Entity information:
Income Taxes

In December 2017, the President signed U.S. tax reform legislation (2017 Tax Act), which includes a broad range of provisions, many of which significantly differ from those contained in previous U.S. tax law. Changes in tax law are accounted for in the period of enactment. As such, the 2017 consolidated financial statements reflect the immediate tax effect of the 2017 Tax Act, which was enacted on December 22, 2017 (Enactment Date). The 2017 Tax Act contains several key provisions including, among other things:
•
A one-time tax on the mandatory deemed repatriation of post-1986 untaxed foreign earnings and profits (E&P), referred to as the toll charge;
•
Reduction in the Corporate tax rate from 35% to 21% for tax years beginning after December 31, 2017;
•
Introduction of a new U.S. tax on certain off-shore earnings referred to as Global Intangible Low-Taxed Income (GILTI) at an effective tax rate of 10.5% for tax years beginning after December 31, 2017 (increasing to 13.125% for tax years beginning after December 31, 2025) with a partial offset by foreign tax credits; and
•
Introduction of a territorial tax system beginning in 2018 by providing a 100% dividends received deduction on certain qualified dividends from foreign subsidiaries.

During the fourth quarter of 2017, we recorded an income tax expense of $1,269 million, which was comprised of the following:

•
An income tax expense of $1,890 million for the one-time deemed repatriation of E&P. In accordance with the 2017 Tax Act, the toll charge liability may be paid over eight years. As such, we have recorded $1,732 million and $150 million in non-current and current income tax liability on an undiscounted basis, respectively, as of December 31, 2017; and
•
An income tax benefit of $621 million, primarily for the remeasurement of our deferred tax assets and liabilities at the enacted tax rate of 21%.

The net charge recorded was based on currently available information and interpretations of applying the provisions of the 2017 Tax Act as of the time of filing this Annual Report on Form 10-K. In accordance with authoritative guidance issued by the Securities and Exchange Commission (SEC), the income tax effect for certain aspects of the 2017 Tax Act represent provisional amounts for which our accounting is incomplete but a reasonable estimate could be determined and recorded during the fourth quarter of 2017. The guidance provides for a measurement period, up to one year from the Enactment Date, in which provisional amounts may be adjusted when additional information is obtained, prepared or analyzed about facts and circumstances, that existed as of the Enactment Date, if known, which would have affected the amounts that were initially recorded as provisional amounts. Adjustments to provisional amounts identified during the measurement period should be recorded as an income tax expense or benefit in the period the adjustment is determined.

We continue to evaluate the impacts of the 2017 Tax Act and consider the amounts recorded to be provisional, except for the one-time impact of the change in tax rate on our deferred tax assets and liabilities as of December 31, 2017 for which our accounting is complete. In addition, we are still evaluating the GILTI provisions of the 2017 Tax Act and its impact, if any, on our consolidated financial statements as of December 31, 2017. The FASB allows companies to adopt an accounting policy to either recognize deferred taxes for GILTI or treat such as a tax cost in the year incurred. We have not yet determined our accounting policy because determining the impact of the GILTI provisions requires analysis of our existing legal entity structure, the reversal of our U.S. GAAP and U.S. tax basis differences in the assets and liabilities of our foreign subsidiaries, and our ability to offset any tax with foreign tax credits. As such, we did not record a deferred income tax expense or benefit related to the GILTI provisions in our Consolidated Statement of Income for the year ended December 31, 2017 and we will finalize this during the measurement period. 

The Company recorded a provisional amount for its toll charge, which represents its reasonable estimate of the liability due for the mandatory deemed repatriation of its post-1986 untaxed foreign E&P. Determining the provisional toll charge liability required a significant effort based on a number of factors including:

•
Analyzing our accumulated untaxed foreign E&P since 1986 including historical practices and assertions made in determining such;
•
Determining the composition, including intercompany receivables and payables of specified foreign corporations, of our post-1986 untaxed foreign E&P that is held in cash or liquid assets and other assets at several measurement dates, as a different tax rate is applied to each when determining the toll charge liability; and
•
Assessing the potential impact of existing uncertain tax positions in determining our accumulated undistributed E&P.

For the aforementioned factors as well as the proximity of the enactment of the 2017 Tax Act to our year-end, we had limited time to understand the 2017 Tax Act and its various interpretations (including any additional guidance issued through the time of filing this Annual Report on Form 10-K), to assess how to apply the new law to our specific facts and circumstances and determine the toll charge. These factors also contributed to the tax effects recorded being provisional amounts. In addition, we made certain assumptions in determining the provisional toll charge that may result in adjustments when we finalize our analysis and accounting for the 2017 Tax Act including, but not limited to, the following:

•
Finalize our analysis of our post-1986 untaxed foreign E&P;
•
Finalize our analysis as to the amounts and nature of, among other items, our intercompany transactions and balances as of December 31, 2017, 2016 and 2015 to determine the appropriate composition of our post-1986 untaxed E&P as either cash / liquid assets or other assets; and
•
Finalize our analysis of the impacts of the Tax Act on our accounting for the GILTI provisions.

Certain income tax effects of applying the 2017 Tax Act represent provisional amounts for which our analysis is incomplete but a reasonable estimate could be determined and recorded during the fourth quarter of 2017. Our actual results may materially differ from our current estimate due to, among other things, further guidance that may be issued by U.S. tax authorities or regulatory bodies including the SEC and the FASB to interpret the 2017 Tax Act. We will continue to analyze the 2017 Tax Act and any additional guidance that may be issued so we can finalize the full effects of applying the new legislation on our financial statements in the measurement period.

Income before income taxes is as follows:
 
 
2017
 
2016
 
2015
U.S.
 
$
445

 
$
735

 
$
525

Non-U.S.
 
3,869

 
1,637

 
1,498

Income before income taxes
 
$
4,314

 
$
2,372

 
$
2,023



For the years ended December 31, 2017, 2016 and 2015, U.S. income before income taxes reflects charges related to share-based compensation, upfront collaboration payments, asset impairments, acquisitions and interest expense which in the aggregate, increased from 2015 to 2017. Many of these charges are not deductible for U.S. income tax purposes. Non-U.S. income before income taxes reflects the results of our commercial, research and manufacturing operations outside the U.S.

The provision (benefit) for taxes on income is as follows:
 
 
2017
 
2016
 
2015
United States:
 
 
 
 
 
 
Taxes currently payable:
 
 
 
 
 
 
Federal
 
$
2,545

 
$
569

 
$
321

State and local
 
52

 
43

 
63

Deferred income taxes
 
(1,331
)
 
(343
)
 
(29
)
Total U.S. tax provision
 
1,266

 
269

 
355

International:
 
 
 
 
 
 
Taxes currently payable
 
107

 
106

 
71

Deferred income taxes
 
1

 
(2
)
 
(5
)
Total international tax provision
 
108

 
104

 
66

Total provision
 
$
1,374

 
$
373

 
$
421



Amounts are reflected in the preceding tables based on the location of the taxing authorities.

Deferred taxes arise because of different treatment between financial statement accounting and tax accounting, known as temporary differences. We record the tax effect on these temporary differences as deferred tax assets (generally items that can be used as a tax deduction or credit in future periods) or deferred tax liabilities (generally items for which we received a tax deduction but have not yet recorded in the Consolidated Statements of Income and the tax effects of acquisition related temporary differences). We evaluate the likelihood of the realization of deferred tax assets and record a valuation allowance if it is more likely than not that all or a portion of the asset will not be realized. We consider many factors when assessing the likelihood of future realization of deferred tax assets, including our recent cumulative earnings experience by taxing jurisdiction, expectations of future taxable income, the carryforward periods available to us for tax reporting purposes, tax planning strategies and other relevant factors. Significant judgment is required in making this assessment. As of December 31, 2017 and 2016, it was more likely than not that we would realize our deferred tax assets, net of valuation allowances. The $134 million increase in the valuation allowance from 2016 to 2017 relates primarily to certain state and foreign net operating loss (NOL) carryforwards. As a result of the 2017 Tax Act, we recorded an income tax benefit of $621 million primarily related to the remeasurement of our deferred tax liabilities and assets at December 31, 2017.
Many of our operations are conducted outside the United States. As a result of the 2017 Tax Act and the toll charge, we expect to have access to our offshore earnings as of December 31, 2017 with minimal to no additional U.S. tax impact. Therefore, we no longer consider these earnings to be permanently reinvested offshore. In prior years, we recorded U.S. deferred tax liabilities of $317 million for certain offshore earnings that were expected to be remitted to our domestic operations. These deferred tax liabilities reduced the income tax expense recorded in the fourth quarter of 2017 for the toll charge. The remaining amounts earned overseas were expected to be permanently reinvested outside of the United States, and therefore, no accrual for U.S. taxes was provided. We continue to evaluate our assertions on any remaining outside basis differences in our foreign subsidiaries as of December 31, 2017 and have not completed our analysis. In accordance with authoritative guidance issued by the SEC, we expect to finalize our accounting related to the toll charge and any remaining outside basis differences in our foreign subsidiaries during later periods as we complete our analysis, computations and assertions.
As of December 31, 2017 and 2016 the tax effects of temporary differences that give rise to deferred tax assets and liabilities were as follows:
 
 
2017
 
2016
 
 
Assets
 
Liabilities
 
Assets
 
Liabilities
NOL carryforwards
 
$
249

 
$
—

 
$
133

 
$
—

Tax credit carryforwards
 
11

 
—

 
14

 
—

Share-based compensation
 
317

 
—

 
412

 
—

Other assets and liabilities
 
38

 
(52
)
 
60

 
(10
)
Intangible assets
 
333

 
(2,008
)
 
808

 
(1,013
)
Accrued and other expenses
 
278

 
—

 
263

 
—

Unremitted earnings
 
—

 
—

 
—

 
(317
)
Unrealized (gains) losses on securities
 
—

 
(193
)
 
—

 
(69
)
Subtotal
 
1,226

 
(2,253
)
 
1,690

 
(1,409
)
Valuation allowance
 
(277
)
 
—

 
(143
)
 
—

Total deferred taxes
 
$
949

 
$
(2,253
)
 
$
1,547

 
$
(1,409
)
Net deferred tax asset (liability)
 
 
 
$
(1,304
)
 
$
138

 
 


As of December 31, 2017 and 2016, deferred tax assets and liabilities were classified on our Consolidated Balance Sheets as follows:
 
 
2017
 
2016
Other non-current assets
 
$
23

 
$
138

Deferred income tax liabilities
 
(1,327
)
 
—

Net deferred tax asset (liability)
 
$
(1,304
)
 
$
138



Reconciliation of the U.S. statutory income tax rate to the Company's effective tax rate is as follows:
Percentages
 
2017
 
2016
 
2015
U.S. statutory rate
 
35.0
 %
 
35.0
 %
 
35.0
 %
Foreign tax rate differences
 
(28.8
)%
 
(21.1
)%
 
(21.0
)%
State taxes, net of federal benefit
 
0.6
 %
 
0.8
 %
 
1.2
 %
Change in valuation allowance
 
0.8
 %
 
0.5
 %
 
2.0
 %
Acquisition and collaboration related differences
 
2.1
 %
 
(0.7
)%
 
4.5
 %
Changes in uncertain tax positions
 
0.1
 %
 
(0.4
)%
 
(0.5
)%
Stock compensation
 
(6.7
)%
 
—
 %
 
—
 %
2017 Tax Act
 
29.4
 %
 
—
 %
 
—
 %
Other
 
(0.7
)%
 
1.6
 %
 
(0.4
)%
Effective income tax rate
 
31.8
 %
 
15.7
 %
 
20.8
 %


Our reconciliation of the U.S. statutory income tax rate to our effective tax rate includes foreign tax rate differences from our foreign operations which are subject to income taxes at different rates than the United States. The benefit related to foreign tax rate differences primarily results from our commercial operations in Switzerland, which include significant research and development and manufacturing for worldwide markets. We operated under an income tax agreement in Switzerland through 2015 that provided an exemption from most Swiss income taxes on our operations in Switzerland. Beginning in 2016, we have been operating under a new agreement with the Swiss tax authorities which reflects a reorganization and expansion of our Swiss operations, and results in similar tax benefits through the end of 2024. The difference between the maximum statutory Swiss income tax rate (approximately 15.6% in 2017, 15.6% in 2016 and 17.0% in 2015) and our Swiss income tax rate under the tax agreements resulted in a reduction in our 2017, 2016 and 2015 effective tax rates of 14.8, 20.5 and 25.7 percentage points, respectively. The increase in the tax benefit from foreign tax rate differences was primarily due to an increase in pre-tax earnings from foreign tax jurisdictions.

The impact of acquisition and collaboration related differences on our effective tax rate was higher in 2017 and 2015 compared to 2016 primarily due to a non-recurring tax benefit related to a loss on our investment in Avila in 2016. The increase in tax benefits from stock compensation related to excess tax benefits from employee stock compensation upon adoption of ASU 2016-09. The reconciliation also includes the effect of changes in uncertain tax positions, which include the effect of settlements, expirations of statutes of limitations, and other changes in prior year tax positions.

As of December 31, 2017, we had U.S. federal NOL carryforwards of approximately $200 million and state NOL carryforwards of approximately $1.1 billion that will expire in the years 2018 through 2037. We also have U.S. federal and state research and experimentation credit carryforwards of approximately $12 million that will expire in the years 2020 through 2034. Deferred tax assets for most of our U.S. federal and state carryforwards and all of our foreign carryforwards are subject to a full valuation allowance. Prior to the adoption of ASU 2016-09, excess tax benefits related to share-based compensation deductions incurred after December 31, 2005 were required to be recognized in the period in which the tax deduction was realized through a reduction of income taxes payable. As a result, we had not recorded deferred tax assets for these share-based compensation deductions included in our NOL carryforwards and research and experimentation credit carryforwards. ASU 2016-09 was effective for us on January 1, 2017. Among other provisions, the new standard requires that excess tax benefits and tax deficiencies that arise upon vesting or exercise of share-based payments be recognized as income tax benefits and expenses in the income tax provision. Previously, such amounts were recorded to additional paid-in-capital. This aspect of the new guidance was required to be adopted prospectively, and accordingly, the income tax provision for the year ended December 31, 2017 includes $290 million of excess tax benefits arising from share-based compensation awards that vested or were exercised during the period. In addition, at January 1, 2017, the Company recorded a cumulative-effect adjustment to Retained earnings, with a corresponding increase to net deferred tax assets, in the amount of $17 million related to previously unrecognized excess tax benefits.

During the third quarter of 2017, we completed an updated analysis of our current and prior year estimates of our U.S. research and development and orphan drug tax credits. The analysis resulted in additional net income tax benefits of approximately $65 million including $55 million related to prior year estimated tax credits, which were recorded on our Consolidated Statements of Income within Income tax provision. The effect of the change in estimate increased net income by approximately $65 million. On a per share basis, this increased both of the Company’s basic and diluted income per share by $0.08.

We realized excess tax benefits related to share-based compensation in 2016 and 2015 for income tax purposes an increased additional paid-in capital in the amount of approximately $185 million and $302 million, respectively. We have recorded deferred income tax expense in 2017 of $227 million and deferred income tax benefits in 2016 and 2015 of $61 million and $107 million, respectively, primarily related net unrealized gains/losses on securities, as a component of accumulated other comprehensive income.

In 2015, we acquired all of the outstanding common stock of Receptos. The acquisition was accounted for using the acquisition method of accounting, and we recorded a deferred tax liability of $2.5 billion related to the acquisition. Upon integration of the acquired assets into our offshore research, manufacturing, and commercial operations, the deferred tax liability was reclassified to a non-current tax liability which represented an estimate of income tax that may have been incurred in the future upon successful development of the acquired IPR&D into a commercially viable product. Upon enactment of the 2017 Tax Act, the non-current tax liability was reclassified to a deferred tax liability and remeasured for the enacted change in tax rates that are expected to apply when the temporary difference reverses.

Our tax returns are under routine examination in many taxing jurisdictions. The scope of these examinations includes, but is not limited to, the review of our taxable presence in a jurisdiction, our deduction of certain items, our claims for research and development tax credits, our compliance with transfer pricing rules and regulations and the inclusion or exclusion of amounts from our tax returns as filed. Our U.S. federal income tax returns have been audited by the IRS through the year ended December 31, 2008. Tax returns for the years ended December 31, 2009, 2010, and 2011 are currently under examination by the IRS. We are also subject to audits by various state and foreign taxing authorities, including, but not limited to, most U.S. states and major European and Asian countries where we have operations.

We regularly reevaluate our tax positions and the associated interest and penalties, if applicable, resulting from audits of federal, state and foreign income tax filings, as well as changes in tax law (including regulations, administrative pronouncements, judicial precedents, etc.) that would reduce the technical merits of the position to below more likely than not. We believe that our accruals for tax liabilities are adequate for all open years. Many factors are considered in making these evaluations, including past history, recent interpretations of tax law and the specifics of each matter. Because tax regulations are subject to interpretation and tax litigation is inherently uncertain, these evaluations can involve a series of complex judgments about future events and can rely heavily on estimates and assumptions. We apply a variety of methodologies in making these estimates and assumptions, which include studies performed by independent economists, advice from industry and subject matter experts, evaluation of public actions taken by the IRS and other taxing authorities, as well as our industry experience. These evaluations are based on estimates and assumptions that have been deemed reasonable by management. However, if management's estimates are not representative of actual outcomes, our results of operations could be materially impacted.
Unrecognized tax benefits, generally represented by liabilities on the consolidated balance sheet and all subject to tax examinations, arise when the estimated benefit recorded in the financial statements differs from the amounts taken or expected to be taken in a tax return because of the uncertainties described above. A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows:
 
 
2017
 
2016
Balance at beginning of year
 
$
414

 
$
326

Increases related to prior year tax positions
 
67

 
—

Decreases related to prior year tax positions
 
—

 
(11
)
Increases related to current year tax positions
 
426

 
108

Settlements
 
—

 
—

Lapses of statutes of limitations
 
(11
)
 
(9
)
Balance at end of year
 
$
896

 
$
414



These unrecognized tax benefits relate primarily to issues common among multinational corporations. If recognized, unrecognized tax benefits of approximately $826 million would have a net impact on the effective tax rate. We account for interest and penalties related to uncertain tax positions as part of our provision for income taxes. Accrued interest as of December 31, 2017 and 2016 is approximately $60 million and $40 million, respectively.

We have recorded changes in the liability for unrecognized tax benefits related to income tax audits, new information, and expirations of statutes of limitations in various taxing jurisdictions. The liability for unrecognized tax benefits is expected to increase in the next twelve months relating to operations occurring in that period. Any settlements of examinations with taxing authorities or expirations of statutes of limitations would likely result in a decrease in our liability for unrecognized tax benefits and a corresponding increase in taxes paid or payable and/or a decrease in income tax expense. It is reasonably possible that the amount of the liability for unrecognized tax benefits could change by a significant amount during the next twelve-month period as a result of settlements or expirations of statutes of limitations. Finalizing examinations with the relevant taxing authorities can include formal administrative and legal proceedings and, as a result, it is difficult to estimate the timing and range of possible change related to the Company’s unrecognized tax benefits. An estimate of the range of the possible change cannot be made until issues are further developed or examinations close. Our estimates of tax benefits and potential tax benefits may not be representative of actual outcomes, and variation from such estimates could materially affect our financial statements in the period of settlement or when the statutes of limitations expire.