Entity information:
Income Taxes
The components of income before income taxes for each fiscal year were as follows:
 
 
2017
 
2016
 
2015
 
 
 
 
 
 
 
(In millions)
U.S.
$
514

 
$
199

 
$
629

Foreign
3,217

 
1,814

 
969

 
$
3,731

 
$
2,013

 
$
1,598


The components of the provision for income taxes for each fiscal year were as follows:
 
2017
 
2016
 
2015
 
 
 
 
 
 
 
(In millions)
Current:
 
 
 
 
 
U.S.
$
67

 
$
(36
)
 
$
134

Foreign
233

 
351

 
199

State
9

 
(2
)
 
18

 
309

 
313

 
351

Deferred:
 
 
 
 
 
U.S.
(11
)
 
55

 
(194
)
Foreign
(7
)
 
(89
)
 
69

State
6

 
13

 
(5
)
 
(12
)
 
(21
)
 
(130
)
 
$
297

 
$
292

 
$
221


A reconciliation between the statutory U.S. federal income tax rate of 35 percent and Applied’s actual effective income tax rate for each fiscal year is presented below:
 
 
2017
 
2016
 
2015
Tax provision at U.S. statutory rate
35.0
 %
 
35.0
 %
 
35.0
 %
Resolutions of prior years’ income tax filings
(1.9
)
 
3.9

 
(4.9
)
Effect of foreign operations taxed at various rates
(24.9
)
 
(24.1
)
 
(16.3
)
State income taxes, net of federal benefit
0.3

 
0.6

 
0.9

Research and other tax credits
(0.7
)
 
(1.3
)
 
(0.2
)
U.S. domestic production deduction
(0.2
)
 
(0.2
)
 
(0.6
)
Share-based compensation
0.4

 
0.4

 
0.8

Other
—

 
0.2

 
(0.9
)
 
8.0
 %
 
14.5
 %
 
13.8
 %

 
The effective tax rate for fiscal 2017 was lower than fiscal 2016 primarily due to the recognition of previously unrecognized foreign tax credits and changes in the geographical composition of income. In addition, the effective tax rate in fiscal 2016 included unfavorable resolutions and changes related to income tax liabilities for uncertain tax positions as well as the reinstatement of the U.S. federal R&D tax credit retroactive to its expiration in December of 2015, neither of which reoccurred in fiscal 2017.
The effective tax rate for fiscal 2016 was higher than fiscal 2015 primarily due to resolutions and changes related to income tax liabilities for uncertain tax positions, partially offset by changes in the geographical composition of income. The effective tax rate for fiscal 2015 included an adjustment to decrease provision for income taxes of $28 million primarily to correct an error in the recognition of cost of sales in the U.S. related to intercompany sales. The impact of the adjustment to fiscal 2015 was determined to be immaterial on the originating periods and fiscal 2015.
In the reconciliation between the statutory U.S. federal income tax rate and the effective income tax rate, the effect of foreign operations taxed at various rates represents the difference between an income tax provision at the U.S. federal statutory income tax rate and the recorded income tax provision, with the difference expressed as a percentage of worldwide income before income taxes. This effect is substantially related to the tax effect of pre-tax income in jurisdictions with lower statutory tax rates. The foreign operations with the most significant effective tax rate impact are Singapore and Israel. The statutory tax rates for fiscal 2017 for Singapore and Israel are 17% and 24%, respectively. Applied has been granted conditional reduced tax rates for both jurisdictions that expire in fiscal 2026 and fiscal 2021, respectively, excluding potential renewals and subject to certain conditions with which Applied expects to comply. The tax benefit arising from these tax rates was $452 million for fiscal 2017 or $0.42 per diluted share.
Deferred tax assets and liabilities are recognized for the estimated future tax effects of temporary differences between the book and tax bases of assets and liabilities. Deferred tax assets are also recognized for net operating loss and tax credit carryovers. Deferred tax assets are offset by a valuation allowance to the extent it is more likely than not that they are not expected to be realized. The components of deferred income tax assets and liabilities were as follows:
 
 
October 29,
2017
 
October 30,
2016
 
 
 
 
 
(In millions)
Deferred tax assets:
 
 
 
Allowance for doubtful accounts
$
13

 
$
20

Inventory reserves and basis difference
156

 
151

Installation and warranty reserves
1

 
3

Accrued liabilities
31

 
53

Deferred revenue
15

 
17

Tax credits
317

 
210

Deferred compensation
81

 
45

Share-based compensation
53

 
55

Other
67

 
176

Gross deferred tax assets
734

 
730

Valuation allowance
(227
)
 
(207
)
Total deferred tax assets
507

 
523

Deferred tax liabilities:
 
 
 
Fixed assets
(36
)
 
(29
)
Intangible assets
(76
)
 
(81
)
Undistributed foreign earnings
(11
)
 
(42
)
Foreign exchange
(4
)
 
—

Total gross deferred tax liabilities
(127
)
 
(152
)
Net deferred tax assets
$
380

 
$
371


The following table presents a summary of non-current deferred tax assets and liabilities:
 
 
October 29,
2017
 
October 30,
2016
 
 
 
 
 
(In millions)
Non-current deferred tax asset
$
385

 
$
372

Non-current deferred tax liability
(5
)
 
(1
)
 
$
380

 
$
371

A valuation allowance is recorded to reflect the estimated amount of net deferred tax assets that may not be realized. Changes in the valuation allowance in each fiscal year were as follows:
 
2017
 
2016
 
2015
 
 
 
 
 
 
 
(In millions)
Beginning balance
$
207

 
$
207

 
$
173

Increases
20

 
27

 
40

Decreases
—

 
(27
)
 
(6
)
Ending balance
$
227

 
$
207

 
$
207

For fiscal 2017, U.S. income taxes have not been provided for approximately $8.2 billion of cumulative undistributed earnings of several foreign subsidiaries. Applied intends to indefinitely reinvest these earnings in foreign operations. If these earnings were distributed to the U.S. in the form of dividends or otherwise, or if the shares of the relevant foreign subsidiaries were sold or otherwise transferred, Applied would be subject to additional U.S. income taxes (subject to an adjustment for foreign tax credits) and foreign withholding taxes. Determination of the amount of unrecognized deferred income tax liability related to these earnings is not practicable.
At October 29, 2017, Applied has state research and development tax credit carryforwards of $221 million, including $199 million of credits that are carried over until exhausted and $22 million that are carried over for 15 years and begin to expire in fiscal 2025. Applied has net operating loss carryforwards in state jurisdictions of $3 million which begin to expire in fiscal 2018. Management believes it is more likely than not that all net operating loss and tax credit carryforwards at October 29, 2017, net of valuation allowance, will be utilized.
Applied’s income taxes payable have been reduced by the tax benefits associated with share-based compensation. These benefits, credited directly to additional paid-in capital with a corresponding reduction to taxes payable, amounted to $55 million, $23 million and $56 million for fiscal 2017, 2016 and 2015, respectively.
Applied maintains liabilities for uncertain tax positions. These liabilities involve considerable judgment and estimation and are continuously monitored by management based on the best information available. Gross unrecognized tax benefits are classified as non-current income taxes payable in other liabilities in the Consolidated Balance Sheets. A reconciliation of the beginning and ending balances of gross unrecognized tax benefits in each fiscal year is as follows:
 
 
2017
 
2016
 
2015
 
 
 
 
 
 
 
(In millions)
Beginning balance of gross unrecognized tax benefits
$
320

 
$
177

 
$
134

Settlements with tax authorities
(42
)
 
(25
)
 
(16
)
Lapses of statutes of limitation
(15
)
 
(2
)
 
(1
)
Increases in tax positions for current year
95

 
62

 
43

Increases in tax positions for prior years
33

 
109

 
21

Decreases in tax positions for prior years
—

 
(1
)
 
(4
)
Ending balance of gross unrecognized tax benefits
$
391

 
$
320

 
$
177



In the provision for income taxes in the Consolidated Statements of Operations, a tax expense of $17 million, a tax expense of $24 million, and a tax benefit of $6 million, were realized in fiscal 2017, 2016 and 2015, respectively, related to interest and penalties on unrecognized tax benefits. The liability for interest and penalties for fiscal 2017, 2016 and 2015 was $46 million, $33 million and $14 million, respectively, and was classified as non-current income taxes payable.
Included in the balance of unrecognized tax benefits for fiscal 2017, 2016 and 2015 are $284 million, $302 million, and $167 million, respectively, of tax benefits that, if recognized, would affect the effective tax rate. During the next twelve months, it is reasonably possible that existing liabilities for unrecognized tax benefits could be reduced by approximately $116 million as a result of negotiations with taxing authorities and the expiration of statutes of limitation.
In fiscal 2017, Applied paid $29 million, including interest and penalties, as a result of a settlement of fiscal 2011 in Italy. This settlement resulted in the recognition of a tax expense of $6 million. In fiscal 2016, Applied accrued $25 million, including interest and penalties, as a result of a settlement of fiscal 2011 through fiscal 2015 in Switzerland. This settlement resulted in the recognition of a tax expense of $19 million. In fiscal 2015, Applied paid $19 million, including interest and penalties, as a result of a settlement of fiscal 2009 through fiscal 2011 in Italy and paid $2 million, including interest, as a result of a settlement of fiscal 2013 in Switzerland related to Varian. These settlements resulted in the recognition of a tax benefit of $10 million.
A number of Applied’s tax returns remain subject to examination by taxing authorities. These include U.S. returns for fiscal 2010 and later years, and foreign tax returns for fiscal 2009 and later years.
The timing of the resolution of income tax examinations, as well as the amounts and timing of various tax payments that may be part of the settlement process, is highly uncertain. This could cause fluctuations in Applied’s financial condition and results of operations. Applied continues to have ongoing negotiations with various taxing authorities throughout the year.