Income Taxes



	Years Ended March 31,
(In millions)	2015		2014		2013
Income from continuing operations before income taxes
U.S.	$	1,893	$	1,554	$	1,562
Foreign	764		617		388
Total income from continuing operations before income taxes	$	2,657	$	2,171	$	1,950

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



	Years Ended March 31,
(In millions)	2015			2014			2013
Current
Federal	$	453		$	484		$	(84	)
State	90			64			14
Foreign	101			193			46
Total current	644			741			(24		)

Deferred
Federal	195			24			538
State	53			10			80
Foreign	(77		)	(18		)	(7		)
Total deferred	171			16			611
Income tax expense	$	815		$	757		$	587

During 2015, 2014 and 2013, income tax expense related to continuing operations was $815 million, $757 million and $587 million and included net discrete tax benefit of $33 million, net discrete tax expense of $94 million and net discrete tax benefit of $29 million. Our discrete tax expense for 2014 is primarily related to a $122 million charge regarding an unfavorable decision from the Tax Court of Canada with respect to transfer pricing issues. 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”) related to a transfer pricing matter impacting years 2003 through 2010, and have filed Notices of Appeal to the Tax Court of Canada for all of these years. On December 13, 2013, the Tax Court of Canada dismissed our appeal of the 2003 reassessment and we have filed a Notice of Appeal to the Federal Court of Appeal regarding this tax year. After the close of 2015, we reached an agreement in principle with the CRA to settle the transfer pricing matter for years 2003 through 2010. Since the agreement in principle did not occur within 2015, we have not reflected this potential settlement in our 2015 financial statements. We will record the final settlement amount in a subsequent quarter and do not expect it to have a material impact to income tax expense.

During 2015, we reached an agreement with the Internal Revenue Service (“IRS”) to settle all outstanding issues relating to years 2003 through 2006 and recognized discrete tax benefits of $55 million to record previously unrecognized tax benefits and related interest.

The IRS has been examining our U.S. corporation income tax returns for 2007 through 2009. We anticipate that they will issue a Revenue Agent Report in 2016 to disclose the results of their audit and any proposed assessments. The CRA is currently examining our Canadian income tax returns for years 2011 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)	2015			2014			2013
Income tax expense at federal statutory rate	$	930		$	760		$	683
State income taxes net of federal tax benefit	81			57			58
Foreign income taxed at various rates	(247		)	(177		)	(143		)
Canadian litigation	—			122			—
Controlled substance distribution reserve	58			—			—
Unrecognized tax benefits and settlements	10			(6		)	1
Tax credits	(10		)	(6		)	(13		)
Other, net	(7		)	7			1
Income tax expense	$	815		$	757		$	587

At March 31, 2015, undistributed earnings of our foreign operations totaling $4,916 million 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)	2015			2014
Assets
Receivable allowances	$	83		$	94
Deferred revenue	72			136
Compensation and benefit related accruals	681			632
Net operating loss and credit carryforwards	316			337
Other	266			287
Subtotal	1,418			1,486
Less: valuation allowance	(229		)	(200		)
Total assets	1,189			1,286
Liabilities
Inventory valuation and other assets	(2,333		)	(2,161		)
Fixed assets and systems development costs	(324		)	(320		)
Intangibles	(1,073		)	(1,477		)
Other	(61		)	(117		)
Total liabilities	(3,791		)	(4,075		)
Net deferred tax liability	$	(2,602	)	$	(2,789	)

Current net deferred tax asset	$	26		$	42
Current net deferred tax liability	(1,819		)	(1,588		)
Long-term deferred tax asset	50			19
Long-term deferred tax liability	(859		)	(1,262		)
Net deferred tax liability	$	(2,602	)	$	(2,789	)

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.

We have federal, state and foreign net operating loss carryforwards of $44 million, $1,930 million and $711 million. The federal and state net operating losses will expire at various dates from 2016 through 2035. Substantially all of our foreign net operating losses have indefinite lives.

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



	Years Ended March 31,
(In millions)	2015			2014			2013
Unrecognized tax benefits at beginning of period	$	647		$	560		$	595
Additions based on tax positions related to prior years	62			106			46
Reductions based on tax positions related to prior years	(18		)	(23		)	(106		)
Additions based on tax positions related to current year	27			23			31
Reductions based on settlements	(65		)	(4		)	(2		)
Reductions based on the lapse of the applicable statutes of limitations	(12		)	(7		)	(2		)
Exchange rate fluctuations	(25		)	(8		)	(2		)
Unrecognized tax benefits at end of period	$	616		$	647		$	560

Of the total $616 million in unrecognized tax benefits at March 31, 2015, $457 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 $137 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 2015 and 2014, we recognized an income tax benefit of $24 million and income tax expense of $48 million related to interest and penalties in our consolidated statements of operations. The income tax benefit for interest and penalties recognized in 2015 was primarily due to the lapses of statutes of limitations. 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. At March 31, 2015 and 2014, we had $122 million and $179 million accrued for the payment of interest and penalties on unrecognized tax benefits.