In connection with the U.S. tax law changes enacted in December 2017 and in accordance with SEC Staff Accounting Bulletin 118 (SAB 118), the Company completed its analysis of the income tax effects of the U.S.
tax law changes during the three months ended February 28, 2019. The incremental net tax benefit recorded upon completion of the analysis of the income tax effects of the U.S. tax law changes was not material to our
Consolidated Financial Statements.
In fiscal 2018, as a direct result of the U.S. tax law changes, the Company performed preliminary analysis and recorded a provisional estimated net tax benefit of $125 million. This provisional net tax benefit arose from a benefit of $648 million from re-measuring the Company’s net U.S. deferred tax liabilities, partially offset by the Company’s accrual for the transition tax and other U.S. tax law changes of $523 million. In fiscal 2019, the Company finalized its provisional estimates and recognized incremental net income tax expense, which was not material to our Consolidated Financial Statements, upon completing the accounting related to the U.S. tax law changes, primarily related to the refinement of the transition tax expense on the one-time mandatory repatriation of previously untaxed earnings of foreign subsidiaries.
The U.S. tax law changes include broad and complex changes. Among other things, the U.S. tax law changes reduced the federal corporate tax rate from 35% to 21% effective January 1, 2018 and required companies to immediately accrue for a one-time transition tax on certain un-repatriated earnings of foreign subsidiaries, which is generally payable over an eight-year period. The U.S. tax law changes modified the taxation of foreign earnings, repealed the deduction for domestic production activities, limited interest deductibility and established a global intangible low tax income (GILTI) regime.
The lower corporate income tax rate of 21% became effective January 1, 2018 and was phased in as a result of our August 31 fiscal year-end. This resulted in a blended U.S. statutory federal tax rate of approximately 26% for fiscal 2018. This statutory federal tax rate is 21% for fiscal 2019 and subsequent fiscal years, which provided a benefit to the Company’s fiscal 2019 tax provision of approximately $89 million.
During 2019, the U.S. Treasury Department issued regulations to apply retroactively covering certain
components of the 2017 U.S. tax law changes. Certain guidance included in these regulations is inconsistent with the Company’s interpretation that led to the recognition of $247 million of tax benefits in prior periods. Despite this new guidance, the Company remains confident in its interpretation of the U.S. tax law changes and intends to defend this position through litigation, if necessary. However, if the Company is ultimately unsuccessful in defending its position, it may be required to reverse all or a portion of the benefits previously recorded.
By establishing the GILTI regime, the Act created a minimum tax on certain foreign sourced earnings. The taxability of the foreign earnings and the applicable tax rates are dependent on future events. The Company’s accounting policy for the minimum tax on foreign sourced earnings is to report the tax effects on the basis that the minimum tax will be recognized in tax expense in the year it is incurred as a period expense.
As the Company repatriates the undistributed earnings of its foreign subsidiaries for use in the United States, the earnings from its foreign subsidiaries will generally not be subject to U.S. federal tax. The Company
continuously evaluates the amount of foreign earnings that are not necessary to be permanently reinvested in its foreign subsidiaries.
The components of earnings before income tax provision were (in millions):
2019 2018 2017
U.S. $1,898 $3,292 $1,953
Non–U.S. 2,629 2,683 2,900
Total $4,527 $5,975 $4,853
The provision for income taxes consists of the following (in millions):
2019 2018 2017
Current provision
Federal $201 $ 866 $ 759
State 46 103 45
Non–U.S. 241 353 390
488 1,322 1,194 Deferred provision
Federal – tax law change — (648) —
Federal – excluding tax law change 151 304 (306)
State 4 78 (24)
Non–U.S. – tax law change — — (80)
Non–U.S. – excluding tax law change (55) (58) (24)
100 (324) (434)
Income tax provision $588 $ 998 $ 760
The difference between the statutory federal income tax rate and the effective tax rate is as follows:
2019 2018 2017
Federal statutory rate 21.0% 25.7% 35.0%
State income taxes, net of federal benefit 0.9 2.3 0.3
Foreign income taxed at non-U.S. rates (2.1) (12.2) (11.8)
Non-taxable income (3.5) (5.2) (5.3)
Non-deductible expenses 0.5 2.1 1.5
Transition tax — 12.4 —
Tax law changes (0.4) (10.9) (1.6)
Change in valuation allowance1 1.9 8.7 0.7
Tax credits (4.8) (6.9) (2.9)
Other (0.5) 0.7 (0.2)
Effective income tax rate 13.0% 16.7% 15.7%
1 Net of changes in related tax attributes.
The deferred tax assets and liabilities included in the Consolidated Balance Sheets consist of the following (in millions):
2019 2018
Deferred tax assets:
Compensation and benefits 133 152
Insurance 90 74
Accrued rent 219 271
Allowance for doubtful accounts 13 27
Tax attributes 6,687 2,351
Stock compensation 45 44
Deferred income 115 110
Other 78 44
7,380 3,073
Less: valuation allowance 6,638 2,226
Total deferred tax assets 742 847
Deferred tax liabilities:
Accelerated depreciation 475 603
Inventory 394 301
Intangible assets 1,116 1,234
Equity method investment 481 459
2,466 2,597
Net deferred tax liabilities $1,724 $1,750
As of August 31, 2019, the Company has recorded deferred tax assets for tax attributes of $6.7 billion, primarily reflecting the benefit of $3.1 billion in U.S. federal, $159 million in state and $23.7 billion in non-U.S. ordinary and capital losses. In addition, these deferred tax assets include $61 million of income tax credits. Of these deferred tax assets, $6.4 billion will expire at various dates from 2020 through 2036. The residual deferred tax assets of $248 million have no expiry date.
The Company believes it is more likely than not that the benefit from certain deferred tax assets will not be realized. In recognition of this risk, the Company has recorded a valuation allowance of $6.6 billion against those deferred tax assets as of August 31, 2019.
Income taxes paid, net of refunds were $0.9 billion, $0.6 billion and $1.1 billion for fiscal years 2019, 2018 and 2017, respectively.
ASC Topic 740, Income Taxes, provides guidance regarding the recognition, measurement, presentation and disclosure in the financial statement of tax positions taken or expected to be taken on a tax return, including the decision whether to file in a particular jurisdiction. As of August 31, 2019, unrecognized tax benefits of
$499 million were reported as long-term liabilities on the Consolidated Balance Sheets while an immaterial amount is reported as current tax liabilities. Both of these amounts include interest and penalties, when applicable.
The following table provides a reconciliation of the total amounts of unrecognized tax benefits (in millions):
2019 2018 2017
Balance at beginning of year $456 $409 $269
Gross increases related to tax positions in a prior period 33 123 151
Gross decreases related to tax positions in a prior period (53) (15) (36)
Gross increases related to tax positions in the current period 26 29 33
Settlements with taxing authorities (2) (87) (2)
Currency — — (1)
Lapse of statute of limitations (5) (3) (5)
Balance at end of year $455 $456 $409
At August 31, 2019, 2018 and 2017, $311 million, $331 million and $286 million, respectively, of unrecognized tax benefits would favorably impact the effective tax rate if recognized. During the next twelve months, based on current knowledge, it is reasonably possible the amount of unrecognized tax benefits could decrease by up to
$16 million due to anticipated tax audit settlements and the expirations of statutes of limitations associated with tax positions related to multiple tax jurisdictions.
The Company recognizes interest and penalties in the income tax provision in its Consolidated Statements of Earnings. At August 31, 2019 and August 31, 2018, the Company had accrued interest and penalties of
$47 million and $87 million, respectively. For the year ended August 31, 2019, the amount reported in income tax expense related to interest and penalties was $40 million income tax benefit.
The Company files a consolidated U.S. federal income tax return as well as income tax returns in various states and multiple foreign jurisdictions. It is generally no longer under audit examinations for U.S. federal income tax purposes for any years prior to fiscal 2014. With few exceptions, it is no longer subject to state and local income tax examinations by tax authorities for years before fiscal 2007. In foreign tax jurisdictions, the Company is generally no longer subject to examination by the tax authorities in the United Kingdom prior to 2015, Luxembourg prior to 2013, in Germany prior to 2014, in France prior to 2008 and in Turkey prior to 2014.
The Company has received tax holidays from Swiss cantonal income taxes relative to certain of its Swiss operations. The income tax holidays are expected to extend through September 2022. The holidays had a beneficial impact of $127 million and $127 million (inclusive of capital GILTI tax cost) during fiscal 2019 and 2018, respectively. This benefit is primarily included as part of the foreign income taxed at non-U.S. rates line in the effective tax rate reconciliation table above.
At August 31, 2019, it is not practicable for the Company to determine the amount of the unrecognized deferred tax liability it has with respect to temporary differences related to investments in foreign subsidiaries and foreign corporate joint ventures that are essentially permanent in duration.