Income Taxes

The domestic and international components of income before income tax and noncontrolling interest for the fiscal years ended October 29, 2016, October 31, 2015, and November 1, 2014, are presented as follows (in thousands):



	Fiscal Year Ended
	October 29, 2016		October 31, 2015		November 1, 2014
United States	$	51,383	$	250,788	$	192,730
International	210,655		188,263		160,891
Total	$	262,038	$	439,051	$	353,621

The income tax expense (benefit) for the fiscal years ended October 29, 2016, October 31, 2015, and November 1, 2014, consisted of the following (in thousands):



	Fiscal Year Ended
	October 29, 2016			October 31, 2015			November 1, 2014
U.S. federal taxes:
Current	$	50,317		$	64,042		$	61,666
Deferred	(18,976		)	14,775			33,065
Total U.S. federal taxes	31,341			78,817			94,731
State taxes:
Current	10,501			9,790			16,597
Deferred	(1,743		)	761			(2,599		)
Total state taxes	8,758			10,551			13,998
Non-U.S. taxes:
Current	8,207			9,713			6,655
Deferred	(195		)	(392		)	266
Total non-U.S. taxes	8,012			9,321			6,921
Total	$	48,111		$	98,689		$	115,650

The difference between the U.S. federal statutory tax rate and the Company’s effective tax rate for fiscal years ended October 29, 2016, October 31, 2015, and November 1, 2014, consisted of the following:



	Fiscal Year Ended
	October 29, 2016		October 31, 2015		November 1, 2014
U.S. federal statutory tax rate	35.0	%	35.0	%	35.0	%
State taxes, net of federal tax benefit	(2.3	)	0.2		3.1
Foreign income taxed at other than U.S. rates	(24.9	)	(14.5	)	(16.9	)
Stock-based compensation expense	5.2		1.9		2.3
Research and development credit	(1.8	)	(0.9	)	(3.1	)
Permanent items	0.3		0.3		0.3
Change in liabilities for uncertain tax positions	3.2		0.5		0.5
Goodwill impairment charge	—		—		8.3
Audit settlement and reinstated tax credit	—		—		0.1
Change in valuation allowance	2.5		1.3		1.6
Other	1.2		(1.3	)	1.5
Effective tax rate	18.4	%	22.5	%	32.7	%

In general, the Company’s provision for income taxes differs from the tax computed at the U.S. federal statutory tax rate due to state taxes, non-U.S. operations being taxed at rates lower than the U.S. federal statutory rate, non-deductible stock-based compensation expense, tax credits, and adjustments to unrecognized tax benefits. The non-U.S. operations primarily relate to Brocade’s European, Asia Pacific, and Japanese subsidiaries.

The effective tax rate in fiscal year 2016 was lower than the U.S. federal statutory tax rate of 35% primarily due to the effects of earnings in foreign jurisdictions being taxed at rates lower than the U.S. federal statutory tax rate, a benefit from the qualified domestic manufacturing deduction, a benefit from the tax reserves released related to an audit settlement with the Internal Revenue Service, and a benefit from the federal research and development tax credit that was reinstated on December 18, 2015, and made retroactive for calendar year 2015.

The effective tax rate in fiscal year 2015 was lower than the U.S. federal statutory tax rate of 35% primarily due to the effects of earnings in foreign jurisdictions being taxed at rates lower than the U.S. federal statutory tax rate, a benefit from the qualified domestic manufacturing deduction, and a benefit from the federal research and development tax credit that was reinstated on December 19, 2014, and made retroactive for calendar year 2014.

The effective tax rate for fiscal year 2016 is lower compared with fiscal years 2015 and 2014 primarily due to the effects of the relatively greater fiscal year 2016 earnings in foreign jurisdictions being taxed at rates lower than the U.S. federal statutory tax rate, a benefit from the tax reserves released related to an audit settlement with the Internal Revenue Service, and a benefit from the federal research and development tax credit that was reinstated on December 18, 2015, permanently, and made retroactive for calendar year 2015.

The Company’s effective tax rate for fiscal year 2015 is lower compared with fiscal year 2014 primarily due to the goodwill impairment charge recorded in fiscal year 2014, which is nondeductible for tax purposes.

As of October 29, 2016, U.S. federal income taxes and foreign withholding taxes were not provided for on an estimated cumulative total of $1,048.9 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. The Company’s existing cash and cash equivalents totaled $1,257.1 million as of October 29, 2016. Of this amount, approximately 85% was held by its 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 fiscal years ended October 29, 2016, and October 31, 2015, are presented as follows (in thousands):



	October 29, 2016			October 31, 2015
Net operating loss carryforwards	$	9,018		$	7,871
Stock-based compensation expense	27,822			19,868
Tax credit carryforwards	104,382			87,830
Reserves and accruals	98,561			110,796
Other	47			140
Gross deferred tax assets	239,830			226,505
Valuation allowance	(106,217		)	(88,581		)
Total deferred tax assets	133,613			137,924
Acquired intangibles and goodwill	(90,374		)	(18,155		)
Fixed assets	(26,479		)	(28,370		)
Other	(4,024		)	(35,935		)
Total deferred tax liabilities	(120,877		)	(82,460		)
Total net deferred tax assets	$	12,736		$	55,464

As of October 29, 2016, the Company believes that sufficient positive evidence exists from historical operations and projections of taxable income in future years to conclude that it is more likely than not that the Company will realize its deferred tax assets except for California deferred tax assets and capital loss carryforwards. Accordingly, the Company applies a valuation allowance to the California deferred tax assets due to the change in California law that occurred in November 2012, and to capital loss carryforwards due to the limited carryforward periods of these tax assets.

As of October 29, 2016, the Company had federal net operating loss carryforwards of $89.5 million, California state net operating loss carryforwards of $77.5 million and other significant state net operating loss carryforwards of approximately $132.4 million. Additionally, the Company had federal tax credit carryforwards of $143.3 million and state tax credit carryforwards of $218.0 million. The federal net operating loss and tax credit carryforwards expire on various dates between fiscal year 2018 through 2036. The state net operating loss and credit carryforwards expire on various dates between fiscal year 2017 through 2035. The federal net operating loss carryforwards and federal tax credit carryforwards include excess tax deductions related to stock-based compensation. 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, Foundry, Ruckus, and other acquisitions, all of the tax attributes from these companies are subject to an annual limitation. The Company expects some of these tax attributes to expire due to the annual limitation.

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 process. 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 29, 2016			October 31, 2015
Unrecognized tax benefits, beginning balance	$	117,569		$	119,615
Gross increases for tax positions taken in prior periods	15,874			705
Gross decreases for tax positions taken in prior periods	(7,734		)	(6,843		)
Increase from business combinations	52,665			—
Gross increases for tax positions taken in current period	35,350			8,418
Changes due to settlements with taxing authorities	(10,294		)	—
Reductions resulting from lapses of statutes of limitations	(3,474		)	(4,326		)
Unrecognized tax benefits, ending balance	$	199,956		$	117,569

As of October 29, 2016, the Company had net unrecognized tax benefits of $151.8 million, which if recognized, would result in a reduction of the Company’s effective tax rate.

The Internal Revenue Service (“IRS”) and other tax authorities regularly examine the Company’s income tax returns. In August 2016, the Company reached a settlement agreement with the IRS related to its examination of its federal income tax returns for fiscal years 2009 and 2010. In addition, in October 2014, the Geneva Tax Administration issued its final assessments for fiscal years 2003 to 2012, disputing certain of the Company’s transfer pricing arrangements. In November 2014, the Company filed a protest to challenge the final assessments. The Company believes that reserves for unrecognized tax benefits are adequate for all open tax years. The timing of income tax examinations, as well as the amounts and timing of related settlements, if any, are highly uncertain. Before the end of fiscal year 2017, 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. After the Company reaches a settlement with the tax authorities, the Company expects to record a corresponding adjustment to its unrecognized tax benefits. Taking into consideration the inherent uncertainty as to settlement terms, the timing of payments, and the impact of such settlements on the unrecognized tax benefits, the Company estimates the range of potential decreases in underlying uncertainty in income tax is between $0 and $9.0 million in the next 12 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 29, 2016, the Company recognized $0.4 million of interest and penalties related to unrecognized tax benefits. There were no material interest or penalties during the fiscal year ended October 31, 2015. The total net accrued interest and penalties included in the Company’s liability related to unrecognized tax benefits as of October 29, 2016, and October 31, 2015, was $2.9 million and $2.5 million, respectively.

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 $4.2 million in fiscal year 2016, $48.0 million in fiscal year 2015, and $59.9 million in fiscal year 2014.