7. Income Taxes

Earnings/(loss) before Income Taxes and Provision for Income Taxes

The following table summarizes earnings/(loss) before income taxes:



(in millions)	2019		2018			2017
U.S. operations	$	1,478	$	391		$	1,772
Non-U.S. operations	273		(619		)	152
Earnings/(loss) before income taxes	$	1,751	$	(228	)	$	1,924

The following table summarizes the components of provision for/(benefit from) income taxes:



(in millions)	2019			2018			2017
Current:
Federal	$	295		$	341		$	273
State and local	89			41			10
Non-U.S.	85			143			56
Total current	$	469		$	525		$	339

Deferred:
Federal	$	(28	)	$	(1,003	)	$	258
State and local	(37		)	16			37
Non-U.S.	(18		)	(25		)	(4		)
Total deferred	(83		)	(1,012		)	291
Provision for/(benefit from) income taxes	$	386		$	(487	)	$	630

Effective Tax Rate

The following table presents a reconciliation of the provision based on the federal statutory income tax rate to our effective income tax rate:



	2019 (1)		2018 (2)		2017 (1)
Provision at Federal statutory rate	21.0	%	28.1	%	35.0	%
State and local income taxes, net of federal benefit	0.9		(16.0	)	1.0
Tax effect of foreign operations	(0.7	)	(48.4	)	(7.3	)
Nondeductible/nontaxable items	2.5		(10.2	)	0.2
Goodwill impairment	—		(124.7	)	—
Tax Act	(0.8	)	410.9		—
Change in valuation allowances	4.5		(76.9	)	7.7
Foreign tax credits	(1.0	)	27.3		(1.6	)
China tax related to divestiture	—		(25.8	)	—
Legal entity reorganization	(3.6	)	71.4		—
Other	(0.7	)	(21.9	)	(2.3	)
Effective income tax rate	22.1	%	213.8	%	32.7	%


(1)	The effective income tax rate for fiscal 2019 and 2017 represents an income tax expense tax rate.


(2)	The effective income tax rate for fiscal 2018 represents an income tax benefit tax rate.

The income tax expense rate in fiscal 2019 was 22.1% compared to an income tax benefit rate of 213.8% in fiscal 2018 and an income tax expense rate of 32.7% in fiscal 2017. Fluctuations in the effective tax rates are primarily due to fiscal 2018 net benefits from the enactment of the Tax Act, the impact of nondeductible goodwill impairment charge, and a benefit from a capital loss due to international legal entity reorganization. There were also changes in valuation allowances related to capital losses, credit carryforwards and net operating loss carryforwards in U.S. federal, U.S. state and international jurisdictions.

Our effective tax rate has benefits from negotiated lower than statutory tax rates in select foreign jurisdictions which individually are not material to our effective tax rate but in aggregate have a favorable tax impact of approximately $40 million.

On December 22, 2017, the United States enacted the Tax Act. The Tax Act made broad and complex changes to the U.S. tax code that affected fiscal 2018 and will incrementally affect our fiscal year 2019 financial results in several ways. First, the U.S. statutory tax rate in fiscal 2019 is reduced to 21.0%. Second, the Tax Act established new tax provisions that affected us beginning July 1, 2018 including, (1) eliminating the U.S. manufacturing deduction; (2) establishing new limitations on deductible interest expense and certain executive compensation; (3) eliminating the corporate alternative minimum tax; (4) creating the base erosion anti-abuse tax; (5) creating a new provision designed to tax global intangible low-tax income (“GILTI”) and allow for a deduction related to foreign derived intangible income ("FDII"); (6) generally eliminating U.S. federal income taxes on dividends from foreign subsidiaries; and (7) changing rules related to uses and limitations of net operating loss carryforwards created in tax years beginning after December 31, 2017.

Regarding the new GILTI tax rules, we elected to treat taxes due on future GILTI inclusions in U.S. taxable income as a current period expense when incurred.

In accordance with SAB 118, we finalized our provisional estimates related to transitional tax benefits (i.e., remeasurement of deferred tax assets and liabilities and the repatriation tax on undistributed foreign earnings) which did not have a significant impact on tax expense during fiscal 2019. Future adjustments to the financial statements may be necessary as final tax regulations, including issued and pending regulatory changes are issued. We will assess any impact as additional guidance is issued.

During the fiscal year ended June 30, 2019, the Company completed the final calculation of the U.S. repatriation tax after the issuance of final regulations by the U.S Treasury Department under section 965. After completion of the calculation and an overall review of the cash positions post-tax reform and business needs globally, the Company is changing its assertion on $309 million previously considered indefinitely reinvested as of June 30, 2018, which did not have a material impact on our provision for income taxes.

As of June 30, 3019, foreign earnings of approximately $780 million are considered indefinitely reinvested for working capital and other offshore investment needs. The computation of tax required if those earnings are repatriated is not practicable.

Deferred Income Taxes

Deferred income taxes arise from temporary differences between financial reporting and tax reporting bases of assets and liabilities and operating loss and tax credit carryforwards for tax purposes.

The following table presents the components of the deferred income tax assets and liabilities at June 30:



(in millions)	2019			2018
Deferred income tax assets:
Receivable basis difference	$	35		$	41
Accrued liabilities	133			110
Share-based compensation	39			40
Loss and tax credit carryforwards	621			526
Deferred tax assets related to uncertain tax positions	30			30
Other	6			101
Total deferred income tax assets	864			848
Valuation allowance for deferred income tax assets	(542		)	(412		)
Net deferred income tax assets	$	322		$	436

Deferred income tax liabilities:
Inventory basis differences	$	(1,056	)	$	(1,103	)
Property-related	(171		)	(176		)
Goodwill and other intangibles	(808		)	(934		)
Total deferred income tax liabilities	$	(2,035	)	$	(2,213	)
Net deferred income tax liability	$	(1,713	)	$	(1,777	)

Deferred income tax assets and liabilities in the preceding table, after netting by taxing jurisdiction, are in the following captions in the consolidated balance sheets at June 30:



(in millions)	2019			2018
Noncurrent deferred income tax asset (1)	$	36		$	37
Noncurrent deferred income tax liability (2)	(1,749		)	(1,814		)
Net deferred income tax liability	$	(1,713	)	$	(1,777	)


(1)	Included in other assets in the consolidated balance sheets.


(2)	Included in deferred income taxes and other liabilities in the consolidated balance sheets.

At June 30, 2019 we had gross federal, state and international loss and credit carryforwards of $463 million, $2.7 billion and $1.9 billion, respectively, the tax effect of which is an aggregate deferred tax asset of $621 million. Substantially all of these carryforwards are available for at least three years. Approximately $524 million of the valuation allowance at June 30, 2019 applies to certain federal, state and international loss carryforwards that, in our opinion, are more likely than not to expire unutilized. However, to the extent that tax benefits related to these carryforwards are realized in the future, the reduction in the valuation allowance would reduce income tax expense.

Unrecognized Tax Benefits

We had $456 million, $423 million and $417 million of unrecognized tax benefits at June 30, 2019, 2018 and 2017, respectively. The June 30, 2019, 2018 and 2017 balances include $303 million, $262 million and $268 million, respectively, of unrecognized tax benefits that, if recognized, would have an impact on the effective tax rate. The remaining unrecognized tax benefits relate to tax positions for which ultimate deductibility is highly certain but for which there is uncertainty as to the timing of such deductibility. Recognition of these tax benefits would not affect our effective tax rate. We include the full amount of unrecognized tax benefits in deferred income taxes and other liabilities in the consolidated balance sheets. The following table presents a reconciliation of the beginning and ending amounts of unrecognized tax benefits:



(in millions)	2019			2018			2017
Balance at beginning of fiscal year	$	423		$	417		$	527
Additions for tax positions of the current year	24			15			29
Additions for tax positions of prior years (1)	39			141			23
Reductions for tax positions of prior years	(5		)	(40		)	(8		)
Settlements with tax authorities (1)	(25		)	(99		)	(154		)
Expiration of the statute of limitations (1)	—			(11		)	—
Balance at end of fiscal year	$	456		$	423		$	417


(1)	Included in fiscal 2018 additions for tax positions of prior years is $110 million related to exposures acquired as part of the Patient Recovery Business for which we are fully indemnified. Also for fiscal 2018 are settlements of $81 million related to the Patient Recovery Business as well as $11 million of statute expirations.

It is reasonably possible that there could be a change in the amount of unrecognized tax benefits within the next 12 months due to activities of the U.S. Internal Revenue Service ("IRS") or other taxing authorities, possible settlement of audit issues, reassessment of existing unrecognized tax benefits or the expiration of statutes of limitations. We estimate that the range of the possible change in unrecognized tax benefits within the next 12 months is a net decrease of $0 million to $15 million, exclusive of penalties and interest.

We recognize accrued interest and penalties related to unrecognized tax benefits in the provision for income taxes. At June 30, 2019, 2018 and 2017, we had $122 million, $110 million and $99 million, respectively, accrued for the payment of interest and penalties. These balances are gross amounts before any tax benefits and are included in deferred income taxes and other liabilities in the consolidated balance sheets. During fiscal 2019, 2018, and 2017 we recognized $8 million, $8 million, and $12 million of expense for interest and penalties in income tax expense, respectively.

Other Tax Matters

We file income tax returns in the U.S. federal jurisdiction, various U.S. state and local jurisdictions, and various foreign jurisdictions. With few exceptions, we are subject to audit by taxing authorities for fiscal years 2008 through the current fiscal year.

We are a party to a tax matters agreement with CareFusion Corporation ("CareFusion"), which has been acquired by Becton, Dickinson and Company. Under the tax matters agreement, CareFusion is obligated to indemnify us for certain tax exposures and transaction taxes prior to our fiscal 2010 spin-off of CareFusion. The indemnification receivable was $165 million and $151 million at June 30, 2019 and 2018, respectively, and is included in other assets in the consolidated balance sheets.

As a result of the acquisition of the Patient Recovery Business, Medtronic plc is obligated to indemnify us for certain tax exposures and transaction taxes related to periods prior to the acquisition under the purchase agreement. The indemnification receivable was $22 million and $21 million at June 30, 2019 and 2018, respectively, and is included in other assets in the consolidated balance sheets.