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, 2016

Income Tax Disclosure [Abstract]

INCOME TAXES

NOTE 3. INCOME TAXES

The following table summarizes income before income taxes:



	Years ended December 31,
In millions	2016		2015		2014
U.S. income	$	995	$	1,275	$	1,407
Foreign income	935		750		1,027
Income before income taxes	$	1,930	$	2,025	$	2,434

Income tax expense consists of the following:



	Years ended December 31,
In millions	2016			2015			2014
Current
U.S. federal and state	$	211		$	516		$	470
Foreign	213			147			197
Total current	424			663			667
Deferred
U.S. federal and state	57			(151		)	39
Foreign	(7		)	43			(8		)
Total deferred	50			(108		)	31
Income tax expense	$	474		$	555		$	698

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



	Years ended December 31,
	2016		2015		2014
Statutory U.S. federal income tax rate	35.0	%	35.0	%	35.0	%
State income tax, net of federal effect	0.8		1.2		1.1
Differences in rates and taxability of foreign subsidiaries and joint ventures	(7.2	)	(6.6	)	(5.7	)
Research tax credits	(1.7	)	(1.4	)	(1.5	)
Other, net	(2.3	)	(0.8	)	(0.2	)
Effective tax rate	24.6	%	27.4	%	28.7	%

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 2016 was 24.6 percent compared to 27.4 percent for 2015. The 2.8 percent decrease in the effective tax rate from 2015 to 2016 is primarily due to 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. 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 $3.4 billion, $3.3 billion and $3.8 billion for the years ended December 31, 2016, 2015 and 2014, 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 $59 million and $69 million at December 31, 2016 and 2015, respectively. We have $616 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 $139 million.

Income before income taxes included equity income of foreign joint ventures of $225 million, $213 million and $212 million for the years ended December 31, 2016, 2015 and 2014, respectively. This equity income is recorded net of foreign taxes. Additional U.S. income taxes of $13 million, $20 million and $14 million for the years ended December 31, 2016, 2015 and 2014, 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	2016			2015
Deferred tax assets
U.S. state carryforward benefits	$	159		$	133
Foreign carryforward benefits	154			103
Employee benefit plans	401			377
Warranty expenses	405			369
Accrued expenses	107			76
Other	64			78
Gross deferred tax assets	1,290			1,136
Valuation allowance	(307		)	(209		)
Total deferred tax assets	983			927
Deferred tax liabilities
Property, plant and equipment	(319		)	(269		)
Unremitted income of foreign subsidiaries and joint ventures	(59		)	(69		)
Employee benefit plans	(213		)	(212		)
Other	(48		)	(21		)
Total deferred tax liabilities	(639		)	(571		)
Net deferred tax assets	$	344		$	356

Our 2016 U.S. carryforward benefits include $159 million of state credit and net operating loss carryforward benefits that begin to expire in 2017. Our foreign carryforward benefits include $154 million of net operating loss carryforwards that begin to expire in 2017. 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 2016 by a net $98 million and increased in 2015 by a net $65 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	2016		2015
Prepaid and other current assets
Refundable income taxes	$	192	$	176
Other assets
Deferred tax assets	420		390
Long-term refundable income taxes	22		18
Other liabilities and deferred revenue
Deferred tax liabilities	76		34

A reconciliation of unrecognized tax benefits for the years ended December 31, 2016, 2015 and 2014 was as follows:



	December 31,
In millions	2016			2015			2014
Balance at beginning of year	$	135		$	174		$	169
Additions to current year tax positions	10			8			8
Additions to prior years tax positions	18			24			5
Reductions to prior years tax positions	—			—			(2		)
Reductions for tax positions due to settlements with taxing authorities	(104		)	(71		)	(5		)
Reductions for tax positions due to lapse of statute of limitations	—			—			(1		)
Balance at end of year	$	59		$	135		$	174

Included in the December 31, 2016 and 2015, balances are $31 million and $78 million, respectively, 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, $8 million and $7 million as of December 31, 2016, 2015 and 2014, respectively. We recognize potential accrued interest and penalties related to unrecognized tax benefits in income tax expense. For the years ended December 31, 2016, 2015 and 2014, we recognized $2 million, $5 million and $4 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.

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 2012. The U.S. examinations related to tax years 2011-2012 concluded during 2016. The U.S. examinations related to tax years 2013-2015 commenced during 2016.