Cummins Inc. Annual report pursuant to Section 13 and 15(d)

Annual report pursuant to Section 13 and 15(d)

INCOME TAXES

INCOME TAXES

12 Months Ended

Dec. 31, 2015

NOTE 5. INCOME TAXES



	Years ended December 31,
In millions	2015		2014		2013
Income before income taxes
U.S. income	$	1,275	$	1,407	$	1,058
Foreign income	750		1,027		1,061
Total	$	2,025	$	2,434	$	2,119

Income tax expense consists of the following:



	Years ended December 31,
In millions	2015			2014			2013
Current
U.S. federal and state	$	516		$	470		$	239
Foreign	147			197			192
Total current	663			667			431
Deferred
U.S. federal and state	(151		)	39			67
Foreign	43			(8		)	33
Total deferred	(108		)	31			100
Income tax expense	$	555		$	698		$	531

A reconciliation of the statutory U.S. federal income tax rate to the effective tax rate was as follows:



	Years ended December 31,
	2015		2014		2013
Statutory U.S. federal income tax rate	35.0	%	35.0	%	35.0	%
State income tax, net of federal effect	1.2		1.1		0.2
Differences in rates and taxability of foreign subsidiaries and joint ventures	(6.6	)	(5.7	)	(6.0	)
Research tax credits	(1.4	)	(1.5	)	(3.7	)
Other, net	(0.8	)	(0.2	)	(0.4	)
Effective tax rate	27.4	%	28.7	%	25.1	%

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 effective tax rate for 2015 was 27.4 percent compared to 28.7 percent for 2014. The 1.3 percent decrease in the effective tax rate from 2014 to 2015 is primarily due to the release of reserves for uncertain tax positions related to a favorable federal audit settlement and favorable changes in the jurisdictional mix of pre-tax income.

Retained earnings of our U.K. domiciled subsidiaries and certain Singapore, German, Indian and Mexican subsidiaries are considered to be permanently reinvested. During 2013, we released $12 million of U.S. deferred tax liabilities related to prior years unremitted income of certain Indian and Mexican subsidiaries considered to be permanently reinvested starting in 2013. In addition, earnings of our China operations generated after December 31, 2011, are considered to be permanently reinvested. U.S. deferred tax is not provided on these permanently reinvested earnings. Our permanently reinvested foreign earnings are expected to be used for items such as capital expenditures and to fund joint ventures outside of the U.S. The total permanently reinvested retained earnings and related cumulative translation adjustment balances for these entities were $3.3 billion, $3.8 billion and $3.1 billion for the years ended December 31, 2015, 2014, and 2013, 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.

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 tax liabilities on unremitted earnings of foreign subsidiaries and joint ventures, including those in China generated in years prior to 2012, were $69 million and $204 million at December 31, 2015 and 2014, respectively. We have $673 million of retained earnings and related cumulative translation adjustments in our China operations generated prior to December 31, 2011, for which we have provided a U.S. deferred tax liability of $150 million.

Income before income taxes included equity income of foreign joint ventures of $213 million, $212 million and $203 million for the years ended December 31, 2015, 2014 and 2013, respectively. This equity income is recorded net of foreign taxes. Additional U.S. income taxes of $20 million, $14 million and $13 million for the years ended December 31, 2015, 2014 and 2013, 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:



	December 31,
In millions	2015			2014
Deferred tax assets
U.S. state carryforward benefits	$	133		$	124
Foreign carryforward benefits	103			66
Employee benefit plans	377			367
Warranty expenses	369			354
Accrued expenses	76			89
Other	78			45
Gross deferred tax assets	1,136			1,045
Valuation allowance	(209		)	(144		)
Total deferred tax assets	927			901
Deferred tax liabilities
Property, plant and equipment	(269		)	(329		)
Unremitted income of foreign subsidiaries and joint ventures	(69		)	(204		)
Employee benefit plans	(212		)	(161		)
Other	(21		)	(23		)
Total deferred tax liabilities	(571		)	(717		)
Net deferred tax assets	$	356		$	184

Our 2015 U.S. carryforward benefits include $133 million of state credit and net operating loss carryforward benefits that begin to expire in 2016. Our foreign carryforward benefits include $103 million of net operating loss carryforwards that begin to expire in 2016. 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 2015 by a net $65 million and increased in 2014 by a net $43 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.

Our Consolidated Balance Sheets contain the following tax related items:



	December 31,
In millions	2015			2014
Prepaid and other current assets
Deferred tax assets	$	—	⁽¹⁾	$	274
Refundable income taxes	176			170
Other assets
Deferred tax assets	390			40
Long-term refundable income taxes	18			24
Other liabilities and deferred revenue
Deferred tax liabilities	34			130

^{_____________________________________________________________}

⁽¹⁾Prepaid and other current assets include deferred tax assets of zero for the year ended December 31, 2015, as the result of the prospective early adoption of the new standard on balance sheet classification of deferred tax assets.

A reconciliation of unrecognized tax benefits for the years ended December 31, 2015, 2014 and 2013 was as follows:



In millions
Balance at December 31, 2012	$	145
Additions based on tax positions related to the current year	10
Additions based on tax positions related to the prior years	21
Reductions for tax positions related to prior years	(6		)
Reductions for tax positions relating to lapse of statute of limitations	(1		)
Balance at December 31, 2013	169
Additions based on tax positions related to the current year	8
Additions based on tax positions related to the prior years	5
Reductions for tax positions related to prior years	(2		)
Reductions for tax positions relating to settlements with taxing authorities	(5		)
Reductions for tax positions relating to lapse of statute of limitations	(1		)
Balance at December 31, 2014	174
Additions based on tax positions related to the current year	8
Additions based on tax positions related to the prior years	24
Reductions for tax positions relating to settlements with taxing authorities	(71		)
Balance at December 31, 2015	$	135

Included in the December 31, 2015 and 2014, balances are $78 million and $114 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 $8 million, $7 million and $3 million as of December 31, 2015, 2014 and 2013, respectively. We recognize potential accrued interest and penalties related to unrecognized tax benefits in income tax expense. For the years ended December 31, 2015, 2014 and 2013, we recognized $5 million, $4 million and $1 million in net interest expense, respectively.

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.

It is reasonably possible that Cummins existing liabilities for uncertain tax benefits may decrease in an amount ranging from $40 million to $90 million within the next 12 months for U.S. and non-U.S. audits that are in process.

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 2011. The U.S. examinations related to tax years 2011-2012 commenced during 2014.