Income Taxes

12 Months Ended

Dec. 31, 2020

Income Tax Disclosure [Abstract]

Income Taxes

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,
	2020		2019		2018
Income before income tax expense:
Domestic	$	1,160	$	328	$	432
Foreign	1,456		1,305		1,445
	$	2,616	$	1,633	$	1,877
Income tax expense (benefit):
Current:
Federal	$	206	$	136	$	(208)
State	92		24		(15)
Foreign	218		323		280
Total current	516		483		57
Deferred:
Federal	(84)		781		(153)
State	(10)		(16)		106
Foreign	(3)		(1,118)		19
Total deferred	(97)		(353)		(28)
Income tax expense	$	419	$	130	$	29

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,
	2020				2019				2018
Federal income tax provision at statutory rate	$	549	21	%	$	343	21	%	$	394	21	%
State taxes, net of federal benefit	49		2		20		1		36		2
Research and development credits	(70)		(3)		(38)		(2)		(46)		(2)
Foreign rate differential	(103)		(4)		(104)		(7)		(198)		(11)
Foreign-derived intangible income	(40)		(2)		(1)		—		—		—
Change in tax reserves	60		2		96		6		285		15
Audit settlements	—		—		54		3		(115)		(6)
Excess tax benefits related to share-based payments	(30)		(1)		(2)		—		(58)		(3)
U.S. Tax Reform Act	—		—		—		—		(340)		(18)
Change in valuation allowance	35		2		11		1		61		3
Intra-entity IP Transfer	(31)		(1)		(230)		(14)		—		—
Other	—		—		(19)		(1)		10		1
Income tax expense	$	419	16	%	$	130	8	%	$	29	2	%

The Company’s tax rate is affected by the tax rates in the jurisdictions in which the Company operates, some of which have a statutory tax rate less than the U.S. rate and the relative amount of income earned in each jurisdiction.

In October 2019, we completed an intra-entity transfer of certain intellectual property rights to one of our subsidiaries in the U.K., aligning the ownership of these rights with our evolving business. The transfer did not result in a taxable gain; however, our U.K. subsidiary received a step-up in tax basis based on the fair value of the transferred intellectual property rights. Such fair value was determined based on our expectations of future cash flows, long-term growth rates, and discount rates. We recorded a one-time benefit of $230 million in the quarter ended December 31, 2019 for the recognition of a $1.1 billion deferred tax asset in the U.K. related to the amortizable tax basis in the transferred intellectual property, net of uncertain tax positions and a valuation allowance, partially offset by a related $920 million deferred tax liability for U.S. taxes on foreign earnings. The U.K. amortizable tax basis will be recovered over a period of three years to 25 years and the related deferred tax asset was measured using the enacted U.K. corporate tax rates for the years in which the amortization will be realized. We recorded a valuation allowance of $110 million in 2019 for the portion of the deferred tax asset for which it is more-likely-than-not that a benefit will not be realized. We will update the measurement and realizability analysis going forward and record the impact from any change in determination in the period of the change.

During the year ended December 31, 2020, we completed an intra-entity transfer of certain intellectual property rights to the U.S. to better align the profits related to these rights with our evolving business activities. As a result, a significant portion of these earnings began qualifying for preferential treatment as foreign-derived intangible income during 2020. The transfer resulted in a one-time benefit of $31 million in connection with the remeasurement of a U.S. deferred tax asset related to foreign earnings.

On June 27, 2018, we entered into a closing agreement with the Internal Revenue Service (“IRS”) to resolve certain intercompany transfer pricing arrangements for tax periods starting in 2009 (the “Closing Agreement”). The primary adjustments related to the Closing Agreement were recognized in the second quarter of 2018 and consisted of a tax expense of $70 million and a reduction in unrecognized tax benefits of $437 million. In addition, we recognized $185 million of tax benefits related to other tax adjustments resulting from the changes in U.S. tax attributes and taxable income caused by the primary adjustments. The Closing Agreement resulted in federal and state cash tax payments totaling approximately $345 million, of which federal tax payments of $334 million were made in October 2018.

On December 22, 2017, the U.S. Tax Reform Act was enacted. The U.S. Tax Reform Act, among other things, reduced the U.S. corporate income tax rate from 35% to 21%, beginning in 2018, and implemented the Transition Tax. In the fourth quarter of 2018, we completed our analysis of the effect of the U.S. Tax Reform Act and recorded a net tax benefit of $340 million. This is primarily related to adoption of GILTI deferred tax accounting and remeasurement of deferred tax assets and liabilities partially offset by tax expense related to Transition Tax.

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,
	2020		2019
Deferred tax assets:
Deferred revenue	$	274	$	119
Tax attributes carryforwards	123		93
Share-based compensation	51		54
Intangibles	1,287		1,289
Capitalized software development expenses	21		67
Other	160		156
Deferred tax assets	1,916		1,778
Valuation allowance	(228)		(181)
Deferred tax assets, net of valuation allowance	1,688		1,597
Deferred tax liabilities:
Intangibles	(147)		(142)
U.S. deferred taxes on foreign earnings	(577)		(594)
Other	(63)		(73)
Deferred tax liabilities	(787)		(809)
Net deferred tax assets	$	901	$	788

As of December 31, 2020, we had gross tax credit carryforwards of $227 million for state purposes. The tax credit carryforwards are included in deferred tax assets net of unrealized tax benefits that would apply upon the realization of uncertain tax positions. In addition, we had foreign net operating loss carryforwards of $46 million at December 31, 2020, most of which carry forward indefinitely.

We evaluate deferred tax assets each period for recoverability. We record a valuation allowance for assets that do not meet the threshold of “more likely than not” to be realized in the future. To make that determination, we evaluate the likelihood of realization based on the weight of all positive and negative evidence available. As of December 31, 2020 and December 31, 2019, we maintained a valuation allowance related to our California research and development credit carryforwards of $107 million and $71 million, respectively. We will reassess this determination quarterly and record a tax benefit if and when future evidence allows for a partial or full release of this valuation allowance.

In addition, we remeasured the U.K. deferred tax asset related to previously transferred intellectual property rights and corresponding U.S. deferred tax liability due to the change in the U.K.'s corporate income tax rate during 2020. As of December 31, 2020, the U.K. deferred tax asset net of valuation allowance is $1.1 billion and the corresponding U.S. deferred tax liability is $881 million.

Activision Blizzard’s tax years after 2008 remain open to examination by certain major taxing jurisdictions to which we are subject. The Internal Revenue Service is currently examining our federal tax returns for the 2012 through 2016 tax years. We also have several state and non-U.S. audits pending. In addition, King’s pre-acquisition tax returns remain open in various jurisdictions, primarily as a result of transfer pricing matters. We anticipate resolving King’s transfer pricing for both pre- and post-acquisition tax years through a collaborative multilateral process with the tax authorities in the relevant jurisdictions, which include the U.K. and Sweden. While the outcome of this process remains uncertain, it could result in an agreement that changes the allocation of profits and losses between these and other relevant jurisdictions or a failure to reach an agreement that results in unilateral adjustments to the amount and timing of taxable income in the jurisdictions in which King operates.

In December 2017, we received a Notice of Reassessment from the French Tax Authority (the “FTA”) related to transfer pricing for intercompany transactions involving one of our French subsidiaries for the 2011 through 2013 tax years. The total assessment, including penalties and interest, was approximately €571 million (approximately $638 million). In December 2019, the Company reached a settlement with the FTA for the 2011 through 2018 tax years, resulting in the recognition of $54 million of tax expense in the period ended December 31, 2019 and a tax payment of €161 million (approximately $179 million), including interest and penalties, in January 2020.

In addition, certain of our subsidiaries are under examination or investigation, or may be subject to examination or investigation, by tax authorities in various jurisdictions. These proceedings may lead to adjustments or proposed adjustments to our taxes or provisions for uncertain tax positions. Such proceedings may have a material adverse effect on the Company’s consolidated financial position, liquidity, or results of operations in the earlier of the period or periods in which the matters are resolved and in which appropriate tax provisions are taken into account in our financial statements. If we were to receive a materially adverse assessment from a taxing jurisdiction, we would plan to vigorously contest it and consider all of our options, including the pursuit of judicial remedies.

As of December 31, 2020, we had $1.2 billion of gross unrecognized tax benefits, $706 million of which would affect our effective tax rate, if recognized. A reconciliation of total gross unrecognized tax benefits is as follows (amounts in millions):

	For the Years Ended December 31,
	2020		2019		2018
Unrecognized tax benefits balance at January 1	$	1,037	$	926	$	1,138
Gross increase for tax positions taken during a prior year	97		151		103
Gross decrease for tax positions taken during a prior year	(1)		(168)		(123)
Gross increase for tax positions taken during the current year	38		291		132
Settlement with taxing authorities	(3)		(163)		(312)
Lapse of statute of limitations	(2)		—		(12)
Unrecognized tax benefits balance at December 31	$	1,166	$	1,037	$	926

As of December 31, 2020, 2019, and 2018, we had approximately $93 million, $72 million, and $87 million, respectively, of accrued interest and penalties related to uncertain tax positions. For the years ended December 31, 2020, 2019, and 2018, we recorded $19 million, $14 million, and $11 million, respectively, of interest expense related to uncertain tax positions.

The final resolution of the Company’s global tax disputes is uncertain. There is significant judgment required in the analysis of disputes, including the probability determination and estimation of the potential exposure. Based on current information, in the opinion of the Company’s management, the ultimate resolution of these matters is not expected to have a material adverse effect on the Company’s consolidated financial position, liquidity or results of operations, except as noted above.