NOTE 9 — Income Taxes

Income before income taxes is as follows:



	Year Ended May 31,
(In millions)	2014		2013		2012
Income before income taxes:
United States	$	3,066	$	1,231	$	799
Foreign	478		2,025		2,212
TOTAL INCOME BEFORE INCOME TAXES	$	3,544	$	3,256	$	3,011

The provision for income taxes is as follows:



	Year Ended May 31,
(In millions)	2014			2013			2012
Current:
United States
Federal	$	371		$	432		$	286
State	93			69			51
Foreign	398			398			488
Total	862			899			825
Deferred:
United States
Federal	8			—			(47		)
State	(3		)	(4		)	5
Foreign	(16		)	(90		)	(29		)
Total	(11		)	(94		)	(71		)
TOTAL INCOME TAX EXPENSE	$	851		$	805		$	754

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



	Year Ended May 31,
	2014		2013		2012
Federal income tax rate	35.0	%	35.0	%	35.0	%
State taxes, net of federal benefit	1.8	%	1.4	%	1.3	%
Foreign earnings	2.2	%	-11.8	%	-11.9	%
Deferred charge	-14.6	%	0.0	%	0.0	%
Other, net	-0.4	%	0.1	%	0.6	%
EFFECTIVE INCOME TAX RATE	24.0	%	24.7	%	25.0	%

The effective tax rate from continuing operations for the year ended May 31, 2014 was 70 basis points lower than the effective tax rate from continuing operations for the year ended May 31, 2013 primarily due to an increase in the amount of earnings from lower tax rate jurisdictions.

During the fourth quarter of the fiscal year ended May 31, 2014, the Company reached a resolution with the IRS on a U.S. Unilateral Advanced Pricing Agreement that covers intercompany transfer pricing for fiscal years 2011 through 2020. This agreement resulted in a reduction in the Company's permanently reinvested foreign earnings, which increased the effective income tax rate and Income taxes payable. The agreement also resulted in a reduction of previously unrecognized tax benefits and the creation of a deferred tax charge, both of which reduced the effective income tax rate. The net result of the agreement did not have a material impact on the Company’s effective income tax rate in fiscal 2014.

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 rate was partially offset by a higher effective tax rate on operations as a result of an increase in earnings in higher tax jurisdictions.

Deferred tax assets and (liabilities) comprise the following:



	As of May 31,
(In millions)	2014			2013
Deferred tax assets:
Allowance for doubtful accounts	$	11		$	20
Inventories	49			40
Sales return reserves	113			101
Deferred compensation	211			197
Stock-based compensation	162			140
Reserves and accrued liabilities	95			66
Foreign loss carry-forwards	16			19
Foreign tax credit carry-forwards	—			106
Undistributed earnings of foreign subsidiaries	194			147
Other	51			47
Total deferred tax assets	902			883
Valuation allowance	(9		)	(5		)
Total deferred tax assets after valuation allowance	893			878
Deferred tax liabilities:
Property, plant and equipment	(237		)	(241		)
Intangibles	(94		)	(78		)
Other	(2		)	(20		)
Total deferred tax liability	(333		)	(339		)
NET DEFERRED TAX ASSET	$	560		$	539

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



	As of May 31,
(In millions)	2014			2013			2012
Unrecognized tax benefits, as of the beginning of the period	$	447		$	285		$	212
Gross increases related to prior period tax positions⁽¹⁾	814			77			48
Gross decreases related to prior period tax positions⁽¹⁾	(166		)	(3		)	(25		)
Gross increases related to current period tax positions	125			130			91
Gross decreases related to current period tax positions	(30		)	(9		)	(1		)
Settlements⁽¹⁾	(676		)	—			(20		)
Lapse of statute of limitations	(4		)	(21		)	(9		)
Changes due to currency translation	(4		)	(12		)	(11		)
UNRECOGNIZED TAX BENEFITS, AS OF THE END OF THE PERIOD	$	506		$	447		$	285

(1)

During the fourth quarter of the fiscal year ended May 31, 2014, the Company reached a resolution with the IRS on a U.S. Unilateral Advanced Pricing Agreement that covers intercompany transfer pricing for fiscal years 2011 through 2020. As a result, the Company recorded a gross increase in unrecognized tax benefits related to prior period tax positions, a gross decrease in unrecognized tax benefits related to prior period tax positions, and a settlement. The net impact of these items resulted in a decrease to unrecognized tax benefits.

As of May 31, 2014, the total gross unrecognized tax benefits, excluding related interest and penalties, were $506 million, $264 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 $55 million, $4 million, and $17 million during the years ended May 31, 2014, 2013, and 2012, respectively. As of May 31, 2014 and 2013, accrued interest and penalties related to uncertain tax positions were $167 million and $112 million, respectively (excluding federal benefit).

The Company is subject to taxation primarily in the United States, 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 2014 tax years, and many issues are at an advanced stage in the examination process. 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 2008 and calendar 2008, 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 $70 million within the next 12 months.

The Company provides for U.S. income taxes on the undistributed earnings of foreign subsidiaries unless they are considered indefinitely reinvested outside the United States. At May 31, 2014, the indefinitely reinvested earnings in foreign subsidiaries upon which United States income taxes have not been provided was approximately $6.6 billion, which includes a reduction of permanently reinvested earnings for the year ended May 31, 2014. 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 $2.1 billion at May 31, 2014.

A portion of the Company's foreign operations are benefiting from a tax holiday, which is set to expire in 2021. 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 $138 million, $108 million, and $117 million for the fiscal years ended May 31, 2014, 2013, and 2012, respectively. The benefit of the tax holiday on Diluted earnings per common share was $0.15, $0.12, and $0.12 for the fiscal years ended May 31, 2014, 2013, and 2012, respectively.

Deferred tax assets at May 31, 2014 and 2013 were reduced by a valuation allowance relating to tax benefits of certain subsidiaries with operating losses. The net change in the valuation allowance was an increase of $4 million, a decrease of $22 million, and an increase of $23 million for the years ended May 31, 2014, 2013, and 2012, respectively.

The Company has available domestic and foreign loss carry-forwards of $55 million at May 31, 2014. Such losses will expire as follows:



	Year Ending May 31,
(In millions)	2015		2016		2017		2018		2019-2034		Indefinite		Total
Net operating losses	$	—	$	—	$	—	$	6	$	37	$	12	$	55

During the years ended May 31, 2014, 2013, and 2012, income tax benefits attributable to employee stock-based compensation transactions of $135 million, $76 million, and $120 million, respectively, were allocated to Total shareholders’ equity.