Note 6: Taxes on Earnings

Provision for Taxes

HP's effective tax rate was 22.6% and 25.0% for the three months ended July 31, 2015 and 2014, respectively, and 22.0% and 23.2% for the nine months ended July 31, 2015 and 2014, respectively. HP's effective tax rate generally differs from the U.S. federal statutory rate of 35% due to favorable tax rates associated with certain earnings from HP's operations in lower-tax jurisdictions throughout the world. HP has not provided U.S. taxes for all foreign earnings because HP plans to reinvest some of those earnings indefinitely outside the U.S.

In the three and nine months ended July 31, 2015, HP recorded discrete items resulting in net tax benefits of $164 million and $349 million, respectively. These amounts included a tax benefit of $122 million and $237 million, for the three and nine months ended July 31, 2015, respectively, on separation charges and a tax benefit of $23 million and $75 million for the three and nine months ended July 31, 2015, respectively, on combined restructuring and acquisition-related charges. The nine month period ended July 31, 2015, also included a tax benefit of $47 million arising from the retroactive research and development credit provided by the Tax Increase Prevention Act of 2014 signed into law in December 2014. Additionally, in the three and nine months ended July 31, 2015, HP recorded various other discrete tax benefits of $19 million and tax charges of $10 million, respectively.

In the three and nine months ended July 31, 2014, HP recorded discrete items resulting in net tax benefits of $88 million and $53 million, respectively. These amounts include tax benefits of $100 million and $145 million related to restructuring charges, respectively.

Uncertain Tax Positions

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 U.S. Internal Revenue Service ("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's Reports ("RAR") for its fiscal 2001, 2002, 2006, 2007 and 2008 tax years. In addition, HP expects the IRS to issue RARs for 2009, 2010 and 2011 tax years relating to certain tax positions taken on the filed tax returns, including matters related to the U.S. taxation of certain intercompany loans. While these RARs may be material in amount, HP believes it has valid positions supporting its tax returns and, if necessary, it will rigorously defend such matters.

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.

As of July 31, 2015 and October 31, 2014, the amount of unrecognized tax benefits was $11.1 billion and $4.1 billion respectively, of which up to $2.4 billion and $2.2 billion would affect HP's effective tax rate if realized as of the respective periods. The $7.0 billion increase in the amount of unrecognized tax benefits for the nine months ended July 31, 2015 primarily relates to the timing of intercompany royalty income recognition which does not affect HP's effective tax rate. HP recognizes interest income from favorable settlements and interest expense and penalties accrued on unrecognized tax benefits in Provision for taxes in the Consolidated Condensed Statements of Earnings. As of July 31, 2015, HP had accrued $254 million for interest and penalties.

HP engages in continuous discussion and negotiation with taxing authorities regarding tax matters in various jurisdictions. HP does not expect complete resolution of any 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 $1.1 billion within the next 12 months.

Deferred Tax Assets and Liabilities

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

	As of
	July 31, 2015			October 31, 2014
	In millions
Current deferred tax assets	$	3,242		$	2,754
Current deferred tax liabilities		(216	)		(284	)
Long-term deferred tax assets		899			740
Long-term deferred tax liabilities		(2,965	)		(1,124	)

Net deferred tax assets net of deferred tax liabilities	$	960		$	2,086

HP periodically engages in intercompany advanced royalty payment and 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 U.S. GAAP treatment, deferred taxes are recognized. In the first quarter of fiscal 2015, HP executed an intercompany advanced royalty payment arrangement resulting in advanced payments of $8.2 billion, while during fiscal 2014, HP executed a multi-year intercompany licensing arrangement and an intercompany advanced royalty payment arrangement which resulted in combined advanced payments of $11.5 billion, the result of which was the recognition of net U.S. long-term deferred tax assets of $2.1 billion and $1.7 billion in the respective periods. In these transactions, the payments were received in the U.S. from a foreign consolidated affiliate, with a deferral of intercompany revenues over the term of the arrangements, approximately 5 years and 15 years, respectively. Intercompany royalty revenue and the amortization expense related to the licensing rights are eliminated in consolidation.

Separation costs are expenses associated with HP's plan to separate into two independent publicly-traded companies. These costs include finance, IT, consulting and legal fees, real estate, and other items that are incremental and one-time in nature. HP is recording a deferred tax asset on a portion of these costs and expenses as they are incurred through fiscal 2015. HP expects a portion of these deferred tax assets associated with separation costs and expenses will be eliminated, as non-deductible expenses, at the time the separation is executed. Furthermore, HP concluded on the legal form of the separation and in May, 2015 announced that Hewlett Packard Enterprise Company ("Hewlett Packard Enterprise") will be the spinnee in the U.S. Accordingly, HP expects to effect certain internal reorganizations of, and transactions among, its wholly-owned subsidiaries and operating activities in preparation for the legal form of separation. As a result, in future periods, HP expects to record the impact of separation-related activities, which may result in adjustments to increase certain deferred tax assets and could have a material impact on HP's operations.