Income Taxes

The components of income before income taxes for each fiscal year were as follows:



	2018		2017		2016

	(In millions)
U.S.	$	439	$	514	$	199
Foreign	4,255		3,217		1,814
	$	4,694	$	3,731	$	2,013

The components of the provision for income taxes for each fiscal year were as follows:



	2018			2017			2016

	(In millions)
Current:
U.S.	$	1,035		$	67		$	(36	)
Foreign	126			233			351
State	22			9			(2		)
	1,183			309			313
Deferred:
U.S.	151			(11		)	55
Foreign	57			(7		)	(89		)
State	(10		)	6			13
	198			(12		)	(21		)
	$	1,381		$	297		$	292

A reconciliation between the statutory U.S. federal income tax rate and Applied’s actual effective income tax rate for each fiscal year is presented below:



	2018		2017		2016
Tax provision at U.S. statutory rate	23.4	%	35.0	%	35.0	%
Changes in U.S. tax law	23.7		—		—
Resolutions of prior years’ income tax filings	(0.7	)	(1.9	)	3.9
Effect of foreign operations taxed at various rates	(15.6	)	(24.9	)	(24.1	)
State income taxes, net of federal benefit	0.2		0.3		0.6
Research and other tax credits	(0.7	)	(0.7	)	(1.3	)
U.S. domestic production deduction	(0.1	)	(0.2	)	(0.2	)
Share-based compensation	(0.7	)	0.4		0.4
Other	(0.1	)	—		0.2
	29.4	%	8.0	%	14.5	%

On December 22, 2017, the U.S. government enacted the Tax Cuts and Jobs Act (the “Tax Act”). The Tax Act includes a reduction to the U.S. federal corporate tax rate from 35.0 percent to 21.0 percent and requires a one-time transition tax on certain unrepatriated earnings of foreign subsidiaries payable over eight years. U.S. deferred tax assets and liabilities were subject to remeasurement due to the reduction of the U.S. federal corporate tax rate. Applied has a blended U.S. federal corporate tax rate of 23.4 percent for fiscal 2018 based on the number of days before and after the effective date of the Tax Act.

The U.S. Securities and Exchange Commission issued Staff Accounting Bulletin No. 118 (SAB 118), which provides guidance on accounting for the income tax effects of the Tax Act. SAB 118 provides a measurement period for companies to complete this accounting. Pursuant to SAB 118, provisional adjustments were recorded when reasonable estimates could be determined. These provisional estimates will be revised as information becomes available and as guidance is issued by the Internal Revenue Service. The accounting for the income tax effects of the Tax Act will be completed during the measurement period, which will not extend beyond one year from the Tax Act enactment date. Applied continues to evaluate certain unrepatriated earnings of foreign subsidiaries used to calculate the transition tax. The remeasurement of U.S. deferred tax assets and liabilities is complete.

The Tax Act also includes provisions that do not affect Applied in fiscal 2018, including a provision designed to tax global intangible low-taxed income (“GILTI”). Due to the complexity of the GILTI tax rules, this provision and related tax accounting will continue to be evaluated. An accounting policy choice is allowed to either treat taxes due on future U.S. inclusions related to GILTI in taxable income as a current-period expense when incurred (the “period cost method”) or factor such amounts into the measurement of deferred taxes (the “deferred method”). The calculation of the deferred balance with respect to the new GILTI tax provisions will depend, in part, on analyzing global income to determine whether future U.S. inclusions in taxable income are expected related to GILTI and, if so, what the impact is expected to be. An accounting policy choice has not yet been made.

Before the Tax Act, U.S. income tax had not been provided for certain unrepatriated earnings that were considered indefinitely reinvested. Income tax is now provided for all unrepatriated earnings.

The effective tax rate for fiscal 2018 was higher than fiscal 2017 primarily due to tax expense of $1.1 billion for the transition tax and remeasurement of deferred tax assets as a result of the Tax Act, partially offset by changes in the geographical composition of income, tax benefits from the lower U.S. federal corporate tax rate, adoption of authoritative guidance for share-based compensation, and the resolution of tax liabilities for uncertain tax positions. In addition, fiscal 2017 included tax benefits from the recognition of previously unrecognized foreign tax credits.

The effective tax rate for fiscal 2017 was lower than fiscal 2016 primarily due to the recognition of previously unrecognized foreign tax credits and changes in the geographical composition of income. In addition, fiscal 2016 included unfavorable resolutions and changes related to income tax liabilities for uncertain tax positions as well as the reinstatement of the U.S. federal R&D tax credit retroactive to its expiration in December of 2015 which did not reoccur in fiscal 2017.

In the reconciliation between the statutory U.S. federal income tax rate and the effective income tax rate, the effect of foreign operations taxed at various rates represents the difference between an income tax provision at the U.S. federal statutory income tax rate and the recorded income tax provision, with the difference expressed as a percentage of worldwide income before income taxes. This effect is substantially related to the tax effect of pre-tax income in jurisdictions with lower statutory tax rates. The foreign operations with the most significant effective tax rate impact are in Singapore. The statutory tax rate for fiscal 2018 for Singapore is 17%. Applied has been granted conditional reduced tax rates that expire in fiscal 2025, excluding potential renewal and subject to certain conditions with which Applied expects to comply. The tax benefit arising from these tax rates was $272 million for fiscal 2018 or $0.28 per diluted share.

Deferred tax assets and liabilities are recognized for the estimated future tax effects of temporary differences between the book and tax bases of assets and liabilities. Deferred tax assets are also recognized for net operating loss and tax credit carryovers. Deferred tax assets are offset by a valuation allowance to the extent it is more likely than not that they are not expected to be realized. The components of deferred income tax assets and liabilities were as follows:



	October 28, 2018			October 29, 2017

	(In millions)
Deferred tax assets:
Allowance for doubtful accounts	$	8		$	13
Inventory reserves and basis difference	117			156
Installation and warranty reserves	7			1
Accrued liabilities	20			31
Deferred revenue	9			15
Tax credits	236			317
Deferred compensation	79			81
Share-based compensation	37			53
Other	48			67
Gross deferred tax assets	561			734
Valuation allowance	(230		)	(227		)
Total deferred tax assets	331			507
Deferred tax liabilities:
Fixed assets	(48		)	(36		)
Intangible assets	(38		)	(76		)
Undistributed foreign earnings	(32		)	(11		)
Foreign exchange	(3		)	(4		)
Total gross deferred tax liabilities	(121		)	(127		)
Net deferred tax assets	$	210		$	380

The following table presents a summary of non-current deferred tax assets and liabilities:



	October 28, 2018			October 29, 2017

	(In millions)
Non-current deferred tax asset	$	222		$	385
Non-current deferred tax liability	(12		)	(5		)
	$	210		$	380

A valuation allowance is recorded to reflect the estimated amount of net deferred tax assets that may not be realized. Changes in the valuation allowance in each fiscal year were as follows:



	2018			2017		2016

	(In millions)
Beginning balance	$	227		$	207	$	207
Increases	8			20		27
Decreases	(5		)	—		(27		)
Ending balance	$	230		$	227	$	207

At October 28, 2018, Applied has state research and development tax credit carryforwards of $236 million, including $227 million of credits that are carried over until exhausted and $9 million that are carried over for 15 years and begin to expire in fiscal 2028. Management believes it is more likely than not that all tax credit carryforwards, net of valuation allowance, will be utilized.

Applied maintains liabilities for uncertain tax positions. These liabilities involve considerable judgment and estimation and are continuously monitored by management based on the best information available. Gross unrecognized tax benefits are classified as non-current income taxes payable. A reconciliation of the beginning and ending balances of gross unrecognized tax benefits in each fiscal year is as follows:



	2018			2017			2016

	(In millions)
Beginning balance of gross unrecognized tax benefits	$	391		$	320		$	177
Settlements with tax authorities	(152		)	(42		)	(25		)
Lapses of statutes of limitation	(37		)	(15		)	(2		)
Increases in tax positions for current year	91			95			62
Increases in tax positions for prior years	83			33			109
Decreases in tax positions for prior years	(2		)	—			(1		)
Ending balance of gross unrecognized tax benefits	$	374		$	391		$	320

Tax expense for interest and penalties on unrecognized tax benefits for fiscal 2018, 2017 and 2016 was $12 million, $17 million and $24 million, respectively. The income tax liability for interest and penalties for fiscal 2018, 2017 and 2016 was $26 million, $46 million and $33 million, respectively, and was classified as non-current income taxes payable.

Included in the balance of unrecognized tax benefits for fiscal 2018, 2017 and 2016 are $294 million, $284 million, and $302 million, respectively, of tax benefits that, if recognized, would affect the effective tax rate.

In fiscal 2018, Applied paid $158 million, including interest and penalties, as a result of a settlement in Israel for fiscal 2011 through fiscal 2015 resulting in the recognition of a tax benefit of $6 million. In fiscal 2017, Applied paid $29 million, including interest and penalties, as a result of a settlement in Italy for fiscal 2011 resulting in the recognition of a tax expense of $6 million. In fiscal 2016, Applied paid $25 million, including interest and penalties, as a result of a settlement in Switzerland for fiscal 2011 through fiscal 2015 resulting in the recognition of a tax expense of $19 million.

Applied’s tax returns remain subject to examination by taxing authorities. These include U.S. returns for fiscal 2010 and later years, and foreign tax returns for fiscal 2009 and later years.

The timing of the resolution of income tax examinations, as well as the amounts and timing of various tax payments that may be part of the settlement process, is highly uncertain. This could cause fluctuations in Applied’s financial condition and results of operations. Applied continues to have ongoing negotiations with various taxing authorities throughout the year.