NOTE 9 — Income Taxes

Income before income taxes is as follows:



	Year Ended May 31,
(In millions)	2017		2016		2015
Income before income taxes:
United States	$	1,240	$	956	$	1,967
Foreign	3,646		3,667		2,238
TOTAL INCOME BEFORE INCOME TAXES	$	4,886	$	4,623	$	4,205

The provision for income taxes is as follows:



	Year Ended May 31,
(In millions)	2017			2016			2015
Current:
United States
Federal	$	398		$	304		$	596
State	82			71			80
Foreign	439			568			369
Total	919			943			1,045
Deferred:
United States
Federal	(279		)	(57		)	(66		)
State	(9		)	(16		)	(11		)
Foreign	15			(7		)	(36		)
Total	(273		)	(80		)	(113		)
TOTAL INCOME TAX EXPENSE	$	646		$	863		$	932

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



	Year Ended May 31,
	2017		2016		2015
Federal income tax rate	35.0	%	35.0	%	35.0	%
State taxes, net of federal benefit	1.1	%	1.1	%	0.9	%
Foreign earnings	-20.7	%	-18.2	%	-14.8	%
Resolution of a U.S. tax matter	-3.2	%	—	%	—	%
Other, net	1.0	%	0.8	%	1.1	%
EFFECTIVE INCOME TAX RATE	13.2	%	18.7	%	22.2	%

The effective tax rate for the year ended May 31, 2017 was 550 basis points lower than the effective tax rate for the year ended May 31, 2016 primarily due to a one-time benefit in the first quarter of the fiscal year related to the resolution with the U.S. Internal Revenue Service (IRS) of a foreign tax credit matter and a decrease in foreign earnings taxed in the United States.

The effective tax rate for the year ended May 31, 2016 was 350 basis points lower than the effective tax rate for the year ended May 31, 2015 primarily due to an increase in the proportion of earnings from operations outside of the United States, which are generally subject to a lower tax rate.

Deferred tax assets and liabilities comprise the following:



	As of May 31,
(In millions)	2017			2016
Deferred tax assets:
Allowance for doubtful accounts	$	4		$	5
Inventories	90			88
Sales return reserves	130			182
Deferred compensation	348			274
Stock-based compensation	225			206
Reserves and accrued liabilities	84			78
Net operating loss carry-forwards	84			44
Foreign tax credit carry-forwards	208			—
Undistributed earnings of foreign subsidiaries	173			179
Other	106			72
Total deferred tax assets	1,452			1,128
Valuation allowance	(82		)	(52		)
Total deferred tax assets after valuation allowance	1,370			1,076
Deferred tax liabilities:
Property, plant and equipment	(254		)	(268		)
Intangibles	(90		)	(92		)
Other	(2		)	(4		)
Total deferred tax liability	(346		)	(364		)
NET DEFERRED TAX ASSET	$	1,024		$	712

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



	As of May 31,
(In millions)	2017			2016			2015
Unrecognized tax benefits, beginning of the period	$	506		$	438		$	506
Gross increases related to prior period tax positions	31			49			32
Gross decreases related to prior period tax positions	(163		)	(20		)	(123		)
Gross increases related to current period tax positions	115			81			82
Gross decreases related to current period tax positions	—			—			(9		)
Settlements	(12		)	(13		)	(27		)
Lapse of statute of limitations	(21		)	(17		)	(10		)
Changes due to currency translation	5			(12		)	(13		)
UNRECOGNIZED TAX BENEFITS, END OF THE PERIOD	$	461		$	506		$	438

As of May 31, 2017, total gross unrecognized tax benefits, excluding related interest and penalties, were $461 million, $230 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 decreased by $38 million during the year ended May 31, 2017, increased by $45 million during the year ended May 31, 2016 and decreased by $3 million during the year ended May 31, 2015. As of May 31, 2017 and 2016, accrued interest and penalties related to uncertain tax positions were $171 million and $209 million, respectively (excluding federal benefit).

The Company is subject to taxation in the United States as well as various state and foreign jurisdictions. As previously disclosed, the Company received statutory notices of deficiency from the IRS for fiscal 2011 and fiscal 2012 proposing a total increase in tax of $254 million, subject to interest, related to a foreign tax credit matter. The Company contested these deficiencies by filing petitions with the U.S Tax Court. During the three months ended August 31, 2016, the Company reached a resolution with the IRS on this matter. Decisions were subsequently filed in U.S. District Tax Court stating there is no deficiency in income tax due from the Company. In the current period, the Company closed all U.S. federal income tax matters for fiscal years 2013 and 2014, with the exception of certain transfer pricing adjustments. The Company is currently under audit by the IRS for fiscal years 2015 and 2016.

The Company’s major foreign jurisdictions, China and the Netherlands, have concluded substantially all income tax matters through calendar 2006 and fiscal 2010, 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 $69 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, 2017, the indefinitely reinvested earnings in foreign subsidiaries upon which United States income taxes have not been provided were approximately $12.2 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 $4.1 billion at May 31, 2017.

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 tax benefit attributable to this tax holiday was $187 million, $173 million and $174 million for the fiscal years ended May 31, 2017, 2016 and 2015, respectively. The benefit of the tax holiday on diluted earnings per common share was $0.11, $0.10 and $0.10 for the fiscal years ended May 31, 2017, 2016 and 2015, respectively.

Deferred tax assets at May 31, 2017 and 2016 were reduced by a valuation allowance primarily relating to tax benefits of certain entities with operating losses. There was a $30 million net increase in the valuation allowance for the year ended May 31, 2017, compared to a net increase of $43 million for the year ended May 31, 2016 and no net change for the year ended May 31, 2015.

The Company has recorded deferred tax assets of $208 million at May 31, 2017 for foreign tax credit carry-forwards which expire in 2027.

The Company has available domestic and foreign loss carry-forwards of $266 million at May 31, 2017. Such losses will expire as follows:



	Year Ending May 31,
(In millions)	2018		2019		2020		2021		2022-2035		Indefinite		Total
Net operating losses	$	5	$	1	$	1	$	1	$	62	$	196	$	266

During the years ended May 31, 2017, 2016 and 2015, income tax benefits attributable to employee stock-based compensation transactions of $177 million, $281 million and $224 million, respectively, were allocated to Total shareholders’ equity.