Income Taxes



	Years Ended March 31,
(In millions)	2014		2013		2012
Income from continuing operations before income taxes
U.S.	$	1,554	$	1,562	$	1,293
Foreign	542		366		600
Total income from continuing operations before income taxes	$	2,096	$	1,928	$	1,893

Income tax expense related to continuing operations consists of the following:



	Years Ended March 31,
(In millions)	2014			2013			2012
Current
Federal	$	484		$	(84	)	$	265
State	64			14			51
Foreign	178			40			28
Total current	726			(30		)	344

Deferred
Federal	24			538			132
State	10			80			29
Foreign	(18		)	(7		)	9
Total deferred	16			611			170
Income tax expense	$	742		$	581		$	514

Income tax expense included $94 million of net discrete tax expense in 2014, and $29 million and $66 million of net discrete tax benefit in 2013 and 2012. Discrete tax expense for 2014 primarily related to a $122 million charge regarding an unfavorable decision from the Tax Court of Canada with respect to transfer pricing issues. Included in the 2012 discrete tax benefit is a $31 million credit to income tax expense as a result of the reversal of an unrecognized tax benefit relating to our AWP litigation. The 2013 federal and state current income tax expense reflects the utilization of alternative minimum tax credit carryforwards.

We have received reassessments from the Canada Revenue Agency (“CRA”) for a total of $219 million related to a transfer pricing matter impacting years 2003 through 2009. We previously appealed the reassessment for 2003 to the Tax Court of Canada and have filed a notice of objection for 2004 through 2009. On December 13, 2013, the Tax Court of Canada dismissed our appeal of the reassessment with respect to 2003. On January 10, 2014, we filed a Notice of Appeal to the Federal Court of Appeal in response to the judgment of the Tax Court of Canada. As a result of the unfavorable Tax Court Decision relating to 2003, we recognized a discrete tax expense of $122 million in the third quarter of 2014, which includes tax and interest, for the years 2003 through 2013. The ultimate resolution of these issues could result in an increase or decrease to income tax expense.

We have received tax assessments of $98 million from the U.S. Internal Revenue Service (“IRS”) relating to 2003 through 2006. We are pursuing administrative relief through the appeals process. We continue to believe in the merits of our tax positions and that we have adequately provided for any potential adverse results relating to these examinations in our financial statements.

The IRS is currently examining our U.S. corporation income tax returns for 2007 through 2009. The CRA is currently examining our Canadian income tax returns for 2010 through 2013. In nearly all jurisdictions, the tax years prior to 2003 are no longer subject to examination.

Significant judgments and estimates are required in determining the consolidated income tax provision and evaluating income tax uncertainties. Although our major taxing jurisdictions are the U.S. and Canada, we are subject to income taxes in numerous foreign jurisdictions. Our income tax expense, deferred tax assets and liabilities and uncertain tax liabilities reflect management’s best assessment of estimated current and future taxes to be paid. We believe that we have made adequate provision for all income tax uncertainties.

The reconciliation between our effective tax rate on income from continuing operations and statutory tax rate is as follows:



	Years Ended March 31,
(In millions)	2014			2013			2012
Income tax expense at federal statutory rate	$	734		$	670		$	670
State income taxes net of federal tax benefit	57			58			56
Foreign income taxed at various rates	(166		)	(136		)	(174		)
Canadian litigation	122			—			—
Unrecognized tax benefits and settlements	(6		)	1			(18		)
Tax credits	(6		)	(13		)	(13		)
Other, net	7			1			(7		)
Income tax expense	$	742		$	581		$	514

At March 31, 2014 undistributed earnings of our foreign operations totaling $4.2 billion were considered to be permanently reinvested. No deferred tax liability has been recognized on the basis difference created by such earnings since it is our intention to utilize those earnings in the foreign operations as well as to fund certain research and development activities for an indefinite period of time. The determination of the amount of deferred taxes on these earnings is not practicable because the computation would depend on a number of factors that cannot be known until a decision to repatriate the earnings is made.

Deferred tax balances consisted of the following:



	March 31,
(In millions)	2014			2013
Assets
Receivable allowances	$	106		$	84
Deferred revenue	136			106
Compensation and benefit related accruals	641			553
Net operating loss and credit carryforwards	430			341
Other	289			281
Subtotal	1,602			1,365
Less: valuation allowance	(270		)	(118		)
Total assets	1,332			1,247
Liabilities
Inventory valuation and other assets	(2,163		)	(2,089		)
Fixed assets and systems development costs	(321		)	(267		)
Intangibles	(1,531		)	(734		)
Other	(118		)	(24		)
Total liabilities	(4,133		)	(3,114		)
Net deferred tax liability	$	(2,801	)	$	(1,867	)

Current net deferred tax asset	$	51		$	16
Current net deferred tax liability	(1,588		)	(1,626		)
Long-term deferred tax asset	19			21
Long-term deferred tax liability	(1,283		)	(278		)
Net deferred tax liability	$	(2,801	)	$	(1,867	)

We assess the available positive and negative evidence to determine whether deferred tax assets are more likely than not to be realized. As a result of this assessment, valuation allowances have been recorded on certain deferred tax assets in various tax jurisdictions. The increase in valuation allowances in the current year relate primarily to net operating losses incurred in certain tax jurisdictions for which no tax benefit was recognized and deferred tax assets that were acquired as part of the Celesio acquisition which are not more likely than not to be realized.

We have federal, state and foreign net operating loss carryforwards of $53 million, $2,524 million and $935 million. The federal and state net operating losses will expire at various dates from 2015 through 2034. Substantially all of our foreign net operating losses have indefinite lives. In addition, we have Canadian research and development credit carryforwards of $11 million, and we believe it is more likely than not that these credits will be realized. The Canadian research and development credits will expire at various dates from 2029 to 2034.

The following table summarizes the activity related to our gross unrecognized tax benefits for the last three years:



	Years Ended March 31,
(In millions)	2014			2013			2012
Unrecognized tax benefits at beginning of period	$	560		$	595		$	635
Additions based on tax positions related to prior years	106			46			11
Reductions based on tax positions related to prior years	(31		)	(108		)	(72		)
Additions based on tax positions related to current year	23			31			37
Reductions based on settlements	(4		)	(2		)	(1		)
Reductions based on the lapse of the applicable statutes of limitations	(7		)	(2		)	(15		)
Unrecognized tax benefits at end of period	$	647		$	560		$	595

Of the total $647 million in unrecognized tax benefits at March 31, 2014, $490 million would reduce income tax expense and the effective tax rate if recognized. During the next twelve months, it is reasonably possible that audit resolutions and the expiration of statutes of limitations could potentially reduce our unrecognized tax benefits by up to $230 million. However, this amount may change because we continue to have ongoing negotiations with various taxing authorities throughout the year.

We report interest and penalties on unrecognized tax benefits as income tax expense. In 2014 and 2013, we recognized income tax expense of $48 million and a reduction to income tax expense of $8 million, related to interest and penalties in our consolidated statements of operations. The income tax expense for interest and penalties recognized in 2014 was primarily due to the additional interest resulting from the increase of our Canadian gross unrecognized tax benefits. The reduction to income tax expense in 2013 was primarily due to the reversal of accrued interest resulting from the reduction of our gross unrecognized tax benefits. At March 31, 2014 and 2013, we had $179 million and $131 million, accrued for the payment of interest and penalties on unrecognized tax benefits.