AGILENT TECHNOLOGIES INC

5. INCOME TAXES

The domestic and foreign components of income from continuing operations before taxes are:



	Years Ended October 31,
	2017		2016		2015
	(in millions)
U.S. operations	$	116	$	27	$	77
Non-U.S. operations	687		517		403
Total income from continuing operations before taxes	$	803	$	544	$	480

The provision for income taxes is comprised of:



	Years Ended October 31,
	2017			2016			2015
	(in millions)
U.S. federal taxes:
Current	$	15		$	(1	)	$	(91	)
Deferred	110			19			97
Non-U.S. taxes:
Current	1			77			62
Deferred	(7		)	(14		)	(27		)
State taxes, net of federal benefit:
Current	1			3			1
Deferred	(1		)	(2		)	—
Total provision	$	119		$	82		$	42

The income tax provision does not reflect potential future tax savings resulting from excess deductions associated with our various share-based award plans.

The significant components of deferred tax assets and deferred tax liabilities included on the consolidated balance sheet are:



	October 31,
	2017					2016
	Deferred Tax Assets			Deferred Tax Liabilities		Deferred Tax Assets			Deferred Tax Liabilities
	(in millions)
Inventory	$	16		$	—	$	13		$	—
Intangibles	—			93		—			92
Property, plant and equipment	12			—		16			—
Warranty reserves	12			—		14			—
Pension benefits and retiree medical benefits	70			—		136			—
Employee benefits, other than retirement	28			—		28			—
Net operating loss, capital loss, and credit carryforwards	328			—		293			—
Unremitted earnings of foreign subsidiaries	—			163		—			53
Share-based compensation	45			—		41			—
Deferred revenue	45			—		42			—
Other	1			—		12			—
Subtotal	557			256		595			145
Tax valuation allowance	(138		)	—		(129		)	—
Total deferred tax assets or deferred tax liabilities	$	419		$	256	$	466		$	145

The decrease in 2017 as compared to 2016 for the deferred tax asset relating to pension benefits is due mainly to the tax effect of changes in pension plans recognized in other comprehensive income (loss). During the third quarter of 2017, the company determined a portion of current year foreign earnings from its low tax jurisdictions would not be considered as indefinitely reinvested. As such, a liability for that portion of unremitted foreign earnings was accrued causing an increase in ending deferred tax liability.

Agilent records U.S. income taxes on the undistributed earnings of foreign subsidiaries unless the subsidiaries' earnings are considered indefinitely reinvested outside the U.S. As of October 31, 2017 the company recognized a $163 million deferred tax liability for the overall residual tax expected to be imposed upon the repatriation of unremitted foreign earnings not considered permanently reinvested. As of October 31, 2017, the cumulative amount of undistributed earnings considered indefinitely reinvested was $5.8 billion. No deferred tax liability has been recognized on the basis difference created by such earnings since it is our intention to utilize those earnings in the company’s foreign operations. Due to the availability of U.S. foreign tax credits, the determination of the unrecognized deferred tax liability on these earnings is not practicable.

The breakdown between long-term deferred tax assets and deferred tax liabilities was as follows for the years 2017 and 2016:



	October 31,
	2017			2016
	(in millions)
Long-term deferred tax assets (included within other assets)	$	240		$	386
Long-term deferred tax liabilities (included within other long-term liabilities)	(77		)	(65		)
Total	$	163		$	321

Valuation allowances require an assessment of both positive and negative evidence when determining whether it is more likely than not that deferred tax assets are recoverable. Such assessment is required on a jurisdiction by jurisdiction basis. As of October 31, 2017, we continued to maintain a valuation allowance of $138 million until sufficient positive evidence exists to support reversal. The valuation allowance is mainly related to deferred tax assets for California R&D credits, net operating losses in the state of Colorado and the Netherlands and capital losses in the U.S. and foreign jurisdictions.

At October 31, 2017, we had federal, state and foreign net operating loss carryforwards of approximately $10 million, $670 million and $310 million, respectively. The federal and state net operating loss carryforwards are subject to various limitations under Section 382 of the Internal Revenue Code and applicable state tax laws. If not utilized, the federal and state net operating loss carryforwards will both begin to expire in 2018. If not utilized, $124 million of the foreign net operating loss carryforwards will begin to expire in 2018. The remaining $186 million of the foreign net operating losses carry forward indefinitely. At October 31, 2017, we had federal and foreign capital loss carryforwards of $48 million and $129 million, respectively. If not utilized, the federal capital loss carryforwards will begin to expire in 2022. The foreign capital losses carry forward indefinitely. At October 31, 2017, we had federal and state tax credit carryforwards, net of reserves. of approximately $144 million and $55 million, respectively. If not utilized, the federal tax credit carryforwards will begin to expire in 2018. The state tax credits carry forward indefinitely.

The differences between the U.S. federal statutory income tax rate and our effective tax rate are:



	Years Ended October 31,
	2017			2016			2015
	(in millions)
Profit before tax times statutory rate	$	281		$	190		$	167
State income taxes, net of federal benefit	2			2			(8		)
Non-U.S. income taxed at different rates	(43		)	(68		)	(72		)
Change in unrecognized tax benefits	(110		)	(27		)	(116		)
Repatriation of foreign earnings	—			—			68
Valuation allowances	1			18			(2		)
Adjustments to earnings of foreign subsidiaries	—			(11		)	—
Other, net	(12		)	(22		)	5
Provision for income taxes	$	119		$	82		$	42
Effective tax rate	14.8		%	15.1		%	8.7		%

Agilent enjoys tax holidays in several different jurisdictions, most significantly in Singapore. The tax holidays provide lower rates of taxation on certain classes of income and require various thresholds of investments and employment or specific types of income in those jurisdictions. The tax holidays are due for renewal between 2018 and 2023. As a result of the incentives, the impact of the tax holidays decreased income taxes by $93 million, $86 million, and $65 million in 2017, 2016, and 2015, respectively. The benefit of the tax holidays on net income per share (diluted) was approximately $0.29, $0.26, and $0.19 in 2017, 2016 and 2015, respectively.

For 2017, the company's income tax expense was $119 million with an effective tax rate of 14.8 percent. Our effective tax rate is impacted by earnings realized in foreign jurisdictions with statutory tax rates lower than the federal statutory tax rate. During the year, the company determined a portion of current year foreign earnings from its low tax jurisdictions would not be considered as indefinitely reinvested. As such, a deferred tax liability for that portion of unremitted foreign earnings was accrued causing an increase in the annual tax expense. Our annual effective tax rate also included tax benefits due to the settlement of an audit in Germany for the years 2005 through 2008 and the lapse of U.S. statute of limitation for the fiscal years 2012 and 2013. This benefit was offset by a deferred tax liability required for the tax expected upon repatriation of related unremitted foreign earnings that were not asserted as indefinitely invested outside the U.S.

For 2016, the company's income tax expense was $82 million with an effective tax rate of 15.1 percent. The income tax provision from continuing operations for the year ended October 31, 2016 included net discrete tax expense of $17 million primarily due to tax expense related to the establishment of a valuation allowance on an equity method impairment that would generate a capital loss when realized.

For 2015, the company’s income tax expense was $42 million with an effective tax rate of 8.7 percent. The income tax expense from continuing operations for the year ended October 31, 2015 included a net discrete tax benefit of $55 million primarily due to the settlement of an Internal Revenue Service (“IRS) audit in the U.S. and the recognition of tax expense related to the repatriation of dividends.

The breakdown between current and long-term income tax assets and liabilities, excluding deferred tax assets and liabilities, was as follows for the years 2017 and 2016:



	October 31,
	2017			2016
	(in millions)
Current income tax assets (included within other current assets)	$	77		$	83
Long-term income tax assets (included within other assets)	18			19
Current income tax liabilities (included within other accrued liabilities)	(55		)	(49		)
Long-term income tax liabilities (included within other long-term liabilities)	(131		)	(190		)
Total	$	(91	)	$	(137	)

The calculation of our tax liabilities involves dealing with uncertainties in the application of complex tax law and regulations in a multitude of jurisdictions. Although the guidance on the accounting for uncertainty in income taxes prescribes the use of a recognition and measurement model, the determination of whether an uncertain tax position has met those thresholds will continue to require significant judgment by management. In accordance with the guidance on the accounting for uncertainty in income taxes, for all U.S. and other tax jurisdictions, we recognize potential liabilities for anticipated tax audit issues based on our estimate of whether, and the extent to which, additional taxes and interest will be due. The ultimate resolution of tax uncertainties may differ from what is currently estimated, which could result in a material impact on income tax expense. If our estimate of income tax liabilities proves to be less than the ultimate assessment, a further charge to expense would be required. If events occur and the payment of these amounts ultimately proves to be unnecessary, the reversal of the liabilities would result in tax benefits being recognized in the period when we determine the liabilities are no longer necessary.

The aggregate changes in the balances of our unrecognized tax benefits including all federal, state and foreign tax jurisdictions are as follows:



	2017			2016			2015
	(in millions)
Balance, beginning of year	$	293		$	289		$	417
Additions for tax positions related to the current year	32			31			33
Additions for tax positions from prior years	1			1			3
Reductions for tax positions from prior years	(3		)	(27		)	(156		)
Settlements with taxing authorities	(52		)	—			(4		)
Statute of limitations expirations	(47		)	(1		)	(4		)
Balance, end of year	$	224		$	293		$	289

As of October 31, 2017, we had $224 million of unrecognized tax benefits of which $202 million, if recognized, would affect our effective tax rate.

We recognized a tax benefit of $9 million, a tax expense of $2 million and a tax benefit of $2 million of interest and penalties related to unrecognized tax benefits in 2017, 2016 and 2015, respectively. Interest and penalties accrued as of October 31, 2017 and 2016 were $16 million and $25 million, respectively.

In the U.S., tax years remain open back to the year 2014 for federal income tax purposes and the year 2000 for significant states. There were no substantial changes to the status of these open tax years during 2017. The U.S. statute of limitation for audit of tax returns for the fiscal years 2012 and 2013 expired in July, 2017. The statute expiration resulted in the recognition, within the continuing operations, of previously unrecognized tax benefits of $40 million. This discrete tax benefit was offset by a deferred tax liability required for the tax expected upon repatriation of related unremitted foreign earnings that were not asserted as indefinitely invested outside the U.S.

On September 22, 2015, we reached an agreement with the Internal Revenue Service ("IRS") for the tax years 2008 through 2011. The settlement resulted in the recognition, within the continuing operations, of previously unrecognized tax benefits of $119 million, offset by a tax liability on foreign distributions of approximately $99 million principally related to the repatriation of foreign earnings.

In other major jurisdictions where the company conducts business, the tax years generally remain open back to the year 2001. During the first quarter of fiscal year 2017, the company settled its ongoing tax audit in Italy for the years 2011 to 2013 resulting in a net tax expense of $7 million. The settlement resulted in the recognition of previously unrecognized tax benefits of approximately $14 million. During the third quarter of fiscal year 2017, the company settled its ongoing tax audit in Germany for the years 2005 to 2008, which resulted in the recognition of previously unrecognized tax benefits of approximately $51 million.

With these jurisdictions and the U.S., it is reasonably possible that there could be significant changes to our unrecognized tax benefits in the next twelve months due to either the expiration of a statute of limitation or a tax audit settlement which will be partially offset by an anticipated tax liability related to unremitted foreign earnings, where applicable. Given the number of years and numerous matters that remain subject to examination in various tax jurisdictions, management is unable to estimate the range of possible changes to the balance of our unrecognized tax benefits.

On July 27, 2015, the U.S. Tax Court issued an opinion in Altera Corp. v. Commissioner related to the treatment of stock-based compensation expense in an intercompany cost-sharing arrangement. A final decision was entered by the U.S. Tax Court on December 1, 2015. At this time, the U.S. Department of the Treasury has not withdrawn the requirement from its regulations to include stock-based compensation. The IRS appealed the decision and filed its arguments opposing the Tax Court decision in June 2016. The case is currently in the appeals process in the Ninth Circuit. Due to the uncertainty surrounding the Court’s decision, we concluded that no adjustment to our consolidated financial statements is appropriate at this time.