NOTE 4. INCOME TAXES

        Income tax expense (benefit) consists of the following:

        A reconciliation of the U.S. federal income tax rate of 35 percent to the actual effective tax rate is as follows:

        The effective tax rate for 2011 includes a net income tax benefit of $48 million (net of additional reserves for uncertain tax positions of $41 million) related to prior year refund claims filed for additional research tax credits, as well as additional foreign income and related foreign tax credits. Our effective tax rate for 2011 also includes a net income tax benefit of $19 million related to the release of deferred U.S. tax liabilities on foreign earnings, as a result of restructuring our foreign operations. Also included in 2011 is a discrete tax benefit of $16 million resulting from the reduction of our unrecognized tax benefits primarily due to settlements with taxing authorities. The 2011 income tax provision also includes other discrete tax items totaling to a $2 million net tax charge, primarily relating to the enactment of state law changes in Indiana and the United Kingdom (U.K.) as well as adjustments to our income tax accounts based on our 2010 tax return filings.

        Retained earnings of our U.K. domiciled subsidiaries and certain Singapore, German and Indian subsidiaries are considered to be permanently reinvested. The total permanently reinvested retained earnings and related cumulative translation adjustment balances for these entities were $1.5 billion, $1.2 billion and $0.8 billion for the years ended December 31, 2011, 2010 and 2009, respectively. These amounts were determined primarily based on book retained earnings balances for these subsidiaries translated at historical rates. The determination of the deferred tax liability related to these retained earnings and cumulative translation adjustment balances which are considered to be permanently reinvested outside the U.S. is not practicable. We may periodically repatriate a portion of these earnings to the extent we can do so essentially tax-free or at minimal tax cost.

        For our remaining subsidiary companies and joint ventures outside the U.S., we provide for the additional taxes that would be due upon the dividend distribution of the income of those foreign subsidiaries and joint ventures assuming the full utilization of foreign tax credits. Deferred taxes on unremitted earnings of foreign subsidiaries and joint ventures, including those in China, were $222 million and $217 million at December 31, 2011 and 2010, respectively. We have $693 million of retained earnings and related cumulative translation adjustments in our China operations as of December 31, 2011, and have provided a U.S. deferred tax liability of $172 million related to these earnings that will be distributed to the U.S. in the future as well as the related translation impacts as of December 31, 2011. Earnings of our China operations for periods beginning after December 31, 2011 will be considered to be permanently reinvested and additional U.S. deferred tax will not be provided on these future earnings. These future earnings are expected to be used for capital expenditures and to fund joint ventures in China. During 2010, we released $3 million of U.S. deferred tax liabilities related to prior years unremitted income of certain German and Indian subsidiaries of our U.K. group now considered to also be permanently reinvested. Income before income taxes includes equity income of foreign joint ventures of $234 million, $218 million and $117 million for the years ended December 31, 2011, 2010 and 2009, respectively. This equity income is recorded net of foreign taxes. Additional U.S. income taxes of $49 million, $50 million and $31 million for the years ended December 31, 2011, 2010 and 2009, respectively, were provided for the additional U.S. taxes that will ultimately be due upon the distribution of the foreign joint venture equity income.

        Carryforward tax benefits and the tax effect of temporary differences between financial and tax reporting that give rise to net deferred tax assets are as follows:

        Our 2011 U.S. federal and state carryforward benefits include $86 million of state credit and net operating loss carryforward benefits that begin to expire in 2012. Our foreign carryforward benefits include $42 million of net operating loss carryforwards that begin to expire in 2013. A valuation allowance is recorded to reduce the gross deferred tax assets to an amount we believe is more likely than not to be realized. The valuation allowance increased in 2011 by a net $21 million and increased in 2010 by a net $6 million. The valuation allowance is primarily attributable to the uncertainty regarding the realization of a portion of the U.S. state and foreign net operating loss and tax credit carryforward benefits. Other assets includes deferred tax assets of $167 million and $203 million for the years ended December 31, 2011 and 2010. Other liabilities and deferred revenue includes deferred tax liabilities of $18 million and $6 million for the years ended December 31, 2011 and 2010, respectively.

        A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows:

        Included in the December 31, 2011 and 2010, balances are $75 million and $33 million related to tax positions that, if recognized, would favorably impact the effective tax rate in future periods. Also, we had accrued interest expense related to the unrecognized tax benefits of $7 million, $30 million and $22 million as of December 31, 2011, 2010 and 2009, respectively. We recognize potential accrued interest and penalties related to unrecognized tax benefits in income tax expense. During the years ending December 31, 2011, 2010 and 2009, we recognized $(15) million, $5 million and $4 million in net interest expense, respectively. In 2011, as a result of the settlement of certain tax positions with tax authorities in China, we reduced our liability for unrecognized tax benefits by $39 million and the related net accrued interest of $16 million. The $39 million reduction was fully offset by adjustments to other income tax balance sheet accounts resulting in zero net income statement impact. As the settlement with the tax authorities included no interest or penalties being incurred, we recognized a $16 million income tax benefit in 2011 from the release of the accrued interest previously recorded related to the unrecognized tax benefits that were settled.

        Audit outcomes and the timing of audit settlements are subject to significant uncertainty. Although we believe that adequate provision has been made for such issues, there is the possibility that the ultimate resolution of such issues could have an adverse effect on our earnings. Conversely, if these issues are resolved favorably in the future, the related provision would be reduced, thus having a positive impact on earnings. We do not expect any significant change to our unrecognized tax benefits within the next year.

        As a result of our global operations, we file income tax returns in various jurisdictions including U.S. federal, state and foreign jurisdictions. We are routinely subject to examination by taxing authorities throughout the world, including Australia, Belgium, Brazil, Canada, China, France, India, Mexico, the U.K. and the U.S. With few exceptions, our U.S. federal, major state and foreign jurisdictions are no longer subject to income tax examinations for years before 2005.