Entity information:
Income Taxes
The following illustrates domestic and foreign income before income taxes:
 
 
Fiscal Year Ended September 30,
(in thousands)
 
2017
 
2016
 
2015
Domestic
 
$
394,721

 
$
906,415

 
$
55,545

Foreign
 
523,166

 
484,495

 
213,419

Total
 
$
917,887

 
$
1,390,910

 
$
268,964


The income tax provision (benefit) is as follows:
 
 
Fiscal Year Ended September 30,
(in thousands)
 
2017
 
2016
 
2015
Current provision:
 
 

 
 

 
 

Federal
 
$
141,071

 
$
11,892

 
$
310,847

State and local
 
35,950

 
26,741

 
46,240

Foreign
 
57,313

 
55,275

 
29,216

 
 
234,334

 
93,908

 
386,303

Deferred provision (benefit):
 
 

 
 

 
 

Federal
 
265,074

 
(119,218
)
 
1,283

State and local
 
54,995

 
(11,490
)
 
18,201

Foreign
 
(1,000
)
 
(219
)
 
1,342

 
 
319,069

 
(130,927
)
 
20,826

Provision (benefit) for income taxes
 
$
553,403

 
$
(37,019
)
 
$
407,129


A reconciliation of the statutory U.S. federal income tax rate to the effective income tax rate is as follows:
 
Fiscal Year Ended September 30,
 
2017
 
2016
 
2015
Statutory U.S. federal income tax rate
35.0%
 
35.0%
 
35.0%
State and local income tax rate, net of federal tax benefit
5.4
 
0.6
 
10.4
Foreign
(14.6)
 
(8.4)
 
(20.4)
Warrants
—
 
(32.8)
 
109.7
Valuation allowance
2.2
 
2.2
 
9.2
Excess tax benefits related to share-based compensation
(3.8)
 
—
 
—
Non-deductible litigation settlements and accruals (see Note 13)
34.3
 
—
 
—
Other
1.8
 
0.7
 
7.5
Effective income tax rate
60.3%
 
(2.7)%
 
151.4%

In March 2013, the Company issued Warrants (as defined in Note 7) in connection with various agreements and arrangements with WBA, as successor in interest to Walgreen Co. ("Walgreens") and Alliance Boots GmbH ("Alliance Boots"). At that time, the Company determined that the Warrants had a fair value of $242.4 million on the date of issuance, which was an estimate of the approximate tax deductible amount that would be deducted ratably on the Company's income tax return over the 10-year term of the various agreements, and that any value in excess of the initial fair value of the Warrants on the date of issuance would not be tax deductible. The Company reevaluated its position, and in November 2015, the Company received a private letter ruling from the Internal Revenue Service ("IRS"), which entitled it to an income tax deduction equal to the fair value of the Warrants on the date of exercise. As a result, the Company recorded a deferred tax asset and recognized a tax benefit adjustment of approximately $456 million, which represented the estimated benefit from the tax deduction for the increase in the fair value of the Warrants from the issuance date through September 30, 2015. This tax benefit adjustment had a significant impact to the Company's effective tax rate in the fiscal year ended September 30, 2016. In March 2016 and August 2016, the Warrants were exercised in full by WBA. In the aggregate, the total fair value of the Warrants based upon their respective exercise dates was $1,565.9 million. An additional tax benefit of approximately $52 million was recognized primarily related to the change in the fair value of the Warrants from September 30, 2015 to their respective exercise dates in the fiscal year ended September 30, 2016.
Deferred income taxes reflect the future tax consequences of differences between the tax bases of assets and liabilities and their financial reporting amounts. Significant components of the Company's deferred tax liabilities (assets) are as follows:
 
 
September 30,
(in thousands)
 
2017
 
2016
Merchandise inventories
 
$
1,519,779

 
$
1,281,364

Property and equipment
 
150,240

 
123,443

Goodwill and other intangible assets
 
1,214,597

 
1,248,297

Other
 
1,126

 
6,709

Gross deferred tax liabilities
 
2,885,742

 
2,659,813

 
 
 
 
 
Net operating loss and tax credit carryforwards
 
(320,180
)
 
(321,541
)
Capital loss carryforwards
 
(64,346
)
 
(65,535
)
Allowance for doubtful accounts
 
(25,871
)
 
(25,272
)
Accrued expenses
 
(36,188
)
 
(37,842
)
Employee and retiree benefits
 
(17,121
)
 
(17,759
)
Share-based compensation
 
(59,495
)
 
(52,238
)
Other
 
(81,009
)
 
(90,383
)
Gross deferred tax assets
 
(604,210
)
 
(610,570
)
Valuation allowance for deferred tax assets
 
211,080

 
165,531

Deferred tax assets, net of valuation allowance
 
(393,130
)
 
(445,039
)
Net deferred tax liabilities
 
$
2,492,612

 
$
2,214,774


The following tax carryforward information is presented as of September 30, 2017. The Company had $26.5 million of potential tax benefits from federal net operating loss carryforwards expiring in 1 to 19 years, $118.1 million of potential tax benefits from state net operating loss carryforwards expiring in 1 to 20 years, and $23.8 million of potential tax benefits from foreign net operating loss carryforwards, which have varying expiration dates. The Company had $64.3 million of potential tax benefits from capital loss carryforwards expiring in 1 to 3 years. The Company had $12.3 million of foreign tax credit carryforwards expiring in 1 to 9 years. The Company had $2.6 million of state tax credit carryforwards and $140.0 million in federal alternative minimum tax credit carryforwards and $2.1 million in foreign alternative minimum tax credit carryforwards. The Company had $9.9 million in federal research and development tax credit carryforwards expiring in 18 to 20 years.
In the fiscal year ended September 30, 2017, the Company increased the valuation allowance on deferred tax assets by $45.5 million due to the addition of certain state and foreign net operating loss carryforwards. Included in the $45.5 million valuation allowance is a $17.1 million valuation allowance that was established in connection with the adoption of ASU 2016-09 (see Note 1). This amount was not recognized in the Consolidated Statement of Operations in the fiscal year ended September 30, 2017. In the fiscal year ended September 30, 2016, the Company increased the valuation allowance on deferred tax assets by $33.4 million primarily due to the addition of certain state and foreign net operating loss carryforwards.
In the fiscal year ended September 30, 2017, tax benefits of $36.7 million related to the exercise of employee stock options and lapses of restricted shares were recorded in Income Tax Expense in the Company's Consolidated Statement of Operations. In the fiscal year ended September 30, 2016, there were no tax benefits related to the exercise of employee stock options and lapses of restricted shares. In the fiscal year ended September 30, 2015, tax benefits of $88.1 million related to the exercise of employee stock options and lapses of restricted shares were recorded within Additional Paid-In Capital (see Note 1).
Income tax payments, net of refunds, were $105.0 million, $17.5 million, and $299.6 million in the fiscal years ended September 30, 2017, 2016, and 2015, respectively.
The Company and its subsidiaries file income tax returns in the U.S. federal jurisdiction and various states and foreign jurisdictions. With few exceptions, the Company is no longer subject to U.S. federal, state and local, or foreign income tax examinations by tax authorities for years before 2013.
As of September 30, 2017 and 2016, the Company had unrecognized tax benefits, defined as the aggregate tax effect of differences between tax return positions and the benefits recognized in the Company's financial statements, of $338.4 million and $88.2 million, respectively ($304.2 million and $63.1 million, net of federal benefit, respectively). If recognized in the fiscal years ended September 30, 2017 and 2016, $289.2 million and $48.0 million, respectively, of these benefits would have reduced income tax expense and the effective tax rate. As of September 30, 2017 and 2016, included in the unrecognized tax benefits are $14.5 million and $12.4 million of interest and penalties, respectively, which the Company records in Income Tax Expense in the Company's Consolidated Statements of Operations.
A reconciliation of the beginning and ending amount of unrecognized tax benefits, excluding interest and penalties, is as follows:
 
 
Fiscal Year Ended September 30,
(in thousands)
 
2017
 
2016
 
2015
Unrecognized tax benefits at beginning of period
 
$
75,766

 
$
44,722

 
$
42,908

Additions of tax positions of the current year
 
252,866

 
24,145

 
3,616

Additions to tax positions of the prior years
 
1,049

 
11,840

 
—

Reductions of tax positions of the prior years
 
(668
)
 
(1,407
)
 
(871
)
Settlements with taxing authorities
 
(3,285
)
 
(2,589
)
 
(33
)
Expiration of statutes of limitations
 
(1,859
)
 
(945
)
 
(898
)
Unrecognized tax benefits at end of period
 
$
323,869

 
$
75,766

 
$
44,722


Included in the additions of unrecognized tax positions in the fiscal year ended September 30, 2017 is approximately $235.1 million for an uncertain tax position related to the $625.0 million civil litigation reserve recognized during the fiscal year ended September 30, 2017 (see Note 13). During the next 12 months, it is reasonably possible that state tax audit resolutions and the expiration of statutes of limitations could result in a reduction of unrecognized tax benefits by approximately $5.2 million.
Cumulative undistributed earnings of international subsidiaries were $1.3 billion at September 30, 2017. No deferred federal income taxes were provided for the undistributed earnings as they are permanently reinvested in the Company's international operations. It is not practicable to estimate the amount of U.S. tax that would result upon the eventual repatriation of such earnings.