Income Taxes

Domestic and foreign income (loss) before income taxes and details of the income tax expense (benefit) are as follows (amounts in millions):



	For the Years Ended December 31,
	2015			2014			2013
Income before income tax expense:
Domestic	$	355		$	325		$	626
Foreign	766			656			693
	$	1,121		$	981		$	1,319
Income tax expense (benefit):
Current:
Federal	$	169		$	146		$	110
State	31			12			7
Foreign	40			38			31
Total current	240			196			148
Deferred:
Federal	1			26			134
State	(21		)	(18		)	(12		)
Foreign	9			(58		)	39
Total deferred	(11		)	(50		)	161

Income tax expense	$	229		$	146		$	309

For the year ended December 31, 2015, 2014, and 2013, income tax benefits attributable to equity-based compensation transactions exceeded the amounts recorded based on grant date fair value. Accordingly, $65 million, $30 million, and $11 million were credited to shareholder’s equity, respectively, in these years.

The items accounting for the difference between income taxes computed at the U.S. federal statutory income tax rate and the income tax expense (benefit) at the effective tax rate for each of the years are as follows (amounts in millions):



	For the Years Ended December 31,
	2015					2014					2013
Federal income tax provision at statutory rate	$	392		35	%	$	343		35	%	$	462		35	%
State taxes, net of federal benefit	5			—		5			—		6			—
Research and development credits	(26		)	(2	)	(24		)	(2	)	(49		)	(4	)
Foreign rate differential	(228		)	(20	)	(245		)	(25	)	(174		)	(13	)
Change in tax reserves	136			12		128			13		89			7
Net operating loss tax attribute assumed from the Purchase Transaction	(63		)	(6	)	(52		)	(5	)	(16		)	(1	)
Other	13			1		(9		)	(1	)	(9		)	(1	)
Income tax expense	$	229		20	%	$	146		15	%	$	309		23	%

The Company's tax rate is affected by the tax rates in the jurisdictions in which the Company operates, the relative amount of income earned by jurisdiction, and the jurisdictions with a statutory tax rate less than the U.S. rate of 35%.

For the year ended December, 2015, 2014 and 2013, the Company's income before income tax expense was $1,121 million, $981 million, and $1,319 million, respectively, and our income tax expense was $229 million (or a 20% effective tax rate), $146 million (or a 15% effective tax rate), and $309 million (or a 23% effective tax rate), respectively. Overall, our effective tax rate differs from the U.S. statutory tax rate of 35%, primarily due to earnings taxed at relatively lower rates in foreign jurisdictions, recognition of the California research and development ("R&D") credits, and recognition of the retroactive reinstatement of the federal R&D tax credit, partially offset by changes in the Company's liability for uncertain tax positions.

In connection with the Purchase Transaction, we assumed certain tax attributes of New VH, which generally consist of New VH's net operating loss ("NOL") carryforwards of approximately $760 million, which represent a potential future tax benefit of approximately $266 million. The utilization of such NOL carryforwards will be subject to certain annual limitations and will begin to expire in 2021. The Company also obtained indemnification from Vivendi against losses attributable to the disallowance of claimed utilization of such NOL carryforwards of up to $200 million in unrealized tax benefits in the aggregate, limited to taxable years ending on or prior to December 31, 2016. No benefit for these tax attributes or indemnification was recorded upon the close of the Purchase Transaction. For the year ended December 31, 2015 and 2014, we utilized $180 million and $148 million, respectively, of the NOL, which resulted in benefits of $63 million and $52 million, respectively. The benefits for the year ended December 31, 2015, were reduced by $5 million for return to provision adjustments recorded. As of December 31, 2015, and 2014, a corresponding reserve of $58 million and $52 million, respectively, were established. As of December 31, 2015, an indemnification asset of $125 million has been recorded in "Other Assets", and, correspondingly, the same amount has been recorded as a reduction to the consideration paid for the shares repurchased in "Treasury Stock" (see Note 1 of the Notes to Consolidated Financial Statements for details about the share repurchase).

Deferred income taxes reflect the net tax effects of temporary differences between the amounts of assets and liabilities for accounting purposes and the amounts used for income tax purposes. The components of the net deferred tax assets (liabilities) are as follows (amounts in millions):



	As of December 31,
	2015			2014
Deferred tax assets:
Allowance for sales returns and price protection	$	66		$	74
Inventory reserve	11			9
Accrued expenses	40			38
Deferred revenue	288			291
Tax credit carryforwards	58			50
Net operating loss carryforwards	10			10
Stock-based compensation	54			69
Transaction costs	9			9
Other	19			13
Deferred tax assets	555			563
Valuation allowance	—			—
Deferred tax assets, net of valuation allowance	555			563
Deferred tax liabilities:
Intangibles	(166		)	(169		)
Prepaid royalties	(30		)	(22		)
Capitalized software development expenses	(81		)	(84		)
State taxes	(7		)	(34		)
Other	(6		)	—
Deferred tax liabilities	(290		)	(309		)
Net deferred tax assets	$	265		$	254

As of December 31, 2015, we have gross tax credit carryforwards of $40 million and $119 million for federal and state purposes, respectively, which begin to expire in fiscal 2025. The tax credit carryforwards are presented in "Deferred tax assets" net of unrealized tax benefits that would apply upon the realization of uncertain tax positions. Through our foreign operations, we have approximately $36 million in NOL carryforwards at December 31, 2015, attributed mainly to losses in France and Ireland, the majority of which can be carried forward indefinitely.

We evaluate our deferred tax assets, including net operating losses and tax credits, to determine if a valuation allowance is required. We assess whether a valuation allowance should be established or released based on the consideration of all available evidence using a "more-likely-than-not" standard. Realization of the U.S. deferred tax assets is dependent upon the continued generation of sufficient taxable income. In making such judgments, significant weight is given to evidence that can be objectively verified. Although realization is not assured, management believes it is more likely than not that the net carrying value of the U.S. deferred tax assets will be realized. At December 31, 2015 and 2014, there are no valuation allowances on deferred tax assets.

Cumulative undistributed earnings of foreign subsidiaries for which no deferred taxes have been provided approximated $4,084 million at December 31, 2015. Deferred income taxes on these earnings have not been provided as these amounts are considered to be permanent in duration. Determination of the unrecognized deferred tax liability on unremitted foreign earnings is not practicable because of the complexity of the hypothetical calculation. In the event of a distribution of these earnings to the U.S. in the form of a dividend, we may be subject to both foreign withholding taxes and U.S. income taxes net of allowable foreign tax credits.

Vivendi Games results for the period January 1, 2008 through July 9, 2008 are included in the consolidated federal and certain foreign state and local income tax returns filed by Vivendi or its affiliates while Vivendi Games results for the period from July 10, 2008 through December 31, 2008 are included in the consolidated federal and certain foreign, state and local income tax returns filed by Activision Blizzard. Vivendi Games tax year 2008 remains open to examination by the major taxing authorities. In addition, Vivendi Games’ tax return for the 2008 tax year is before the appeals function of the IRS and is under examination by several state taxing authorities.

Activision Blizzard's tax years 2008 through 2014 remain open to examination by the major taxing jurisdictions to which we are subject. The IRS is currently examining the Company's federal tax returns for the 2008 through 2011 tax years. During the second quarter of 2015, the Company transitioned the review of its transfer pricing methodology from the advanced pricing agreement review process to the IRS examination team. Their review could result in a different allocation of profits and losses under the Company’s transfer pricing agreements. Such allocation could have a positive or negative impact on our provision for the period in which such a determination is reached and the relevant periods thereafter. The Company also has several state and non-U.S. audits pending.

As of December 31, 2015, we had approximately $552 million of gross unrecognized tax benefits, of which $529 million would affect our effective tax rate if recognized. A reconciliation of total gross unrecognized tax benefits for the years ended December 31, 2015, 2014, and 2013 is as follows (amounts in millions):



	For the Years Ended December 31,
	2015			2014			2013
Unrecognized tax benefits balance at January 1	$	419		$	294		$	207
Gross increase for tax positions of prior-years	8			2			1
Gross decrease for tax positions of prior-years	(11		)	—			—
Gross increase for tax positions of current year	136			125			91
Settlement with taxing authorities	—			(2		)	—
Lapse of statute of limitations	—			—			(5		)
Unrecognized tax benefits balance at December 31	$	552		$	419		$	294

We recognize interest and penalties related to uncertain tax positions in "Income tax expense". As of December 31, 2015 and 2014, we had approximately $41 million and $18 million, respectively, of accrued interest and penalties related to uncertain tax positions. For the year ended December 31, 2015, 2014, and 2013, we recorded $10 million, $5 million, and $2 million, respectively, of interest expense related to uncertain tax positions.

Based on the current status with the IRS, there is insufficient information to identify any significant changes in unrecognized tax benefits in the next twelve months. However, the Company may recognize a benefit of up to approximately $18 million related to the settlement of tax audits and/or the expiration of statutes of limitations in the next twelve months.

Although the final resolution of the Company's global tax disputes, audits, or any particular issue with the applicable taxing authority is uncertain, based on current information, in the opinion of the Company's management, the ultimate resolution of these matters will not have a material adverse effect on the Company's consolidated financial position, liquidity or results of operations. However, any settlement or resolution of the Company's global tax disputes, audits, or any particular issue with the applicable taxing authority could have a material favorable or unfavorable effect on our business and results of operations in the period in which the matters are ultimately resolved.