Income Taxes

Tax Cuts and Jobs Act (TCJA) and SEC Staff Accounting Bulletin 118 (SAB 118)

On December 22, 2017, the United States enacted into law new U.S. tax legislation, referred to as the TCJA. This law includes provisions for a comprehensive overhaul of the corporate income tax code, including a reduction of the statutory corporate tax rate from 35% to 21%, effective on January 1, 2018. This new legislation also eliminated or reduced certain corporate income tax deductions as well as introduced new provisions that taxed certain foreign income not previously taxed by the United States. The TCJA also includes a provision for a tax on all previously undistributed earnings of U.S. companies located in foreign jurisdictions. Undistributed earnings in the form of cash and cash equivalents is taxed at a rate of 15.5% and all other earnings are taxed at a rate of 8.0%. This tax is payable over 8 years and will not accrue interest.

In December 2017, the SEC provided regulatory guidance for accounting of the impacts of the TCJA, referred to as SAB 118. Under the guidance in SAB 118, the income tax effects, which the accounting under ASC 740 is incomplete, are reported as a provisional amount based on a reasonable estimate. The reasonable estimate is subject to adjustment during a "measurement period", not to exceed one year, until the accounting is complete. The estimate is also subject to the finalization of management’s analysis related to certain matters, such as developing interpretations of the provision of the TCJA, changes to certain estimates and amounts related to the earnings and profits of certain subsidiaries and the filing of tax returns.

As a result of the enactment of the TCJA, the Company recorded a provisional tax cost of $13.0 billion in the fourth quarter of 2017. This provisional charge was assessed as of January 18, 2018 and consisted of:


•	a $10.1 billion charge on previously undistributed foreign earnings as of December 31, 2017


•	a $4.5 billion deferred tax liability for foreign local and withholding taxes, offset by a $1.1 billion deferred tax asset for U.S. foreign tax credits, for repatriation of substantially all those earnings


•	a $0.6 billion tax benefit relating to the remeasurement of U.S. deferred tax assets and liabilities and the impact of the TCJA on tax reserves, and


•	a $0.1 billion charge for U.S. state and local taxes on the repatriation of these foreign earnings.

In determining this charge, the Company utilized the most recent information and guidance available related to the calculation of the tax liability and the impact to its deferred tax assets and liabilities, including those recorded for foreign local and withholding taxes that the Company assessed as of January 18, 2018. The provisional charge may require further adjustments and changes to the Company’s estimates as new guidance is made available. Revisions to the provisional charge may be material to the Company's financial results.

The TCJA also includes provisions for a tax on global intangible low-taxed income (GILTI). GILTI is described as the excess of a U.S. shareholder’s total net foreign income over a deemed return on tangible assets, as provided by the TCJA. In January 2018, in response to inquiries by companies, the FASB issued guidance that allows companies to elect as an accounting policy whether to treat the GILTI tax as a period cost or to recognize deferred tax assets and liabilities when basis differences exist that are expected to affect the amount of GILTI inclusion upon reversal. The Company has provisionally elected to treat GILTI as a period expense pending further analysis of this new tax provision.

The provision for taxes on income consists of:



(Dollars in Millions)	2017			2016		2015
Currently payable:
U.S. taxes	$	11,969		1,896		2,748
International taxes	1,998			1,708		1,309
Total currently payable	13,967			3,604		4,057
Deferred:
U.S. taxes	(1,956		)	294		37
International taxes	4,362			(635	)	(307	)
Total deferred	2,406			(341	)	(270	)
Provision for taxes on income	$	16,373		3,263		3,787

A comparison of income tax expense at the U.S. statutory rate of 35% in 2017, 2016 and 2015, to the Company’s effective tax rate is as follows:



(Dollars in Millions)	2017				2016		2015
U.S.	$	4,865			7,457		8,179
International	12,808				12,346		11,017
Earnings before taxes on income:	$	17,673			19,803		19,196
Tax rates:
U.S. statutory rate	35.0		%		35.0		35.0
International operations ⁽¹⁾	(12.8		)		(17.2	)	(15.4	)
Research and orphan drug tax credits	(0.4		)		(0.4	)	(0.2	)
U.S. state and local	0.6				(0.1	)	0.4
U.S. manufacturing deduction	(0.8		)		(0.6	)	(0.6	)
U.S. tax on international income	0.7				1.3		0.2
Tax benefits on share based compensation	(2.1		)		(1.8	)	—
U.S. tax benefit on asset/business disposals	(0.8		)		—		—
All other	(0.1		)		0.3		0.3
TCJA impact	73.3			⁽²⁾	—		—
Effective Rate	92.6		%		16.5	%	19.7	%

(1) For all periods presented the Company has subsidiaries operating in Puerto Rico under various tax incentives. In 2017, International operations reflects the impacts of operations in jurisdictions with statutory tax rates different than the United States, particularly Ireland, Switzerland and Puerto Rico, which is a favorable impact on the effective tax rate as compared with the 35.0% U.S. statutory rate. The 2017 amount also includes tax cost related to the revaluation of deferred tax balances related to the change in the Belgian statutory tax rate increasing the tax provision by approximately 3.4%.

(2) Includes U.S. state and local taxes provisionally recorded as part TCJA provisional charge which was approximately 0.6% of the total effective tax rate

The 2017 effective tax rate increased by 76.1% as compared to 2016, primarily driven by the enactment of the TCJA in the United States in December 2017. The enactment of the TCJA resulted in a provisional tax charge in the fourth quarter of 2017, of approximately $13.0 billion or approximately 73.3 percentage point increase to the effective tax rate.

The remainder of the increase in the tax rate for 2017 was related to the remeasurement of the Company’s deferred tax assets in Belgium, as a result of changes in the Belgian statutory corporate tax rate enacted in December 2017, offset by a tax benefit for the closure of the Company’s Animas insulin pump business.

The decrease in the 2016 effective tax rate, as compared to 2015 was primarily attributable to the Company adopting a new accounting standard for the reporting of additional tax benefits on share-based compensation that vested or were exercised during the fiscal year. The remainder of the change in the effective tax rate was primarily related to the lower earnings before taxes in the United States and the settlement of several uncertain tax positions in 2016 versus 2015.

The decrease in the 2015 effective tax rate, as compared to 2014 was primarily attributable to the increases in taxable income in lower tax jurisdictions relative to higher tax jurisdictions and a tax benefit resulting from a restructuring of international affiliates.

The items noted above reflect the key drivers of the rate reconciliation.

Temporary differences and carryforwards for 2017 and 2016 were as follows:



	2017 Deferred Tax				2016 Deferred Tax
(Dollars in Millions)	Asset		Liability		Asset	Liability
Employee related obligations	$	2,259			2,958
Stock based compensation	507				749
Depreciation			(9	)		(219	)
Non-deductible intangibles			(6,506	)		(6,672	)
International R&D capitalized for tax	1,307				1,264
Reserves & liabilities	1,718				1,857
Income reported for tax purposes	1,316				1,309
Net operating loss carryforward international	762				717
Undistributed foreign earnings	1,101		(4,457	)
Miscellaneous international	755		(194	)	1,135	(15	)
Miscellaneous U.S.	177				155
Total deferred income taxes	$	9,902	(11,166	)	10,144	(6,906	)

The Company has wholly-owned international subsidiaries that have cumulative net losses. The Company believes that it is more likely than not that these subsidiaries will realize future taxable income sufficient to utilize these deferred tax assets.

The following table summarizes the activity related to unrecognized tax benefits:



(Dollars in Millions)	2017				2016		2015
Beginning of year	$	3,041			3,080		2,465
Increases related to current year tax positions	332				348		570
Increases related to prior period tax positions	232				11		182
Decreases related to prior period tax positions	(416		)	(1)	(338	)	(79	)
Settlements	(2		)		(37	)	(4	)
Lapse of statute of limitations	(36		)		(23	)	(54	)
End of year	$	3,151			3,041		3,080

(1) $347 million of this decrease is related to the TCJA

The unrecognized tax benefits of $3.2 billion at December 31, 2017, if recognized, would affect the Company’s annual effective tax rate. The Company conducts business and files tax returns in numerous countries and currently has tax audits in progress with a number of tax authorities. The IRS has completed its audit for the tax years through 2009 and is currently auditing the tax years 2010-2012. In other major jurisdictions where the Company conducts business, the years remain open generally back to the year 2004. The Company believes it is possible that audits may be completed by tax authorities in some jurisdictions over the next twelve months. However, the Company is not able to provide a reasonably reliable estimate of the timing of any other future tax payments relating to uncertain tax positions.

The Company classifies liabilities for unrecognized tax benefits and related interest and penalties as long-term liabilities. Interest expense and penalties related to unrecognized tax benefits are classified as income tax expense. The Company recognized after tax interest expense of $60 million, $7 million and $44 million in 2017, 2016 and 2015, respectively. The total amount of accrued interest was $436 million and $344 million in 2017 and 2016, respectively.