Note 18 — Income Taxes

For income tax purposes, the components of loss before taxes were as follows:



	Years Ended December 31,
	2017			2016			2015
Domestic	$	(75,143	)	$	(130,920	)	$	(62,903	)
Foreign	(68,830		)	(75,441		)	(66,958		)
	$	(143,973	)	$	(206,361	)	$	(129,861	)

The components of income tax expense (benefit) were as follows:



	Years Ended December 31,
	2017			2016			2015
Current:
Federal	$	(21,859	)	$	(8,025	)	$	46,680
State	(3,938		)	460			1,079
Foreign	9,550			5,099			161
	(16,247		)	(2,466		)	47,920
Deferred:
Federal	27,289			(22,054		)	(27,173		)
State	702			4,701			(3,719		)
Foreign	2,719			(2,806		)	2,754
Provision for (reversal of) valuation allowance on deferred tax assets	(29,979		)	15,639			97,069
	731			(4,520		)	68,931
Total	$	(15,516	)	$	(6,986	)	$	116,851

Income tax expense differs from the amounts computed by applying the U.S. Federal corporate income tax rate of 35% as follows:



	Years Ended December 31,
	2017			2016			2015
Expected income tax expense (benefit) at statutory rate	$	(50,391	)	$	(72,225	)	$	(45,451	)
Differences between expected and actual income tax expense:
U.S Tax Reform - Change in Federal rate	62,758			—			—
U.S Tax Reform - Transition Tax	34,846			—			—
Foreign tax differential including effectively connected income (1)	(12,140		)	42,463			41,695
Provision for (reversal of) liability for uncertain tax positions	(16,925		)	2,236			18,205
Provision for (reversal of) valuation allowance on deferred tax assets (2)	(29,979		)	15,639			97,069
Provision for liability for intra-entity transactions	2,484			3,357			4,700
State tax, after Federal tax benefit	(3,938		)	250			(2,867		)
Excess tax benefits from share-based compensation	(3,701		)	—			—
Other permanent differences	2,783			515			(463		)
Non-deductible regulatory settlements	—			—			700
Other	(1,313		)	779			3,263
Actual income tax expense (benefit)	$	(15,516	)	$	(6,986	)	$	116,851

(1)

The foreign tax differential includes a benefit recognized in 2017 and 2016 for taxable losses earned by OMS which are taxable in the U.S. as effectively connected income (ECI). The foreign tax differential for 2015 included positive ECI expected to be generated for that year. The impact of ECI to income tax expense (benefit) for 2017, 2016 and 2015 was $(28.5) million, $(7.4) million and $7.3 million, respectively.

(2)

The benefit recorded for the provision for valuation allowance in 2017 relates primarily to the reduction in the valuation allowance necessary as a result of revaluing our deferred tax assets due to U.S. tax reform and the reduction in the corporate tax rate. This benefit is partially offset by an increase in valuation allowance necessary for current year losses. The provision for valuation allowance in 2016 and 2015 primarily relates to the recording of the valuation allowance on both the U.S. and USVI net deferred tax assets as of December 31, 2016 and 2015. Also included in the provision for valuation allowance in 2015 is the reversal of a portion of the valuation allowance previously recorded on taxable losses earned by OMS which were taxable in the U.S. as ECI, which is equal to the positive taxable income that is expected to be generated for ECI purposes for the year ended December 31, 2015.

Ocwen is a global company with operations in the USVI, India and the Philippines, among other jurisdictions. In the effective tax rate reconciliation, we first calculate income tax expense attributable to worldwide continuing operations at the U.S. statutory tax rate of 35%. The foreign tax rate differential therefore represents the difference in tax expense between jurisdictional income taxed at the U.S. statutory rate of 35% and each respective jurisdictional statutory rate. As the U.S. tax rate is among the highest global tax rates and a majority of our income is subject to tax in the USVI at a significantly lower tax rate, the foreign tax rate differential component of our effective tax rate reconciliation is often the most significant adjusting item to our global rate.

The Tax Act amends the Internal Revenue Code to reduce tax rates and modify policies, credits, and deductions for individuals and businesses. For businesses, the Tax Act reduces the corporate federal tax rate from a maximum of 35% to a flat 21% rate. The rate reduction took effect on January 1, 2018.

This reduction in the statutory U.S. federal rate is expected to positively impact our future U.S. after-tax earnings. However, the ultimate impact is subject to the effect of other complex provisions in the Tax Act (including the Base Erosion and Anti-Abuse Tax (BEAT), Global Intangible Low-Taxed Income (GILTI), and revised interest deductibility limitations) which we are currently reviewing. It is possible that any impact of these provisions could significantly reduce the benefit of the reduction in the statutory U.S. federal rate. Due to the uncertain practical and technical application of many of these provisions in the Tax Act, at this time, we are unable to make a final determination of the precise impact on its future earnings.

Under the Tax Act, the transition to a new territorial tax system will cause Ocwen to incur a deemed repatriation tax (Transition Tax) on undistributed earnings of non-U.S. subsidiaries. The amount of the Transition Tax is dependent upon many factors, including the accumulated earnings and profits (E&P) of Ocwen’s non-U.S. subsidiaries, our ability and willingness to utilize foreign tax credits and/or net operating loss (NOL) carryforwards, and 2017 taxable income or loss amounts in the U.S. and non-U.S. jurisdictions. The estimated impact of the Transition Tax on the December 31, 2017 financial statements is a reduction to the U.S. federal NOL carryforward of approximately $16.9 million. The reduction of the NOL deferred tax asset results in an offsetting release of the valuation allowance.

Due to the various factors affecting the calculation, our decision regarding how best to utilize the foreign tax credits and/or NOL carryforwards is subject to change as we continue to wait for further guidance and analyze additional information necessary to finalize the calculations and maximize the long-term value to Ocwen. As we await further guidance and continue to analyze our options with regard to the 2017 income tax return filing position, our determination of the impact of the Transition Tax on our December 31, 2017 financial statements for U.S. federal income taxes and state income taxes is preliminary at this time.

Net deferred tax assets were comprised of the following:



	December 31,
	2017			2016
Deferred tax assets
Net operating loss carryforward	$	59,271		$	67,657
Foreign deferred assets	6,769			5,219
Intangible asset amortization	5,541			8,223
Partnership losses	5,360			8,976
Accrued incentive compensation	4,798			8,017
Foreign tax credit	4,262			4,262
Stock-based compensation expense	4,202			5,659
Mortgage servicing rights amortization	3,664			11,592
Accrued other liabilities	3,239			5,543
Accrued legal settlements	3,602			9,178
Tax residuals and deferred income on tax residuals	2,569			4,037
Bad debt and allowance for loan losses	2,383			3,268
Interest expense disallowance	2,032			—
Reserve for servicing exposure	1,312			1,900
Capital losses	937			1,450
Delinquent servicing fees	769			1,647
Other	3,245			1,872
	113,955			148,500
Deferred tax liabilities
Foreign undistributed earnings	4,858			13,619
Other	49			76
	4,907			13,695
	109,048			134,805
Valuation allowance (1)	(107,048		)	(132,073		)
Deferred tax assets, net	$	2,000		$	2,732


(1)	The decline in the valuation allowance of $25.0 million in 2017 is due to a $30.0 million reversal of valuation allowance on deferred tax assets (through a reduction in income tax expense), offset in part by the establishment of a $5.0 million valuation allowance (through a reduction in retained earnings) on the deferred tax asset recognized in connection with our adoption of ASU 2016-09.

As of December 31, 2017, we had a U.S. net deferred tax asset of $62.9 million and a USVI net deferred tax asset of $43.9 million.

As a result of the reduction in the corporate income tax rate from 35% to 21% under the Tax Act, we have revalued our U.S. and USVI net deferred tax assets at December 31, 2017. The net deferred tax assets in the U.S. and USVI jurisdictions have decreased by $36.1 million and $26.6 million, respectively, due to the change in the corporate tax rate. As the net deferred tax assets in these jurisdictions have full valuation allowances, the revaluation of our net deferred tax assets does not have an impact on our consolidated statement of financial position or consolidated statement of operations.

In addition to the reduction in our net deferred tax assets above, the Tax Act may have other impacts to our deferred tax assets, including, but not limited to, a reassessment of the valuation allowance due to changes in future taxable income and the likelihood of our ability to realize the existing deferred tax asset associated with previously disallowed interest expense. As a result, the net deferred tax assets recorded as of December 31, 2017 are provisional in accordance with the guidance in SAB 118. We will record any additional tax effects to our deferred tax assets in the first reporting period during which the amounts are determined.

We conduct periodic evaluations of positive and negative evidence to determine whether it is more likely than not that the deferred tax asset can be realized in future periods. In these evaluations, we gave more significant weight to objective evidence, such as our actual financial condition and historical results of operations, as compared to subjective evidence, such as projections of future taxable income or losses. Both the U.S. and USVI jurisdictions are in a three-year cumulative loss position as of December 31, 2017. Other factors considered in these evaluations are estimates of future taxable income, future reversals of temporary differences, taxable income in prior carryback years, tax character and the impact of tax planning strategies that may be implemented, if warranted.

As a result of these evaluations, we recorded a valuation allowance of $62.9 million and $95.5 million on our U.S. net deferred tax assets at December 31, 2017 and 2016, respectively, and a valuation allowance of $43.9 million and $36.2 million on our USVI net deferred tax assets at December 31, 2017 and 2016, respectively. These U.S. and USVI jurisdictional deferred tax assets are not considered to be more likely than not realizable based on all available positive and negative evidence. We intend to continue maintaining a full valuation allowance on our deferred tax assets in both the U.S. and USVI until there is sufficient evidence to support the reversal of all or some portion of these allowances.

At December 31, 2017, we had U.S. NOL carryforwards and USVI NOL carryforwards of $266.4 million and $463.4 million. These carryforwards will expire beginning 2019 through 2035. We believe that it is more likely than not that the benefit from certain U.S. and USVI NOL carryforwards will not be realized. In recognition of this risk, we have provided a total valuation allowance of $55.9 million and $3.1 million on the deferred tax assets relating to these U.S. and USVI NOL carryforwards, respectively. If our assumptions change and we determine we will be able to realize these NOLs, the tax benefits relating to any reversal of the valuation allowance on deferred tax assets as of December 31, 2017 will be accounted for as a reduction of income tax expense. Additionally, $328.4 million of USVI NOLs have been carried back to offset prior period tax due in the USVI and we have, therefore, reflected the tax-effect of this attribute as a component of income taxes receivable. We also have U.S. and USVI capital loss carryforwards of $0.5 million and $15.3 million, respectively, at December 31, 2017 against which a valuation allowance has been recorded.

NOL carryforwards may be subject to annual limitations under Internal Revenue Code Section 382 (Section 382) (or comparable provisions of foreign or state law) in the event that certain changes in ownership were to occur. We periodically evaluate our NOL carryforwards and whether certain changes in ownership have occurred that would limit our ability to utilize a portion of our NOL carryforwards. If it is determined that an ownership change(s) has occurred, there may be annual limitations on the use of these NOL carryforwards under Section 382 (or comparable provisions of foreign or state law).

Generally, a Section 382 ownership change occurs if, over a rolling three-year period, there has been an aggregate increase of 50 percentage points or more in the percentage of our stock owned by one or more “5-percent shareholders.” Ownership for Section 382 purposes is determined primarily by an economic test, while the SEC definition of beneficial ownership focuses generally on the right to vote or control disposition of the shares. In general, the Section 382 economic test looks to who has the right to receive dividends paid with respect to shares, and who has the right to receive proceeds from the sale or other disposition of shares. Section 382 also contains certain constructive ownership rules, which generally attribute ownership of stock held by estates, trusts, corporations, partnerships or other entities to the ultimate indirect individual owner of the shares, or to related individuals. Generally, a person’s direct or indirect economic ownership interest in shares (rather than record title, voting control or other factors) is taken into account for Section 382 purposes.

For purposes of determining the existence and identity of, and the amount of stock owned by any shareholder, the Internal Revenue Service permits us to rely on the existence or absence of filings with the SEC of Schedules 13D, 13F and 13G (or similar filings) as of any date, subject to our actual knowledge of the ownership of our common stock. Investors who file a Schedule 13G or Schedule 13D (or list our common stock in their Schedules 13F) may beneficially own 5% or more of our common stock for SEC reporting purposes but nonetheless may not be Section 382 “5-percent shareholders” and therefore their beneficial ownership will not result in a Section 382 ownership change.

We are currently in the process of evaluating whether we experienced an ownership change, as defined under Section 382, and have identified risk that an ownership change may have occurred in the U.S. jurisdiction during 2015, which would also result in an ownership change under 382 in the USVI jurisdiction during 2015. As part of this evaluation, Ocwen is seeking additional information pertaining to certain identified 5% shareholders, and their economic ownership for Section 382 purposes. To the extent an ownership change is ultimately determined to have occurred, the annual utilization of our NOLs may be subject to certain limitations under Section 382 and other limitations under state tax laws.

Any reduction to our NOL deferred tax asset due to an annual Section 382 limitation and the NOL carryforward period is expected to result in an offsetting reduction in valuation allowance related to the NOL deferred tax asset. Therefore, at this time, we anticipate that any limitation would not have a material impact on our consolidated statements of operations. However, as we are still in the process of evaluating whether and when we experienced an ownership change and are seeking additional information from shareholders, the final impact of Section 382 limitations has not been determined.

Our major jurisdiction tax years that remain subject to examination are our U.S. federal tax return for the years ended December 31, 2014 through the present, our USVI corporate tax return for the years ended December 31, 2014 through the present, and our India corporate tax returns for the years ended March 31, 2010 through the present. We currently do not have any tax returns under income tax examination in the U.S. or USVI tax jurisdictions.

A reconciliation of the beginning and ending amount of the total liability for uncertain tax positions is as follows:



	Years Ended December 31,
	2017			2016			2015
Beginning balance	$	16,994		$	32,548		$	22,523
Additions for tax positions of prior years	2,281			—			13,162
Reductions for tax positions of prior years	—			—			(2,741		)
Reductions for settlements	(387		)	(14,420		)	—
Lapses in statute of limitations	(16,607		)	(1,134		)	(396		)
Ending balance	$	2,281		$	16,994		$	32,548

We recognized total interest and penalties of $(5.1) million, $(1.0) million and $6.3 million in 2017, 2016 and 2015, respectively. At December 31, 2017 and 2016, accruals for interest and penalties were $1.0 million and $6.2 million, respectively. As of December 31, 2017 and 2016, we had a liability for uncertain tax positions of $2.3 million and $17.0 million, respectively, all of which if recognized would affect the effective tax rate.

It is reasonably possible that there could be a change in the amount of our unrecognized tax benefits within the next 12 months due to activities of the Internal Revenue Service or other taxing authorities, including proposed assessments of additional tax, possible settlement of audit issues, or the expiration of applicable statutes of limitations. We believe that it is reasonably possible that a decrease of up to $2.3 million in unrecognized tax benefits may be necessary within the next 12 months.

As of December 31, 2017, we have recognized a deferred tax liability of $4.9 million for India and Philippines subsidiary undistributed earnings of $30.2 million. With the exception of India and Philippines subsidiary earnings, we consider the remainder of our foreign subsidiary undistributed earnings to be indefinitely invested outside the U.S. based on our specific plans for reinvestment. As of December 31, 2017, our foreign subsidiaries have approximately $209.8 million of undistributed earnings and $257.6 million of cash and short-term investments. Should we decide to repatriate the foreign earnings, we would need to adjust our income tax provision in the period we determined that the earnings will no longer be indefinitely reinvested. Determination of the amount of unrecognized deferred tax liability is not practicable.

OMS is headquartered in Christiansted, St. Croix, USVI and is located in a federally recognized economic development zone where qualified entities are eligible for certain benefits. We refer to these benefits as “EDC benefits” as they are granted by the USVI Economic Development Commission. We were approved as a Category IIA service business, and are therefore entitled to receive benefits that may have a favorable impact on our effective tax rate. These benefits, among others, enable us to avail ourselves of a credit of 90% of income taxes on certain qualified income related to our servicing business. The exemption was granted as of October 1, 2012 and is available for a period of 30 years until expiration on September 30, 2042. The EDC benefits had no impact on our current foreign tax benefit in 2017 because we are incurring current losses in the USVI and do not have carryback potential for these losses. As a result, no current benefit can be recognized for these losses. The impact of these EDC benefits decreased our current foreign tax benefit by $62.7 million and $68.2 million related to 2016 and 2015 USVI losses, respectively. The detriment of these EDC benefits on diluted earnings per share was $(0.51) and $(0.54) for 2016 and 2015, respectively.