14. Income Taxes

The components of Earnings Before Income Tax Provision were (in millions):

	2015		2014		2013
U.S.	$	2,725	$	3,386	$	3,469
Non – U.S.		2,586		171		578
Total	$	5,311	$	3,557	$	4,047

The provision for income taxes consists of the following (in millions):

	2015			2014			2013
Current provision
Federal	$	846		$	1,207		$	1,122
State		121			109			134
Non – U.S.		128			35			15
		1,095			1,351			1,271
Deferred provision
Federal		(23	)		183			228
State		(16	)		(3	)		(2	)
Non – U.S.		-			(5	)		2
		(39	)		175			228
Income tax provision	$	1,056		$	1,526		$	1,499

The difference between the statutory federal income tax rate and the effective tax rate is as follows:

	2015			2014			2013
Federal statutory rate		35.0	%		35.0	%		35.0	%
State income taxes, net of federal benefit		1.3			1.9			2.2
Loss on Alliance Boots call option⁽¹⁾		-			8.5			-
Deferred tax asset recognition⁽¹⁾		(4.1	)		-			-
Gain on previously held equity interest		(5.8	)		-			-
Foreign income taxed at non-U.S. rates		(6.2	)		(3.1	)		(0.3	)
Non-taxable income		(2.6	)		-			-
Non-deductible expenses		2.3			0.3			1.0
Other		-			0.3			(0.9	)
Effective income tax rate		19.9	%		42.9	%		37.0	%

⁽¹⁾

Upon the amendment and immediate exercise of the call option to acquire the remaining 55% ownership of Alliance Boots, the Company was required to compare the fair value of the amended option with the book value of the original option with a gain or loss recognized for the difference. The fair value of the amended option resulted in a financial statement loss of $866 million. The loss on the Alliance Boots call option was, in part, a capital loss and available to be carried forward and offset future capital gains through fiscal 2020. The loss was also the primary contributor to the 2014 valuation allowance amount reported in the deferred income tax table below. In 2015, the deferred tax asset related to the loss was recognized, resulting in the 4.1% effective tax rate benefit reported in the table above as well as a reduction to the valuation allowance amount reported in the deferred income tax table below.

The deferred tax assets and liabilities included in the Consolidated Balance Sheets consist of the following (in millions):

	2015		2014
Deferred tax assets
Postretirement benefits	$	130	$	247
Compensation and benefits		224		166
Insurance		68		98
Accrued rent		167		166
Outside basis difference		73		-
Bad debts		67		65
Tax attributes		341		430
Stock compensation		119		131
Other		93		75
		1,282		1,378
Less: Valuation allowance		125		223
Total deferred tax assets		1,157		1,155
Deferred tax liabilities
Accelerated depreciation		1,234		1,244
Inventory		420		407
Intangible assets		1,822		64
Equity method investment		333		387
Deferred income		889		208
		4,698		2,310
Net deferred tax liabilities	$	3,541	$	1,155

At August 31, 2015, the Company has recorded deferred tax assets of $341 million, primarily reflecting the benefit of $399 million in U.S. federal, $478 million in state and $476 million in non-U.S. ordinary and capital losses. Of these deferred tax assets, $218 million will expire at various dates from 2016 through 2034. The residual deferred tax assets of $123 million have no expiry date.

The Company believes it is more likely than not that the benefit from certain deferred tax assets will not be realized. In recognition of this risk, the Company has recorded a valuation allowance of $125 million against those deferred tax assets as of August 31, 2015.

Income taxes paid were $1.3 billion, $1.2 billion and $1.2 billion for fiscal years 2015, 2014 and 2013, respectively.

ASC Topic 740, Income Taxes, provides guidance regarding the recognition, measurement, presentation and disclosure in the financial statements of tax positions taken or expected to be taken on a tax return, including the decision whether to file in a particular jurisdiction. As of August 31, 2015, unrecognized tax benefits of $224 million were reported as long-term liabilities on the Consolidated Balance Sheets while $73 million were reported as current tax liabilities. Both of these amounts include interest and penalties, when applicable.

The following table provides a reconciliation of the total amounts of unrecognized tax benefits (in millions):

	2015			2014			2013
Balance at beginning of year	$	193		$	208		$	197
Gross increases related to business combination		84			-			-
Gross increases related to tax positions in a prior period		45			55			18
Gross decreases related to tax positions in a prior period		(75	)		(82	)		(32	)
Gross increases related to tax positions in the current period		63			46			30
Settlements with taxing authorities		(45	)		(22	)		(2	)
Lapse of statute of limitations		(4	)		(12	)		(3	)
Balance at end of year	$	261		$	193		$	208

At August 31, 2015, 2014 and 2013, $227 million, $105 million and $116 million, respectively, of unrecognized tax benefits would favorably impact the effective tax rate if recognized. During the next twelve months, based on current knowledge, it is reasonably possible the amount of unrecognized tax benefits could decrease by up to $73 million due to anticipated tax audit settlements and the expirations of statutes of limitations associated with tax positions related to multiple tax jurisdictions.

The Company recognizes interest and penalties in the income tax provision in its Consolidated Statements of Earnings. At August 31, 2015, and August 31, 2014, the Company had accrued interest and penalties of $36 million and $21 million, respectively. For the year ended August 31, 2015, the amount reported in income tax expense related to interest and penalties was $3 million.

The Company files a consolidated U.S. federal income tax return as well as income tax returns in various states and multiple foreign jurisdictions. It is generally no longer under audit examination for U.S. federal income tax purposes for any years prior to fiscal 2014. With few exceptions, it is no longer subject to state and local income tax examinations by tax authorities for years before fiscal 2007. In foreign tax jurisdictions, the Company is generally no longer subject to examination by the tax authorities in Luxembourg prior to 2010, in Germany prior to 2011, in France prior to 2009, and in Turkey prior to 2010. With respect to the United Kingdom, a number of specific issues remain open to examination by the tax authorities back to 2000.

The Company has received tax holidays from Swiss cantonal income taxes relative to certain of its Swiss operations. The income tax holidays are expected to extend through September 2022. The holidays had a beneficial impact of approximately $89 million during 2015. This benefit is primarily included as part of the foreign income taxed at non-U.S. rates line in the effective tax rate reconciliation table above.

At August 31, 2015, it is not practicable for the Company to determine the amount of the unrecognized deferred tax liability it has with respect to temporary differences related to investments in foreign subsidiaries and foreign corporate joint ventures that are essentially permanent in duration.