Entity information:
Income Tax Expense (Benefit)

Income Before Taxes

The domestic and foreign components of income before taxes were as follows:
 
2017
 
2016
 
2015
 
(in millions)
Foreign
$
560

 
$
516

 
$
1,501

Domestic
209

 
(363
)
 
76

Income before taxes
$
769

 
$
153

 
$
1,577



Income Tax Provision

The components of the provision for income taxes were as follows:
 
2017
 
2016
 
2015
 
(in millions)
Current:
 
 
 
 
 
Foreign
$
127

 
$
59

 
$
54

Domestic - Federal
229

 
2

 
43

Domestic - State
4

 
(1
)
 
(13
)
 
360

 
60

 
84

Deferred:
 
 
 
 
 
Foreign
56

 
(39
)
 
12

Domestic - Federal
(44
)
 
(109
)
 
11

Domestic - State
—

 
(1
)
 
5

 
12

 
(149
)
 
28

Income tax provision
$
372

 
$
(89
)
 
$
112



The Company’s income tax expense for 2017 reflects tax expense from the integration of SanDisk and a valuation allowance on both acquired tax attributes and net operating loss carryforwards from restructuring activities. The Company’s income tax benefit for 2016 reflects tax benefits from expenses related to the Merger and from interest expense related to debt facilities.

Remaining net undistributed earnings from foreign subsidiaries at June 30, 2017, on which no U.S. tax has been provided, amounted to $16 billion. The net undistributed earnings are intended to finance local operating requirements and capital investments. Accordingly, an additional U.S. tax provision has not been made on these earnings. The tax liability for these earnings would be approximately $5 billion, if the Company repatriated the undistributed earnings from the foreign subsidiaries.

Deferred Taxes

Temporary differences and carryforwards, which give rise to a significant portion of deferred tax assets and liabilities were as follows:
 
June 30,
2017
 
July 1,
2016
 
(in millions)
Deferred tax assets:
 
 
 
Sales related reserves and accrued expenses not currently deductible
$
84

 
$
82

Accrued compensation and benefits not currently deductible
252

 
207

Net operating loss carryforward
292

 
259

Business credit carryforward
283

 
264

Long-lived assets
236

 
256

Other
141

 
177

Total deferred tax assets
1,288

 
1,245

Deferred tax liabilities:
 
 
 
Long-lived assets
(874
)
 
(1,030
)
Unremitted earnings of certain non-U.S. entities
(38
)
 
—

Other
(11
)
 
(9
)
Total deferred tax liabilities
(923
)
 
(1,039
)
Valuation allowances
(518
)
 
(294
)
Deferred tax liabilities, net
$
(153
)
 
$
(88
)


The increase in deferred tax liabilities, net in 2017, compared to 2016, was primarily due to the increase in deferred tax expense of $12 million, tax effects of OCI items of $10 million, purchase price adjustments to goodwill of $27 million and shortfalls related to stock-based compensation deductions included in additional paid-in capital of $15 million.

The net deferred tax asset valuation allowance increased by $224 million and $128 million in 2017 and 2016, respectively. The valuation allowance increase in 2017 is primarily attributable to $111 million for acquired tax attributes, $46 million for net operating loss carryforwards from restructuring activities, $31 million for capital losses, and $27 million for the current year generation of state tax credits which the Company does not anticipate being able to utilize. The assessment of valuation allowances against deferred tax assets requires estimations and significant judgment. The Company continues to assess and adjust its valuation allowance based on operating results and market conditions. After weighing both the positive and negative evidence available, including but not limited to, earnings history, projected future outcomes, industry and market trends and the nature of each of the deferred tax assets, the Company determined that it is able to realize most of its deferred tax assets with the exception of certain loss and credit carryforwards.

In addition to the deferred tax assets presented above, the Company had benefits related to net operating loss (“NOL”) benefits from stock-based compensation deductions of $20 million and $119 million as of June 30, 2017 and July 1, 2016, respectively. During 2017, the Company recorded $119 million of tax benefits related to stock-based compensation deductions to Shareholders’ equity of which $98 million related to NOL benefits for stock-based compensation deductions and $21 million was related to current year stock-based compensation deductions.

Effective Tax Rate

Reconciliation of the U.S. Federal statutory rate to the Company’s effective tax rate is as follows:
 
2017
 
2016
 
2015
U.S. Federal statutory rate
35
 %
 
35
 %
 
35
 %
Tax rate differential on international income
(27
)
 
(103
)
 
(29
)
Tax effect of U.S. non-deductible convertible debt costs
—

 
13

 
—

Tax effect of U.S. non-deductible acquisition costs
—

 
10

 
—

Tax effect of U.S. foreign income inclusion
4

 
9

 
—

Tax effect of U.S. non-deductible stock-based compensation
1

 
9

 
—

Tax effect of U.S. permanent differences
(1
)
 
1

 
1

State income tax, net of federal tax
1

 
(1
)
 
—

Change in valuation allowance
29

 
16

 
2

Unremitted earnings of certain non-U.S. entities
5

 
—

 
—

Tax related to SanDisk integration
12

 
—

 
—

Retroactive extension of Federal R&D credit
—

 
(9
)
 
—

Income tax credits
(12
)
 
(43
)
 
(4
)
Other
1

 
5

 
2

Effective tax rate
48
 %
 
(58
)%
 
7
 %


Tax Holidays and Carryforwards

A substantial portion of the Company’s manufacturing operations in Malaysia, the Philippines, Singapore and Thailand operate under various tax holidays and tax incentive programs which will expire in whole or in part at various dates from 2018 through 2030. Certain of the holidays may be extended if specific conditions are met. The net impact of these tax holidays and tax incentives was an increase to the Company’s net earnings by $467 million, or $1.58 per diluted share, $500 million, or $2.07 per diluted share, and $641 million, or $2.70 per diluted share, in 2017, 2016, and 2015, respectively.

As of June 30, 2017, the Company had federal and state NOL carryforwards of $765 million and $552 million, respectively. The NOL carryforwards available to offset future federal taxable income expire at various dates from 2020 to 2037 and future state taxable income expire at various dates from 2018 to 2037. As of June 30, 2017, the Company had various federal and state tax credit carryforwards totaling $599 million. The available federal tax credit carryforwards of $78 million to offset future federal taxable income expire at various dates from 2018 to 2037. The remaining credit carryforward amount of $521 million relates primarily to state tax credit carryforwards which are available indefinitely.

The federal and state NOLs and credits relating to various acquisitions are subject to limitations under Sections 382 and 383 of the Internal Revenue Code. The Company expects the total amount of federal NOLs ultimately realized will be reduced by $498 million and state NOLs ultimately realized will be reduced by $422 million. The Company expects the total amount of federal credits ultimately realized will be reduced by $41 million and state tax credit carryforwards ultimately realized will be reduced by $375 million.

The Company had varying amounts of foreign NOL carryforward that do not expire or, if not used, expire in various years, depending on the country. The major jurisdictions that the Company receives foreign NOL carryforward and the related expiration dates of these NOL carryforward tax credits are as follows:

Jurisdiction
 
NOL Carryforward Amount
 
Expiration
 
 
(in millions)
 
 
Japan
 
$
142

 
2024 to 2026
Belgium
 
61

 
No expiration
China
 
53

 
2023
Singapore
 
40

 
No expiration


The Company expects the total amount of NOL carryforwards in Japan ultimately realized will be reduced by $76 million. The Company expects the NOL carryforwards in Belgium, China and Singapore will not be ultimately realized.

Uncertain Tax Positions

With the exception of certain unrecognized tax benefits that are directly associated with the tax position taken, unrecognized tax benefits are presented gross in the Consolidated Balance Sheets. Interest and penalties related to unrecognized tax benefits are recognized in liabilities recorded for uncertain tax positions and are recorded in the provision for income taxes. Accrued interest and penalties included in the Company’s liability related to unrecognized tax benefits as of June 30, 2017, July 1, 2016 and July 3, 2015 was $89 million, $75 million and $55 million, respectively.

The following is a tabular reconciliation of the total amounts of unrecognized tax benefits excluding accrued interest and penalties:
 
2017
 
2016
 
2015
 
(in millions)
Unrecognized tax benefit, beginning balance
$
491

 
$
350

 
$
300

Gross increases related to current year tax positions
35

 
46

 
44

Gross increases related to prior year tax positions
3

 
6

 
6

Gross decreases related to prior year tax positions
(8
)
 
(15
)
 
—

Settlements
(8
)
 
(8
)
 
—

Lapse of statute of limitations
(19
)
 
(8
)
 
(3
)
Acquisitions
28

 
120

 
3

Unrecognized tax benefit, ending balance
$
522

 
$
491

 
$
350



The Company’s unrecognized tax benefits are primarily included within long-term liabilities in the Consolidated Balance Sheets. The entire balance of unrecognized tax benefits as of June 30, 2017, July 1, 2016 and July 3, 2015, if recognized, would affect the effective tax rate.

The Company files U.S. Federal, U.S. state and foreign tax returns. For both federal and state tax returns, with few exceptions, the Company is subject to examination for fiscal years 2008 through 2016. The Company is no longer subject to examination by the IRS for periods prior to 2008, although carry forwards generated prior to those periods may still be adjusted upon examination by the IRS or state taxing authority if they either have been or will be used in a subsequent period. In the major foreign jurisdictions, the Company could be subject to examination in China for calendar years 2007 through 2016, in Ireland for calendar years 2013 through 2016, and Japan in fiscal years 2011 through 2016.

The IRS previously completed its field examination of the Company’s federal income tax returns for fiscal years 2006 through 2009 and proposed certain adjustments. The Company received Revenue Agent Reports from the IRS that seek to increase the Company’s U.S. taxable income which would result in additional federal tax expense totaling $795 million, subject to interest. The issues in dispute relate primarily to transfer pricing with the Company’s foreign subsidiaries and intercompany payable balances. The Company disagrees with the proposed adjustments and in September 2015, filed a protest with the IRS Appeals Office and received the IRS rebuttal in July 2016. Meetings with the IRS Appeals Office began in March 2017. The Company believes that its tax positions are properly supported and will vigorously contest the position taken by the IRS. In September 2015, the IRS commenced an examination of the Company’s fiscal years 2010 through 2012.

The Company believes that adequate provision has been made for any adjustments that may result from tax examinations. However, the outcome of tax examinations cannot be predicted with certainty. If any issues addressed in the Company’s tax examinations are resolved in a manner not consistent with management’s expectations, the Company could be required to adjust its provision for income taxes in the period such resolution occurs. As of June 30, 2017, it is not possible to estimate the amount of change, if any, in the unrecognized tax benefits that is reasonably possible within the next twelve months. Any significant change in the amount of the Company’s liability for unrecognized tax benefits would most likely result from additional information or settlements relating to the examination of the Company’s tax returns.