|12 Months Ended|
Dec. 31, 2012
NOTE 4. INCOME TAXES
Income tax expense consists of the following:
A reconciliation of the U.S. federal income tax rate of 35 percent to the actual effective tax rate was as follows:
Our income tax rates are generally less than the 35 percent U.S. statutory income tax rate primarily because of lower taxes on foreign earnings and research tax credits. Our 2012 income tax provision includes a one-time $134 million tax benefit resulting from transactions entered into and tax return elections made with respect to our United Kingdom (U.K.) operations.
Retained earnings of our U.K. domiciled subsidiaries and certain Singapore, German and Indian subsidiaries are considered to be permanently reinvested. In addition, earnings of our China operations generated after December 31, 2011, are considered to be permanently reinvested and additional U.S. deferred tax is no longer being provided on these earnings generated after 2011. China's permanently reinvested earnings are expected to be used for items such as capital expenditures and to fund joint ventures in China. The total permanently reinvested retained earnings and related cumulative translation adjustment balances for these entities were $2.3 billion, $1.5 billion and $1.2 billion for the years ended December 31, 2012, 2011 and 2010, 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 generated in years prior to 2012, were $213 million and $222 million at December 31, 2012 and 2011, respectively. We have $702 million of retained earnings and related cumulative translation adjustments in our China operations generated prior to December 31, 2011, and have provided a U.S. deferred tax liability of $158 million relating to these earnings and related translation adjustments. We anticipate that these earnings will be distributed to the U.S. within the next five years.
Income before income taxes includes equity income of foreign joint ventures of $192 million, $234 million and $218 million for the years ended December 31, 2012, 2011 and 2010, respectively. This equity income is recorded net of foreign taxes. Additional U.S. income taxes of $9 million, $49 million and $50 million for the years ended December 31, 2012, 2011 and 2010, 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 were as follows:
Our 2012 U.S. federal and state carryforward benefits include $115 million of state credit and net operating loss carryforward benefits that begin to expire in 2013. Our foreign carryforward benefits include $50 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 2012 by a net $24 million and increased in 2011 by a net $21 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. Prepaid and other current assets includes deferred tax assets of $232 million and $268 million for the years ended December 31, 2012 and 2011, respectively. In addition, prepaid and other current assets includes refundable income taxes of $240 million and $45 million for the years ended December 31, 2012 and 2011, respectively. Other assets includes deferred tax assets of $177 million and $167 million for the years ended December 31, 2012 and 2011, respectively. Other liabilities and deferred revenue includes deferred tax liabilities of $13 million and $18 million for the years ended December 31, 2012 and 2011, respectively.
A reconciliation of the beginning and ending amount of unrecognized tax benefits was as follows:
Included in the December 31, 2012 and 2011, balances are $87 million and $75 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 $2 million, $7 million and $30 million as of December 31, 2012, 2011 and 2010, respectively. We recognize potential accrued interest and penalties related to unrecognized tax benefits in income tax expense. During the years ending December 31, 2012, 2011 and 2010, we recognized $(3) million, $(15) million and $5 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 assessments for years before 2009.
The entire disclosure for income taxes. Disclosures may include net deferred tax liability or asset recognized in an enterprise's statement of financial position, net change during the year in the total valuation allowance, approximate tax effect of each type of temporary difference and carryforward that gives rise to a significant portion of deferred tax liabilities and deferred tax assets, utilization of a tax carryback, and tax uncertainties information.
Reference 1: http://www.xbrl.org/2003/role/presentationRef