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, 2013

NOTE 4. INCOME TAXES



	Years ended December 31,
In millions	2013		2012		2011
Income before income taxes
U.S. income	$	1,058	$	998	$	881
Foreign income	1,061		1,273		1,790
Total	$	2,119	$	2,271	$	2,671

Income tax expense consists of the following:



	Years ended December 31,
In millions	2013		2012		2011
Current
U.S. federal and state	$	239	$	118	$	116
Foreign	192		299		524
Total current	431		417		640
Deferred
U.S. federal and state	67		108		69
Foreign	33		8		16
Total deferred	100		116		85
Income tax expense	$	531	$	533	$	725

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



	Years ended December 31,
	2013		2012		2011
Statutory U.S. federal income tax rate	35.0	%	35.0	%	35.0	%
State income tax, net of federal effect	0.2		1.0		0.4
Research tax credits	(3.7	)	(0.4	)	(4.7	)
Differences in rates and taxability of foreign subsidiaries and joint ventures	(6.0	)	(12.1	)	(4.6	)
Other, net	(0.4	)	—		1.0
Effective tax rate	25.1	%	23.5	%	27.1	%

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. As a result of a restructuring of our foreign operations in 2013, our 2013 effective tax rate is approximately 1 percent less than it would have been without restructuring. On January 2, 2013, the American Taxpayer Relief Act of 2012 was signed into law and reinstated the research tax credit back to 2012. As tax law changes are accounted for in the period of enactment, we recognized a $28 million discrete tax benefit in the first quarter of 2013. We also recognized a discrete tax expense of $17 million in the first quarter which primarily related to the write-off of a deferred tax asset deemed unrecoverable. Also included in 2013 is a third quarter discrete net tax expense of $7 million, primarily related to U.S. federal tax return true-up adjustments and third quarter enactment of U.K tax law changes. Additionally, our effective tax rate for 2013 included a fourth quarter discrete net tax benefit of $21 million primarily due to the release of U.S. deferred tax liabilities related to prior years unremitted income of certain Indian and Mexican subsidiaries now considered to be permanently reinvested, as well as adjustments to our income tax accounts principally based on our 2012 state tax return filings. Our 2012 income tax provision included a one-time $134 million tax benefit which resulted from tax planning strategies and tax return elections made with respect to our U.K. operations.

In September 2013, the Internal Revenue Service released final tangible personal property regulations regarding the deduction and capitalization of expenditures related to tangible property. The new rules will become effective for taxable years beginning on or after January 1, 2014. While we are still finalizing our analysis, we do not believe that these regulations will have a material impact on our Consolidated Financial Statements.

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 $3.1 billion, $2.3 billion and $1.5 billion for the years ended December 31, 2013, 2012, and 2011, 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 tax liabilities on unremitted earnings of foreign subsidiaries and joint ventures, including those in China generated in years prior to 2012, were $201 million and $213 million at December 31, 2013 and 2012, respectively. We have $709 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 $151 million. We anticipate that these earnings will be distributed to the U.S. within the next five years.

Income before income taxes included equity income of foreign joint ventures of $203 million, $192 million and $234 million for the years ended December 31, 2013, 2012 and 2011, respectively. This equity income is recorded net of foreign taxes. Additional U.S. income taxes of $13 million, $9 million and $49 million for the years ended December 31, 2013, 2012 and 2011, 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	2013			2012
Deferred tax assets
U.S. federal and state carryforward benefits	$	124		$	115
Foreign carryforward benefits	63			50
Employee benefit plans	328			369
Warranty and marketing expenses	332			308
Accrued expenses	70			75
Other	51			78
Gross deferred tax assets	968			995
Valuation allowance	(101		)	(95		)
Total deferred tax assets	867			900
Deferred tax liabilities
Property, plant and equipment	(304		)	(218		)
Unremitted income of foreign subsidiaries and joint ventures	(201		)	(213		)
Employee benefit plans	(158		)	(47		)
Other	(27		)	(26		)
Total deferred tax liabilities	(690		)	(504		)
Net deferred tax assets	$	177		$	396

Our 2013 U.S. federal and state carryforward benefits include $124 million of state credit and net operating loss carryforward benefits that begin to expire in 2014. Our foreign carryforward benefits include $63 million of net operating loss carryforwards that begin to expire in 2014. 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 2013 by a net $6 million and increased in 2012 by a net $24 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 include deferred tax assets of $232 million and $232 million for the years ended December 31, 2013 and 2012, respectively. In addition, prepaid and other current assets include refundable income taxes of $152 million and $240 million for the years ended December 31, 2013 and 2012, respectively. Other assets include deferred tax assets of $61 million and $177 million for the years ended December 31, 2013 and 2012, respectively. In addition, other assets include $59 million of long-term refundable income taxes for the year ended December 31, 2013. Other liabilities and deferred revenue included deferred tax liabilities of $116 million and $13 million for the years ended December 31, 2013 and 2012, respectively.

A reconciliation of unrecognized tax benefits was as follows:



In millions
Balance at December 31, 2010	$	85
Additions based on tax positions related to the current year	5
Additions based on tax positions related to the prior years	44
Reductions for tax positions related to prior years	(3		)
Reductions for tax positions relating to settlements with taxing authorities	(39		)
Reductions for tax positions relating to lapse of statute of limitations	(6		)
Balance at December 31, 2011	86
Additions based on tax positions related to the current year	4
Additions based on tax positions related to the prior years	57
Reductions for tax positions related to prior years	(2		)
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

Included in the December 31, 2013 and 2012, balances are $107 million and $87 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 $3 million, $2 million and $7 million as of December 31, 2013, 2012 and 2011, respectively. We recognize potential accrued interest and penalties related to unrecognized tax benefits in income tax expense. For the years ended December 31, 2013, 2012 and 2011, we recognized $1 million, $(3) million and $(15) 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 2010. We expect the U.S. examinations related to tax years 2011-2012 will commence during 2014.

- Definition

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.

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