year 2018, Woodward concluded its U.S. federal income tax examinations through fiscal year 2016. Woodward’s fiscal years remaining open to examination for significant U.S. state income tax jurisdictions include fiscal years 2014 and thereafter. Woodward closed various audits in foreign jurisdictions in the second quarter of fiscal year 2019. As a result, fiscal years remaining open to examination in significant foreign jurisdictions include 2016 and thereafter.