Income Taxes

The domestic and international components of income (loss) before provision for (benefit from) income taxes for the years ended October 27, 2012, October 29, 2011 and October 30, 2010 are presented as follows (in thousands):



	Fiscal Year Ended
	October 27, 2012		October 29, 2011 (1)			October 30, 2010
United States	$	115,736	$	(42,118	)	$	36,015
International	108,665		121,546			70,955
Total	$	224,401	$	79,428		$	106,970


(1)	Excludes the impact of repatriation of $200 million from offshore operations to the United States.

The income tax provision (benefit) for the years ended October 27, 2012, October 29, 2011 and October 30, 2010 consisted of the following (in thousands):



	Fiscal Year Ended
	October 27, 2012			October 29, 2011			October 30, 2010
U.S. federal taxes:
Current	$	(11,750	)	$	774		$	(30,768	)
Deferred	33,981			28,111			19,390
Total U.S. federal taxes	22,231			28,885			(11,378		)
State taxes:
Current	613			1,250			4,282
Deferred	(2,412		)	(9,187		)	(10,506		)
Total state taxes	(1,799		)	(7,937		)	(6,224		)
Non-U.S. taxes:
Current	8,770			7,854			8,964
Deferred	18			16			(915		)
Total non-U.S. taxes	8,788			7,870			8,049
Total	$	29,220		$	28,818		$	(9,553	)

The difference between the U.S. federal statutory income tax rate and the Company’s effective tax rate for the years ended October 27, 2012, October 29, 2011 and October 30, 2010 consisted of the following:



	Fiscal Year Ended
	October 27, 2012		October 29, 2011		October 30, 2010
U.S. federal statutory income tax rate	35.0	%	35.0	%	35.0	%
State taxes, net of federal tax benefit	3.8		3.3		4.0
Foreign income taxed at other than U.S. rates	(17.7	)	(48.2	)	(32.6	)
Stock-based compensation	3.5		11.8		12.6
Research and development credit	(3.5	)	(17.6	)	(10.4	)
Permanent items	0.3		1.2		0.9
Change in liabilities for uncertain tax positions	(6.5	)	2.5		(29.0	)
Repatriation from offshore operations	—		62.6		—
Audit settlement and reinstated tax credit	(2.9	)	(11.7	)	10.2
Other	1.0		(2.6	)	0.4
Effective tax rate	13.0	%	36.3	%	(8.9	)%

The effective tax rate in fiscal year 2012 is lower than the 35% U.S. federal statutory rate primarily due to earnings in our subsidiaries outside of the U.S. in jurisdictions where our effective tax rate is lower than in the U.S. Earnings of our subsidiaries outside of the U.S. primarily relate to our European and Asia Pacific businesses, which are headquartered in Switzerland. In the fourth fiscal quarter of 2011, we repatriated $200 million from our offshore operations, with which we repurchased approximately 46.5 million shares of our Company’s stock. The Company recorded tax expense of $49.7 million related to this one-time cash repatriation to fund the stock repurchase program. As of October 27, 2012, U.S. federal income taxes and foreign withholding taxes were not provided for on an estimated cumulative total of $370.5 million of undistributed earnings of the Company’s foreign subsidiaries. The Company intends to reinvest current and accumulated earnings of its foreign subsidiaries for expansion of its business operations outside the United States for an indefinite period of time. Our existing cash, cash equivalents and short-term investments totaled $713.2 million as of October 27, 2012. Of this amount, approximately 60% was held by our foreign subsidiaries. If these earnings were distributed to the United States in the form of dividends or otherwise, or if the shares of the relevant foreign subsidiaries were sold or otherwise transferred, the Company could be subject to additional U.S. income taxes, net of foreign tax credits, and foreign withholding taxes. Determination of the amount of unrecognized deferred income tax liability related to these earnings is not practicable.

The components of deferred tax assets and deferred tax liabilities for the years ended October 27, 2012 and October 29, 2011 are presented as follows (in thousands):



	October 27, 2012			October 29, 2011
Net operating loss carry forwards	$	63,750		$	132,765
Stock-based compensation expense	22,582			28,886
Tax credit carry forwards	145,688			141,209
Reserves and accruals	94,755			104,135
Capitalized research and development expenditures	3,232			8,475
Net unrealized losses on investments	468			330
Gross deferred tax assets	330,475			415,800
Less: Valuation allowance	(22,269		)	(22,566		)
Total deferred tax assets	308,206			393,234
Acquired intangibles and goodwill	(50,266		)	(92,481		)
Fixed assets	(28,110		)	(34,992		)
Other	(2,116		)	(2,129		)
Total deferred tax liabilities	(80,492		)	(129,602		)
Total net deferred tax assets	$	227,714		$	263,632

As of October 27, 2012, the Company believed that sufficient positive evidence existed from historical operations and projections of taxable income in future years to conclude that it was more likely than not that the Company will realize its deferred tax assets. Accordingly, the Company applied a valuation allowance only on the deferred tax assets relating to capital loss carryforwards, due to limited carryforward periods and the character of such tax attributes.

On November 6, 2012, California voters approved California Proposition 39. Proposition 39 affects future California state income tax apportionment that may have a significant negative impact on the Company’s ability to realize certain California deferred tax assets. See Note 19, “Subsequent Events,” of the Notes to Consolidated Financial Statements for more detail about the effect on the Company's financial statements.

As of October 27, 2012, the Company had federal net operating loss carryforwards of $603.1 million, California state net operating loss carryforwards of $71.4 million and other significant state net operating loss carryforwards of approximately $165.5 million. Additionally, the Company had $127.2 million of federal tax credits and $149.8 million of state tax credits. The federal net operating loss and other tax credit carryforwards expire on various dates between fiscal year 2013 through 2032. The state net operating loss and credit carryforwards expire on various dates between fiscal year 2013 through 2032. Under the current tax law, net operating loss and credit carryforwards available to offset future income in any given year may be limited by statute or upon the occurrence of certain events, including significant changes in ownership interests.

As a result of the McDATA and Foundry acquisitions, all the tax attributes from both companies are subject to an annual limitation, but the Company expects to use all the tax attributes before expiration.

The Company applies a recognition threshold and measurement attribute for the financial statement recognition and measurement of an income tax position taken or expected to be taken on a tax return. Recognition of a tax position is determined when it is more likely than not that a tax position will be sustained upon examination, including resolution of any related appeals or litigation processes. A tax position that meets the more-likely-than-not recognition threshold is measured at the largest amount of benefit that is greater than 50% likely of being realized upon ultimate settlement with a taxing authority.

A reconciliation of the beginning and ending amount of total gross unrecognized tax benefits, excluding accrued net interest and penalties, is as follows (in thousands):



	October 27, 2012			October 29, 2011
Unrecognized tax benefits, beginning balance	$	149,430		$	136,812
Gross increases for tax positions taken in prior periods	797			9,066
Gross decreases for tax positions taken in prior periods	(26,001		)	(1,730		)
Gross increases for tax positions taken in current period	6,633			9,601
Changes due to settlements with taxing authorities	(6,771		)	(1,051		)
Reductions resulting from lapses of statutes of limitations	(4,835		)	(3,268		)
Unrecognized tax benefits, ending balance	$	119,253		$	149,430

As of October 27, 2012, the Company had net unrecognized tax benefits of $105.2 million, all of which, if recognized, would result in a reduction of the Company’s effective tax rate.

In general, the Company’s provision for income taxes differs from the tax computed at the U.S. federal statutory income tax rate due to state taxes, the effect of non-U.S. operations, non-deductible stock-based compensation expense and adjustments to unrecognized tax benefits.

For the fiscal year ended October 27, 2012, the Company recorded an income tax expense of $29.2 million. The tax reported was impacted by the effect of a decrease in benefit from the federal research and development tax credit which expired on December 31, 2011, offset by discrete benefits from reserve releases of settled tax audits, and the expiration of certain statutes of limitations.

For the fiscal year ended October 29, 2011, the Company recorded an income tax expense of $28.8 million. The tax reported was primarily as a result of cash repatriated from our foreign subsidiary and foreign tax expenses, offset by discrete benefits from the retroactive reinstatement of the federal research and development tax credit provision, reserve releases of settled tax audits, and the expiration of certain statutes of limitations.

The Internal Revenue Service (“IRS”) and other tax authorities regularly examine the Company’s income tax returns. The IRS is currently examining fiscal years 2009 and 2010. In addition, the IRS has also examined the Company’s income tax returns for fiscal years 2007 and 2008, and in May 2011, the Company received the IRS Revenue Agent’s Report. The IRS is contesting the Company’s transfer pricing for the cost sharing and buy-in arrangements with its foreign subsidiaries. The IRS’ proposed adjustment would offset approximately $317.4 million of the Company’s net operating loss carryforwards. The Company has filed a protest to appeal the amount of proposed adjustments in the Revenue Agent’s Report with the Appeals Office of the IRS. The Company believes it has sufficient reserves recorded for the ultimate settlement amount on this issue. Furthermore, the Company is in negotiations with foreign tax authorities to obtain correlative relief on transfer pricing adjustments settled with the IRS. We believe that our reserves for unrecognized tax benefits are adequate for all open tax years. The timing of the resolution of income tax examinations, as well as the amounts and timing of related settlements, is highly uncertain. The Company believes that before the end of fiscal year 2013, it is reasonably possible that either certain audits will conclude or the statutes of limitations relating to certain income tax examination periods will expire, or both. As such, after we reach settlement with the tax authorities, we expect to record a corresponding adjustment to our unrecognized tax benefits. Given the uncertainty as to settlement terms, the timing of payments and the impact of such settlements on other uncertain tax positions, the range of estimated potential decreases in underlying uncertain tax positions is between $0 and $24 million in the next twelve months.

The Company classifies interest and penalties related to unrecognized tax benefits as a component of income tax expense. During the fiscal year ended October 27, 2012, the Company expensed $0.5 million for net interest and penalties related to income tax liabilities through income tax expense. The total net interest and penalties accrued as of October 27, 2012 was $2.4 million. During the year ended October 29, 2011, the Company expensed $0.4 million for net interest and penalties related to income tax liabilities through income tax expense. The total net interest and penalties accrued as of October 29, 2011 was $3.4 million.

Of the total tax benefits (detriments) resulting from the exercise of employee stock options and employee participation in the Company’s equity compensation plans, the amounts recorded to stockholders’ equity were approximately $(4.8) million in fiscal year 2012, $(5.2) million in fiscal year 2011 and $2.2 million in fiscal year 2010.