Income Taxes

12 Months Ended

Jun. 30, 2020

Income Tax Disclosure [Abstract]

Income Taxes

8. Income Taxes

Earnings/(Loss) before Income Taxes and Provision for/(Benefit From) Income Taxes

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

(in millions)	2020			2019		2018
U.S. operations	$	(4,056	)	$	1,478	$	391
Non-U.S. operations	284			273		(619		)
Earnings/(loss) before income taxes	$	(3,772	)	$	1,751	$	(228	)

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

(in millions)	2020			2019			2018
Current:
Federal	$	659		$	295		$	341
State and local	154			89			41
Non-U.S.	69			85			143
Total current	$	882		$	469		$	525
Deferred:
Federal	$	(822	)	$	(28	)	$	(1,003	)
State and local	(127		)	(37		)	16
Non-U.S.	(12		)	(18		)	(25		)
Total deferred	(961		)	(83		)	(1,012		)
Provision for/(benefit from) income taxes	$	(79	)	$	386		$	(487	)

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:

	2020 (1)		2019 (2)		2018 (1)
Provision at Federal statutory rate	21.0	%	21.0	%	28.1	%
State and local income taxes, net of federal benefit	2.5		0.9		(16.0	)
Tax effect of foreign operations	—		(0.7	)	(48.4	)
Nondeductible/nontaxable items	(0.1	)	2.5		(10.2	)
Goodwill impairment	—		—		(124.7	)
Tax Act	0.1		(0.8	)	410.9
Change in valuation allowances	1.5		4.5		(76.9	)
Foreign tax credits	0.5		(1.0	)	27.3
China tax related to divestiture	—		—		(25.8	)
Legal entity reorganization	—		(3.6	)	71.4
Opioid litigation	(23.2	)	—		—
Other	(0.2	)	(0.7	)	(21.9	)
Effective income tax rate	2.1	%	22.1	%	213.8	%

(1) The effective income tax rate for fiscal 2020 and 2018 represents an income tax benefit tax rate.

(2) The effective income tax rate for fiscal 2019 represents an income tax expense tax rate.

The income tax benefit rate was 2.1% and 213.8% in fiscal 2020 and fiscal 2018 compared to an income tax expense rate of 22.1% in fiscal 2019. Fluctuations in the effective tax rates are primarily due to the impact of opioid litigation in fiscal 2020 and the impact of the U.S. Tax Cuts and Jobs Act ("Tax Act") in fiscal 2018, both described further below, as well as the Medical Unit goodwill impairment in fiscal 2018, as described in Note 1. 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.

In connection with the $5.63 billion pre-tax charge for the opioid litigation, we recorded a tax benefit of $488 million in fiscal 2020, which is net of unrecognized tax benefits of $469 million, reflecting our current assessment of the estimated future deductibility of the amount that may be paid. We have made reasonable estimates and recorded amounts based on management's judgment and our current understanding of the tax law; however, these estimates require significant judgment since the definitive settlement terms and documentation, including provisions related to deductibility, under the Settlement Framework have not been negotiated and the U.S. tax law governing deductibility was changed by the Tax Act. Further, it is possible that the tax authorities could challenge our interpretation of the currently enacted tax law or the estimates and assumptions used to assess the future deductibility of these benefits. The actual amount of the tax benefit related to uncertain tax positions may differ materially from these estimates. See Note 7 for more information regarding these matters.

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 $17 million during fiscal 2020.

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 incrementally affected our fiscal year 2019 financial results in several ways. First, the U.S. statutory tax rate in fiscal 2019 was 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.

As of June 30, 2020, foreign earnings of approximately $800 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. For amounts not

considered indefinitely reinvested, we have recorded an immaterial amount of income tax expense in our financial statements in fiscal 2020.

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)	2020			2019
Deferred income tax assets:
Receivable basis difference	$	39		$	35
Accrued liabilities	607			133
Share-based compensation	38			39
Loss and tax credit carryforwards	589			621
Deferred tax assets related to uncertain tax positions	52			30
Other	87			6
Total deferred income tax assets	1,412			864
Valuation allowance for deferred income tax assets	(470		)	(542		)
Net deferred income tax assets	$	942		$	322
Deferred income tax liabilities:
Inventory basis differences	$	(1,083	)	$	(1,056	)
Property-related	(327		)	(171		)
Goodwill and other intangibles	(751		)	(808		)
Total deferred income tax liabilities	$	(2,161	)	$	(2,035	)
Net deferred income tax liability	$	(1,219	)	$	(1,713	)

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

(in millions)	2020			2019
Noncurrent deferred income tax asset (1)	$	39		$	36
Noncurrent deferred income tax liability (2)	(1,258		)	(1,749		)
Net deferred income tax liability	$	(1,219	)	$	(1,713	)

(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, 2020 we had gross federal, state and international loss and credit carryforwards of $123 million, $2.4 billion and $2.2 billion, respectively, the tax effect of which is an aggregate deferred tax asset of $589 million. Substantially all of these carryforwards are available for at least three years. Approximately $461 million of the valuation allowance at June 30, 2020 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 $998 million, $456 million and $423 million of unrecognized tax benefits at June 30, 2020, 2019 and 2018, respectively. The June 30, 2020, 2019 and 2018 balances include $753 million, $303 million and $262 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)	2020			2019			2018
Balance at beginning of fiscal year	$	456		$	423		$	417
Additions for tax positions of the current year	500			24			15
Additions for tax positions of prior years (1)	78			39			141
Reductions for tax positions of prior years	(27		)	(5		)	(40		)
Settlements with tax authorities (1)	(6		)	(25		)	(99		)
Expiration of the statute of limitations (1)	(3		)	—			(11		)
Balance at end of fiscal year	$	998		$	456		$	423

(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 $370 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, 2020, 2019 and 2018, we had $146 million, $122 million and $110 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 2020, 2019, and 2018 we recognized $16 million, $8 million, and $8 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 $176 million and $165 million at June 30, 2020 and 2019, 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 $19 million and $22 million at June 30, 2020 and 2019, respectively, and is included in other assets in the consolidated balance sheets.