13. Income Taxes

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

	2016		2015		2014
U.S.	$	2,577	$	2,725	$	3,386
Non – U.S.		2,567		2,586		171
Total	$	5,144	$	5,311	$	3,557

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

	2016			2015			2014
Current provision
Federal	$	999		$	846		$	1,207
State		56			121			109
Non – U.S.		371			128			35
		1,426			1,095			1,351
Deferred provision
Federal		(183	)		(23	)		183
State		6			(16	)		(3	)
Non – U.S. – Tax Law Change		(182	)		-			-
Non – U.S. – Excluding Tax Law Change		(70	)		-			(5	)
		(429	)		(39	)		175
Income tax provision	$	997		$	1,056		$	1,526

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

	2016			2015			2014
Federal statutory rate		35.0	%		35.0	%		35.0	%
State income taxes, net of federal benefit		0.8			1.3			1.9
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		(7.8	)		(6.2	)		(3.1	)
Non-taxable income		(4.4	)		(2.6	)		-
Non-deductible expenses		1.1			2.3			0.3
Tax Law changes		(3.5	)		-			-
Tax Credits		(1.5	)		-			-
Other		(0.3	)		-			0.3
Effective income tax rate		19.4	%		19.9	%		42.9	%

⁽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. 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.

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

	2016		2015
Deferred tax assets
Postretirement benefits	$	190	$	130
Compensation and benefits		205		224
Insurance		75		68
Accrued rent		169		167
Outside basis difference		134		73
Bad debts		65		67
Tax attributes		373		341
Stock compensation		97		119
Deferred income		150		-
Other		195		93
		1,653		1,282
Less: Valuation allowance		305		125
Total deferred tax assets		1,348		1,157
Deferred tax liabilities
Accelerated depreciation		1,205		1,234
Inventory		388		420
Intangible assets		1,418		1,822
Equity method investment		978		333
Deferred income		-		889
		3,989		4,698
Net deferred tax liabilities	$	2,641	$	3,541

At August 31, 2016, the Company has recorded deferred tax assets of $373 million, primarily reflecting the benefit of $200 million in U.S. federal, $226 million in state and $837 million in non-U.S. ordinary and capital losses. In addition, these deferred tax assets include $55 million of income tax credits. Of these deferred tax assets, $139 million will expire at various dates from 2017 through 2036. The residual deferred tax assets of $234 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 $305 million against those deferred tax assets as of August 31, 2016.

Income taxes paid were $1.1 billion, $1.3 billion and $1.2 billion for fiscal years 2016, 2015 and 2014, respectively.

ASC Topic 740, Income Taxes, provides guidance regarding the recognition, measurement, presentation and disclosure in the financial statement 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, 2016, unrecognized tax benefits of $252 million were reported as long-term liabilities on the Consolidated Balance Sheets while $51 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):

	2016			2015			2014
Balance at beginning of year	$	261		$	193		$	208
Gross increases related to business combination		-			84			-
Gross increases related to tax positions in a prior period		21			45			55
Gross decreases related to tax positions in a prior period		(47	)		(75	)		(82	)
Gross increases related to tax positions in the current period		68			63			46
Settlements with taxing authorities		(17	)		(45	)		(22	)
Currency		(11	)		-			-
Lapse of statute of limitations		(6	)		(4	)		(12	)
Balance at end of year	$	269		$	261		$	193

At August 31, 2016, 2015 and 2014, $237 million, $227 million and $105 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 $51 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, 2016, and August 31, 2015, the Company had accrued interest and penalties of $34 million and $36 million, respectively. For the year ended August 31, 2016, the amount reported in income tax expense related to interest and penalties was $2 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 2015. 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 2011, in Germany prior to 2011, in France prior to 2011, and in Turkey prior to 2011. 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 $116 million and $89 million during fiscal 2016 and 2015, respectively. 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, 2016, 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.