Note 6: Taxes on Earnings

Provision for Taxes

The domestic and foreign components of earnings (loss) before taxes were as follows:

	For the fiscal years ended October 31
	2014		2013		2012
	In millions
U.S.	$	2,565	$	2,618	$	(3,192	)
Non-U.S.		3,992		3,892		(8,741	)

	$	6,557	$	6,510	$	(11,933	)

The provision for (benefit from) taxes on earnings was as follows:

	For the fiscal years ended October 31
	2014			2013			2012
	In millions
U.S. federal taxes:
Current	$	381		$	475		$	330
Deferred		210			(666	)		81
Non-U.S. taxes:
Current		984			1,275			1,139
Deferred		(42	)		89			(787	)
State taxes:
Current		212			57			(41	)
Deferred		(201	)		167			(5	)

	$	1,544		$	1,397		$	717

The differences between the U.S. federal statutory income tax rate and HP's effective tax rate were as follows:

	For the fiscal years ended October 31
	2014			2013			2012(1)
U.S. federal statutory income tax rate		35.0	%		35.0	%		35.0	%
State income taxes, net of federal tax benefit		0.4	%		0.1	%		0.5	%
Lower rates in other jurisdictions, net		(12.9	)%		(24.5	)%		13.9	%
Valuation allowance		1.7	%		3.8	%		(14.0	)%
Nondeductible goodwill		—			—			(40.3	)%
Uncertain tax positions		(2.3	)%		4.1	%		(1.4	)%
Other, net		1.6	%		3.0	%		0.3	%

		23.5	%		21.5	%		(6.0	)%

(1)	Positive numbers represent tax benefits and negative numbers represent tax expense as HP recorded income tax expense on a pretax loss.

The jurisdictions with favorable tax rates that have the most significant impact on HP's effective tax rate in the periods presented include Puerto Rico, Singapore, Netherlands, China and Ireland. HP plans to reinvest some of the earnings of these jurisdictions indefinitely outside the U.S. and therefore has not provided U.S. taxes on those indefinitely reinvested earnings.

In fiscal 2014, HP recorded $53 million of net income tax charges related to items unique to the year.

In fiscal 2013, HP recorded $471 million of net income tax charges related to items unique to the year. These amounts included $214 million of net increases to valuation allowances, $406 million of tax charges for adjustments to uncertain tax positions and the settlement of tax audit matters and $47 million of tax charges for various prior period adjustments. In addition, HP recorded $146 million of tax benefits from adjustments to prior year foreign income tax accruals and a tax benefit of $50 million arising from the retroactive research and development credit resulting from the American Taxpayer Relief Act of 2012, which was signed into law in January 2013.

In fiscal 2012, HP recorded a $1.3 billion income tax charge to record valuation allowances on certain U.S. deferred tax assets related to the ES segment, which was unique to the year. Other unique items included charges of $297 million for various foreign valuation allowances, as well as $26 million of income tax benefits related to adjustments to prior year foreign income tax accruals, settlement of tax audit matters, and miscellaneous other items.

As a result of certain employment actions and capital investments HP has undertaken, income from manufacturing and services in certain countries is subject to reduced tax rates, and in some cases is wholly exempt from taxes, through 2024. The gross income tax benefits attributable to these actions and investments were estimated to be $1.2 billion ($0.61 diluted net EPS) in fiscal 2014, $827 million ($0.42 diluted net EPS) in fiscal 2013 and $900 million ($0.46 diluted net EPS) in fiscal 2012.

Uncertain Tax Positions

A reconciliation of unrecognized tax benefits is as follows:

	As of October 31
	2014			2013			2012
	In millions
Balance at beginning of year	$	3,484		$	2,573		$	2,118
Increases:
For current year's tax positions		304			290			209
For prior years' tax positions		593			997			651
Decreases:
For prior years' tax positions		(125	)		(146	)		(321	)
Statute of limitations expiration		(46	)		(11	)		(1	)
Settlements with taxing authorities		(82	)		(219	)		(83	)

Balance at end of year	$	4,128		$	3,484		$	2,573

Up to $2.2 billion, $1.9 billion and $1.4 billion of HP's unrecognized tax benefits at October 31, 2014, 2013 and 2012, respectively, would affect HP's effective tax rate if realized.

HP recognizes interest income from favorable settlements and interest expense and penalties accrued on unrecognized tax benefits in Provision for taxes in the Consolidated Statements of Earnings. HP had accrued $254 million and $196 million for interest and penalties as of October 31, 2014 and October 31, 2013, respectively.

HP engages in continuous discussion and negotiation with taxing authorities regarding tax matters in various jurisdictions. HP does not expect complete resolution of any U.S. Internal Revenue Service ("IRS") audit cycle within the next 12 months. However, it is reasonably possible that certain federal, foreign and state tax issues may be concluded in the next 12 months, including issues involving transfer pricing and other matters. Accordingly, HP believes it is reasonably possible that its existing unrecognized tax benefits may be reduced by an amount up to $1.4 billion within the next 12 months.

HP is subject to income tax in the U.S. and approximately 105 other countries and is subject to routine corporate income tax audits in many of these jurisdictions. In addition, HP is subject to numerous ongoing audits by federal, state and foreign tax authorities. The IRS is conducting an audit of HP's 2009, 2010 and 2011 income tax returns. HP has received from the IRS Notices of Deficiency for its fiscal 1999, 2000, 2003, 2004 and 2005 tax years, and Revenue Agent Reports ("RAR") for its fiscal 2001, 2002, 2006, 2007 and 2008 tax years. The proposed IRS adjustments for these tax years would, if sustained, reduce the benefits of tax refund claims HP has filed for net operating loss carrybacks to earlier fiscal years and tax credit carryforwards to subsequent years by approximately $445 million. In addition, HP expects the IRS to issue an RAR for 2009 relating to certain tax positions taken on the filed tax returns, including matters related to the U.S. taxation of certain intercompany loans. While the RAR may be material in amount, HP believes it has valid positions supporting its tax returns and, if necessary, it will vigorously defend such matters.

HP has filed petitions with the U.S. Tax Court regarding certain proposed IRS adjustments regarding tax years 1999 through 2003 and is continuing to contest additional adjustments proposed by the IRS for other tax years. The U.S. Tax Court ruled in May 2012 against HP regarding one of the IRS adjustments for which HP has filed a formal Notice of Appeal. The Court proceedings are expected to begin in fiscal 2015.

Pre-acquisition tax years of HP's U.S. group of subsidiaries providing enterprise services through 2004 have been audited by the IRS, and all proposed adjustments have been resolved. RARs have been received for tax years 2005, 2006, 2007 and the short period ended August 26, 2008, proposing total tax deficiencies of $274 million. HP is contesting certain of these issues.

The IRS began an audit in fiscal 2013 of the 2010 income tax return for HP's U.S. group of subsidiaries providing enterprise services, and has issued an RAR for the short period ended October 31, 2008 and the period ending October 31, 2009 proposing a total tax deficiency of $62 million. HP is contesting certain of these issues.

With respect to major foreign and state tax jurisdictions, HP is no longer subject to tax authority examinations for years prior to 1999. HP is subject to a foreign tax audit concerning an intercompany transaction for fiscal 2009. The relevant taxing authority has proposed an assessment of approximately $680 million. HP is contesting this proposed assessment.

HP believes it has provided adequate reserves for all tax deficiencies or reductions in tax benefits that could result from federal, state and foreign tax audits. HP regularly assesses the likely outcomes of these audits in order to determine the appropriateness of HP's tax provision. HP adjusts its uncertain tax positions to reflect the impact of negotiations, settlements, rulings, advice of legal counsel, and other information and events pertaining to a particular audit. However, income tax audits are inherently unpredictable and there can be no assurance that HP will accurately predict the outcome of these audits. The amounts ultimately paid on resolution of an audit could be materially different from the amounts previously included in the Provision for taxes and therefore the resolution of one or more of these uncertainties in any particular period could have a material impact on net income or cash flows.

HP has not provided for U.S. federal income and foreign withholding taxes on $42.9 billion of undistributed earnings from non-U.S. operations as of October 31, 2014 because HP intends to reinvest such earnings indefinitely outside of the U.S. If HP were to distribute these earnings, foreign tax credits may become available under current law to reduce the resulting U.S. income tax liability. Determination of the amount of unrecognized deferred tax liability related to these earnings is not practicable. HP will remit non-indefinitely reinvested earnings of its non-U.S. subsidiaries for which deferred U.S. federal and withholding taxes have been provided where excess cash has accumulated and HP determines that it is advantageous for business operations, tax or cash management reasons.

Deferred Income Taxes

The significant components of deferred tax assets and deferred tax liabilities were as follows:

	As of October 31
	2014					2013
	Deferred Tax Assets			Deferred Tax Liabilities		Deferred Tax Assets			Deferred Tax Liabilities
	In millions
Loss carryforwards	$	9,476		$	—	$	9,807		$	—
Credit carryforwards		2,377			—		4,261			—
Unremitted earnings of foreign subsidiaries		—			7,828		—			7,469
Inventory valuation		152			8		128			13
Intercompany transactions—profit in inventory		136			—		125			—
Intercompany transactions—excluding inventory		4,403			—		1,923			—
Fixed assets		383			74		289			72
Warranty		616			—		622			—
Employee and retiree benefits		2,790			57		2,350			11
Accounts receivable allowance		107			1		185			1
Intangible assets		212			596		224			886
Restructuring		354			—		340			—
Deferred revenue		1,143			12		1,119			19
Other		1,573			1,145		1,443			759

Gross deferred tax assets and liabilities		23,722			9,721		22,816			9,230
Valuation allowance		(11,915	)		—		(11,390	)		—

Net deferred tax assets and liabilities	$	11,807		$	9,721	$	11,426		$	9,230

Current and long-term deferred tax assets and liabilities included in the Consolidated Balance Sheets as follows:

	As of October 31
	2014			2013
	In millions
Current deferred tax assets	$	2,754		$	3,893
Current deferred tax liabilities		(284	)		(375	)
Long-term deferred tax assets		740			1,346
Long-term deferred tax liabilities		(1,124	)		(2,668	)

Net deferred tax assets net of deferred tax liabilities	$	2,086		$	2,196

Tax deficits of approximately $43 million, $149 million and $175 million were recorded as a result of employee stock program activity and exercise of employee stock options, as a decrease in stockholders' equity in fiscal 2014, 2013 and 2012, respectively.

HP periodically engages in intercompany licensing arrangements that may result in advance payments between subsidiaries in different tax jurisdictions. When the local tax treatment of the intercompany licensing arrangements differs from their U.S. GAAP treatment, deferred taxes are recognized. During fiscal 2014, HP executed a multi-year intercompany licensing arrangement on which advanced royalty payments of $10.4 billion were received in the U.S., the result of which was the recognition of net U.S. long-term deferred tax assets of $1.3 billion. The remaining intercompany royalty revenues of $9.9 billion will be recognized over the life of the arrangement through 2029 in the respective legal entities and eliminated in consolidation. The amortization expense related to the licensing rights will also be eliminated in consolidation. The decrease in deferred tax assets for credit carryforwards and increase in deferred tax assets for intercompany transactions excluding inventory include the deferred tax attributable to this transaction. This results in an increase in long-term deferred tax assets which is presented as a component of HP's long-term deferred tax liabilities due to the effects of jurisdictional netting.

As of October 31, 2014, HP had $858 million, $4.2 billion and $29.7 billion of federal, state and foreign net operating loss carryforwards, respectively. Amounts included in federal net operating loss carryforwards will begin to expire in fiscal 2021 and amounts included in state and foreign net operating loss carryforwards will begin to expire in 2015. HP also has a capital loss carryforward of approximately $272 million which will expire in fiscal 2015. HP has provided a valuation allowance of $133 million and $8.7 billion for deferred tax assets related to state and foreign net operating losses carryforwards, respectively and $104 million for deferred tax assets related to capital loss carryforwards that HP does not expect to realize.

As of October 31, 2014, HP had recorded deferred tax assets for various tax credit carryforwards as follows:

	Carryforward		Valuation Allowance		Initial Year of Expiration
	In millions
U.S. foreign tax credits	$	1,321	$	47		2021
U.S. research and development and other credits		662		—		2018
Tax credits in state and foreign jurisdictions		394		204		2015

Balance at end of year	$	2,377	$	251

Deferred Tax Asset Valuation Allowance

The deferred tax asset valuation allowance and changes were as follows:

	As of October 31
	2014		2013			2012
	In millions
Balance at beginning of year	$	11,390	$	10,223		$	9,057
Income tax expense		184		1,644			865
Other comprehensive income, currency translation and charges to other accounts		341		(477	)		301

Balance at end of year	$	11,915	$	11,390		$	10,223

Total valuation allowances increased by $525 million and $1.2 billion in fiscal 2014 and 2013, respectively. These increases were associated primarily with foreign net operating losses.