NOTE 9 — Income Taxes

Income before income taxes is as follows:



	Year Ended May 31,
(In millions)	2013		2012		2011
Income before income taxes:
United States	$	1,240	$	804	$	1,040
Foreign	2,032		2,221		1,822
TOTAL INCOME BEFORE INCOME TAXES	$	3,272	$	3,025	$	2,862

The provision for income taxes is as follows:



	Year Ended May 31,
(In millions)	2013			2012			2011
Current:
United States
Federal	$	434		$	289		$	298
State	69			51			57
Foreign	398			488			435
Total	901			828			790
Deferred:
United States
Federal	1			(48		)	(62		)
State	(4		)	5			—
Foreign	(90		)	(29		)	(38		)
Total	(93		)	(72		)	(100		)
TOTAL INCOME TAX EXPENSE	$	808		$	756		$	690

A reconciliation from the U.S. statutory federal income tax rate to the effective income tax rate is as follows:



	Year Ended May 31,
	2013		2012		2011
Federal income tax rate	35.0	%	35.0	%	35.0	%
State taxes, net of federal benefit	1.4	%	1.3	%	1.3	%
Foreign earnings	-11.8	%	-11.9	%	-11.4	%
Other, net	0.1	%	0.6	%	-0.8	%
EFFECTIVE INCOME TAX RATE	24.7	%	25.0	%	24.1	%

The effective tax rate from continuing operations for the year ended May 31, 2013 was 30 basis points lower than the effective tax rate from continuing operations for the year ended May 31, 2012 primarily due to tax benefits received from the intercompany sale of intellectual property rights outside of the U.S., the retroactive reinstatement of the research and development credit and the intra-period allocation of tax expense between continuing operations, discontinued operations, and other comprehensive income. The decrease in the effective tax rate was partially offset by a higher effective tax rate on operations as a result of an increase in earnings in higher tax jurisdictions. The effective tax rate from continuing operations for the year ended May 31, 2012 was 90 basis points higher than the effective tax rate from continuing operations for the year ended May 31, 2011 primarily due to the changes in uncertain tax positions partially offset by a reduction in the effective rate related to a decrease in earnings in higher tax jurisdictions.

Deferred tax assets and (liabilities) comprise the following:



	As of May 31,
(In millions)	2013			2012
Deferred tax assets:
Allowance for doubtful accounts	$	20		$	17
Inventories	40			37
Sales return reserves	101			84
Deferred compensation	197			186
Stock-based compensation	140			126
Reserves and accrued liabilities	66			66
Foreign loss carry-forwards	19			35
Foreign tax credit carry-forwards	106			216
Undistributed earnings of foreign subsidiaries	162			82
Other	47			62
Total deferred tax assets	898			911
Valuation allowance	(5		)	(27		)
Total deferred tax assets after valuation allowance	893			884
Deferred tax liabilities:
Property, plant and equipment	(241		)	(191		)
Intangibles	(96		)	(98		)
Other	(20		)	(22		)
Total deferred tax liability	(357		)	(311		)
NET DEFERRED TAX ASSET	$	536		$	573

The following is a reconciliation of the changes in the gross balance of unrecognized tax benefits:



	As of May 31,
(In millions)	2013			2012			2011
Unrecognized tax benefits, as of the beginning of the period	$	285		$	212		$	282
Gross increases related to prior period tax positions	77			48			13
Gross decreases related to prior period tax positions	(3		)	(25		)	(98		)
Gross increases related to current period tax positions	130			91			59
Gross decreases related to current period tax positions	(9		)	(1		)	(6		)
Settlements	—			(20		)	(43		)
Lapse of statute of limitations	(21		)	(9		)	(8		)
Changes due to currency translation	(12		)	(11		)	13
UNRECOGNIZED TAX BENEFITS, AS OF THE END OF THE PERIOD	$	447		$	285		$	212

As of May 31, 2013, the total gross unrecognized tax benefits, excluding related interest and penalties, were $447 million, $281 million of which would affect the Company's effective tax rate if recognized in future periods.

The Company recognizes interest and penalties related to income tax matters in income tax expense. The liability for payment of interest and penalties increased $4 million, $17 million, and $10 million during the years ended May 31, 2013, 2012, and 2011, respectively. As of May 31, 2013 and 2012, accrued interest and penalties related to uncertain tax positions was $112 million and $108 million, respectively (excluding federal benefit).

The Company is subject to taxation primarily in the U.S., China, the Netherlands, and Brazil, as well as various state and other foreign jurisdictions. The Company has concluded substantially all U.S. federal income tax matters through fiscal 2010. The Company is currently under audit by the Internal Revenue Service for the 2011 through 2013 tax years. Many issues are at an advanced stage in the examination process, the most significant of which includes the negotiation of a U.S. Unilateral Advanced Pricing Agreement that covers intercompany transfer pricing issues for fiscal years May 31, 2011 through May 31, 2015. In addition, the Company is in appeals regarding the validation of foreign tax credits taken. The Company’s major foreign jurisdictions, China, the Netherlands and Brazil, have concluded substantially all income tax matters through calendar 2005, fiscal 2007 and calendar 2006, respectively. Although the timing of resolution of audits is not certain, the Company evaluates all domestic and foreign audit issues in the aggregate, along with the expiration of applicable statutes of limitations, and estimates that it is reasonably possible the total gross unrecognized tax benefits could decrease by up to $86 million within the next 12 months.

We provide for United States income taxes on the undistributed earnings of foreign subsidiaries unless they are considered indefinitely reinvested outside the United States. At May 31, 2013, the indefinitely reinvested earnings in foreign subsidiaries upon which United States income taxes have not been provided was approximately $6.7 billion. If these undistributed earnings were repatriated to the United States, or if the shares of the relevant foreign subsidiaries were sold or otherwise transferred, they would generate foreign tax credits that would reduce the federal tax liability associated with the foreign dividend or the otherwise taxable transaction. Assuming a full utilization of the foreign tax credits, the potential net deferred tax liability associated with these temporary differences of undistributed earnings would be approximately $2.2 billion at May 31, 2013.

A portion of the Company's foreign operations are benefiting from a tax holiday, which will phase out in 2019. This tax holiday may be extended when certain conditions are met or may be terminated early if certain conditions are not met. The impact of this tax holiday decreased foreign taxes by $108 million, $117 million, and $36 million for the fiscal years ended May 31, 2013, 2012, and 2011, respectively. The benefit of the tax holiday on net income per share (diluted) was $0.12, $0.12, and $0.04 for the fiscal years ended May 31, 2013, 2012, and 2011, respectively.

Deferred tax assets at May 31, 2013 and 2012 were reduced by a valuation allowance relating to tax benefits of certain subsidiaries with operating losses. The net change in the valuation allowance was a decrease of $22 million, an increase of $23 million, and a decrease of $1 million for the years ended May 31, 2013, 2012, and 2011, respectively.

The Company does not anticipate that any foreign tax credit carry-forwards will expire unutilized.

The Company has available domestic and foreign loss carry-forwards of $58 million at May 31, 2013. Such losses will expire as follows:



	Year Ending May 31,
(In millions)	2014		2015	2016	2017	2018- 2032	Indefinite	Total
Net Operating Losses	$	—	—	2	—	52	4	$	58

During the years ended May 31, 2013, 2012, and 2011, income tax benefits attributable to employee stock-based compensation transactions of $76 million, $120 million, and $68 million, respectively, were allocated to shareholders’ equity.