Notes to Financial Statements

NOTE 13 — INCOME TAXES

The components of the provision for income taxes were as follows:

 

(In millions)                   


Year Ended June 30,    2016     2015     2014  

Current Taxes

                        

U.S. federal

   $ 545      $ 3,661      $ 3,738   

U.S. state and local

     136        364        266   

Foreign

     1,940        2,065        2,073   


 


 


Current taxes

     2,621        6,090        6,077   

Deferred Taxes

                        

Deferred taxes

     332        224        (331


 


 


Provision for income taxes

   $   2,953      $   6,314      $   5,746   
    


 


 


U.S. and foreign components of income (loss) before income taxes were as follows:

 

(In millions)  


Year Ended June 30,    2016     2015     2014  

U.S.

   $ (325   $ 7,363      $ 7,127   

Foreign

     20,076        11,144        20,693   


 


 


Income before income taxes

   $   19,751      $   18,507      $   27,820   
    


 


 


In fiscal year 2016, income before income taxes included the net impact of U.S. and foreign revenue deferrals related to the sales of Windows 10 of $6.0 billion and $588 million, respectively. In fiscal year 2015, income before income taxes included the net impact of U.S. and foreign impairment, integration, and restructuring expenses relating to our phone business of $1.1 billion and $8.9 billion, respectively.

The items accounting for the difference between income taxes computed at the U.S. federal statutory rate and our effective rate were as follows:

 

       
Year Ended June 30,    2016     2015     2014  

Federal statutory rate

     35.0%        35.0%        35.0%   

Effect of:

                        

Foreign earnings taxed at lower rates

     (19.4)%        (20.9)%        (17.1)%   

Phone nondeductible charges and valuation allowance

     1.3%        19.1%        0.9%   

Domestic production activities deduction

     (0.6)%        (2.4)%        (1.0)%   

Excess tax benefits relating to stock-based compensation

     (2.0)%        0%        0%   

Other reconciling items, net

     0.7%        3.3%        2.9%   


 


 


Effective rate

     15.0%        34.1%        20.7%   
    


 


 


 

The reduction from the federal statutory rate is primarily due to earnings taxed at lower rates in foreign jurisdictions resulting from producing and distributing our products and services through our foreign regional operations centers in Ireland, Singapore, and Puerto Rico. Our foreign regional operating centers, which are taxed at rates lower than the U.S. rate, generated 69%, 73%, and 81% of our foreign income before tax in fiscal years 2016, 2015, and 2014, respectively. In general, other reconciling items consist of interest, U.S. state income taxes, and credits. In fiscal years 2016, 2015, and 2014, there were no individually significant other reconciling items.

The decrease in our effective tax rate for fiscal year 2016 compared to fiscal year 2015 was primarily due to changes in the mix of our income before income taxes between the U.S. and foreign countries, including the net impact of revenue deferrals related to sales of Windows 10, tax benefits from the adoption of the new accounting guidance relating to stock-based compensation, and distributions from foreign affiliates. The fiscal year 2015 effective tax rate included the tax impact of losses in foreign jurisdictions for which we may not realize a tax benefit, primarily as a result of impairment and restructuring charges.

The components of the deferred income tax assets and liabilities were as follows:

 

(In millions)             


June 30,    2016     2015  

Deferred Income Tax Assets

                

Stock-based compensation expense

   $ 809      $ 884   

Other expense items

     1,609        1,531   

Restructuring charges

     284        211   

Unearned revenue

     494        520   

Impaired investments

     226        257   

Loss carryforwards

     1,703        1,158   

Depreciation and amortization

     115        798   

Other revenue items

     89        56   


 


Deferred income tax assets

     5,329        5,415   

Less valuation allowance

     (2,180     (2,265


 


Deferred income tax assets, net of valuation allowance

   $    3,149      $    3,150   


 


Deferred Income Tax Liabilities

                

Foreign earnings

   $ (1,242   $ (1,280

Unrealized gain on investments and debt

     (2,102     (2,223

Depreciation and amortization

     (1,008     (685

Other

     (54     (29


 


Deferred income tax liabilities

     (4,406     (4,217


 


Net deferred income tax assets (liabilities)

   $ (1,257   $ (1,067
    


 


Reported As

                

Other long-term assets (a)

   $ 219      $ 228   

Long-term deferred income tax liabilities (a)

     (1,476     (1,295


 


Net deferred income tax assets (liabilities) (a)

   $ (1,257   $ (1,067
    


 


 

(a)

Balances as of June 30, 2015 reflect the impact of the adoption of the new accounting standard in fiscal year 2016 related to balance sheet classification of deferred taxes. See Note 1 – Accounting Policies for additional details.

As of June 30, 2016, we had net operating loss carryforwards of $8.0 billion, including $6.3 billion of foreign net operating loss carryforwards. The valuation allowance disclosed in the table above relates to the foreign net operating loss carryforwards and other net deferred tax assets that may not be realized.

 

Deferred income tax balances reflect the effects of temporary differences between the carrying amounts of assets and liabilities and their tax bases and are stated at enacted tax rates expected to be in effect when the taxes are actually paid or recovered.

As of June 30, 2016, we have not provided deferred U.S. income taxes or foreign withholding taxes on temporary differences of approximately $124.0 billion resulting from earnings for certain non-U.S. subsidiaries which are permanently reinvested outside the U.S. The unrecognized deferred tax liability associated with these temporary differences was approximately $39.3 billion as of June 30, 2016.

Income taxes paid were $3.9 billion, $4.4 billion, and $5.5 billion in fiscal years 2016, 2015, and 2014, respectively.

Tax contingencies and other income tax liabilities were $11.8 billion and $12.1 billion as of June 30, 2016 and 2015, respectively, and are included in other long-term liabilities. This decrease relates primarily to tax credits available for carryover and a partial settlement of the IRS audit for tax years 2007 to 2009, offset by increases relating to intercompany transfer pricing.

Uncertain Tax Positions

Unrecognized tax benefits as of June 30, 2016, 2015, and 2014, were $10.2 billion, $9.6 billion, and $8.7 billion, respectively. If recognized, these tax benefits would affect our effective tax rates for fiscal years 2016, 2015, and 2014, by $8.8 billion, $7.9 billion, and $7.0 billion, respectively.

As of June 30, 2016, 2015, and 2014, we had accrued interest expense related to uncertain tax positions of $1.9 billion, $1.7 billion, and $1.5 billion, respectively, net of federal income tax benefits. Interest expense on unrecognized tax benefits was $163 million, $237 million, and $235 million in fiscal years 2016, 2015, and 2014, respectively, and was included in provision for income taxes.

The aggregate changes in the balance of unrecognized tax benefits were as follows:

 

(In millions)                   


Year Ended June 30,    2016     2015     2014  

Balance, beginning of year

   $ 9,599      $ 8,714      $ 8,648   

Decreases related to settlements

     (201     (50     (583

Increases for tax positions related to the current year

     1,086        1,091        566   

Increases for tax positions related to prior years

     115        94        217   

Decreases for tax positions related to prior years

     (317     (144     (95

Decreases due to lapsed statutes of limitations

     (118     (106     (39


 


 


Balance, end of year

   $   10,164      $   9,599      $   8,714   
    


 


 


While we settled a portion of our IRS audit for tax years 2004 to 2006 during the third quarter of fiscal year 2011, and settled a portion of the IRS audit for tax years 2007 to 2009 during the first quarter of fiscal year 2016, we remain under audit for those years. In February 2012, the IRS withdrew its 2011 Revenue Agents Report for tax years 2004 to 2006 and reopened the audit phase of the examination. As of June 30, 2016, the primary unresolved issue relates to transfer pricing, which could have a significant impact on our consolidated financial statements if not resolved favorably. We believe our allowances for income tax contingencies are adequate. We have not received a proposed assessment for the unresolved issues and do not expect a final resolution of these issues in the next 12 months. Based on the information currently available, we do not anticipate a significant increase or decrease to our tax contingencies for these issues within the next 12 months. We also continue to be subject to examination by the IRS for tax years 2010 to 2016.

We are subject to income tax in many jurisdictions outside the U.S. Our operations in certain jurisdictions remain subject to examination for tax years 1996 to 2016, some of which are currently under audit by local tax authorities. The resolutions of these audits are not expected to be material to our consolidated financial statements.