Income Taxes

U.S. and foreign income before taxes are set forth below:



	2013		2012		2011
U.S.	$	464	$	504	$	266
Foreign	1,087		1,641		1,393
	$	1,551	$	2,145	$	1,659

The details of our income tax provision (benefit) are set forth below:



		2013			2012			2011
Current:	Federal	$	159		$	160		$	78
	Foreign	330			314			374
	State	22			35			9
		$	511		$	509		461

Deferred:	Federal	$	42		$	91		(83		)
	Foreign	(53		)	(57		)	(40		)
	State	(13		)	(6		)	(14		)
		(24		)	28			(137		)
		$	487		$	537		$	324

The reconciliation of income taxes calculated at the U.S. federal tax statutory rate to our effective tax rate is set forth below:



	2013					2012					2011
U.S. federal statutory rate	$	543		35.0	%	$	751		35.0	%	$	580		35.0	%
State income tax, net of federal tax benefit	3			0.2		4			0.2		2			0.1
Statutory rate differential attributable to foreign operations	(177		)	(11.4	)	(165		)	(7.7	)	(218		)	(13.1	)
Adjustments to reserves and prior years	49			3.1		(47		)	(2.2	)	24			1.4
Net benefit from LJS and A&W divestitures	—			—		—			—		(72		)	(4.3	)
Change in valuation allowances	23			1.5		14			0.6		22			1.3
Other, net	46			3.0		(20		)	(0.9	)	(14		)	(0.9	)
Effective income tax rate	$	487		31.4	%	$	537		25.0	%	$	324		19.5	%

Statutory rate differential attributable to foreign operations. This item includes local taxes, withholding taxes, and shareholder-level taxes, net of foreign tax credits. The favorable impact is primarily attributable to a majority of our income being earned outside of the U.S. where tax rates are generally lower than the U.S. rate.

In 2012, this benefit was negatively impacted by the repatriation of current year foreign earnings to the U.S. as we recognized additional tax expense, resulting from the related effective tax rate being lower than the U.S. federal statutory rate.

In 2011, this benefit was positively impacted by the repatriation of current year foreign earnings as we recognized excess foreign tax credits, resulting from the related effective tax rate being higher than the U.S. federal statutory rate.

Adjustments to reserves and prior years. This item includes: (1) changes in tax reserves, including interest thereon, established for potential exposure we may incur if a taxing authority takes a position on a matter contrary to our position; and (2) the effects of reconciling income tax amounts recorded in our Consolidated Statements of Income to amounts reflected on our tax returns, including any adjustments to the Consolidated Balance Sheets. The impact of certain effects or changes may offset items reflected in the 'Statutory rate differential attributable to foreign operations' line.

In 2013, this item was negatively impacted by the provision recorded related to the continuing dispute with the IRS regarding the valuation of rights to intangibles transferred to certain foreign subsidiaries. See discussion below in the Internal Revenue Service Proposed Adjustments for details.

In 2012, this item was favorably impacted by the resolution of uncertain tax positions in certain foreign jurisdictions.

Net benefit from LJS and A&W divestitures. This item includes a one-time $117 million tax benefit, including approximately $8 million U.S. state benefit, recognized on the LJS and A&W divestitures in 2011, partially offset by $45 million of valuation allowance, including approximately $4 million state expense, related to capital loss carryforwards recognized as a result of the divestitures. In addition, we recorded $32 million of tax benefits on $86 million of pre-tax losses and other costs, which resulted in $104 million of total net tax benefits related to the divestitures.

Change in valuation allowances. This item relates to changes for deferred tax assets generated or utilized during the current year and changes in our judgment regarding the likelihood of using deferred tax assets that existed at the beginning of the year. The impact of certain changes may offset items reflected in the 'Statutory rate differential attributable to foreign operations' line.

In 2013, $23 million of net tax expense was driven by $32 million for valuation allowances recorded against deferred tax assets generated during the current year, partially offset by a $9 million net tax benefit resulting from a change in judgment regarding the future use of certain deferred tax assets that existed at the beginning of the year.

In 2012, $14 million of net tax expense was driven by $16 million for valuation allowances recorded against deferred tax assets generated during the current year, partially offset by a $2 million net tax benefit resulting from a change in judgment regarding the future use of certain deferred tax assets that existed at the beginning of the year.

In 2011, $22 million of net tax expense was driven by $15 million for valuation allowances recorded against deferred tax assets generated during the current year and $7 million of tax expense resulting from a change in judgment regarding the future use of certain foreign deferred tax assets that existed at the beginning of the year. These amounts exclude $45 million in valuation allowance additions related to capital losses recognized as a result of the LJS and A&W divestitures, which are presented within Net Benefit from LJS and A&W divestitures.

Other. This item primarily includes the impact of permanent differences related to current year earnings as well as U.S. tax credits and deductions.

In 2013, this item was negatively impacted by the $222 million non-cash impairment of Little Sheep goodwill, which resulted in no related tax benefit.

In 2012, this item was positively impacted by a one-time pre-tax gain of $74 million, with no related income tax expense, recognized on our acquisition of additional interest in, and consolidation of Little Sheep.

The details of 2013 and 2012 deferred tax assets (liabilities) are set forth below:



	2013			2012
Operating losses and tax credit carryforwards	$	310		$	337
Employee benefits	182			251
Share-based compensation	118			108
Self-insured casualty claims	48			50
Lease-related liabilities	120			115
Various liabilities	88			82
Property, plant and equipment	42			39
Deferred income and other	58			57
Gross deferred tax assets	966			1,039
Deferred tax asset valuation allowances	(203		)	(200		)
Net deferred tax assets	$	763		$	839
Intangible assets, including goodwill	$	(233	)	$	(256	)
Property, plant and equipment	(93		)	(95		)
Other	(55		)	(48		)
Gross deferred tax liabilities	$	(381	)	$	(399	)
Net deferred tax assets (liabilities)	$	382		$	440



Reported in Consolidated Balance Sheets as:
Deferred income taxes – current	$	123		$	127
Deferred income taxes – long-term	399			467
Accounts payable and other current liabilities	(2		)	(5		)
Other liabilities and deferred credits	(138		)	(149		)
	$	382		$	440

We have investments in foreign subsidiaries where the carrying values for financial reporting exceed the tax basis. We have not provided deferred tax on the portion of the excess that we believe is essentially permanent in duration. This amount may become taxable upon an actual or deemed repatriation of assets from the subsidiaries or a sale or liquidation of the subsidiaries. We estimate that our total temporary difference upon which we have not provided deferred tax is approximately $2.6 billion at December 28, 2013. A determination of the deferred tax liability on this amount is not practicable.

At December 28, 2013, the Company has foreign operating and capital loss carryforwards of $0.6 billion and U.S. state operating loss, capital loss and tax credit carryforwards of $1.2 billion and U.S. federal capital loss and tax credit carryforwards of $0.2 billion. These losses are being carried forward in jurisdictions where we are permitted to use tax losses from prior periods to reduce future taxable income and will expire as follows:



	Year of Expiration
	2014		2015-2018		2019-2033		Indefinitely		Total
Foreign	$	38	$	132	$	91	$	325	$	586
U.S. state	16		105		1,040		—		1,161
U.S. federal	—		90		64		—		154
	$	54	$	327	$	1,195	$	325	$	1,901

We recognize the benefit of positions taken or expected to be taken in tax returns in the financial statements when it is more likely than not that the position would be sustained upon examination by tax authorities. A recognized tax position is measured at the largest amount of benefit that is greater than fifty percent likely of being realized upon settlement.

The Company had $243 million and $309 million of unrecognized tax benefits at December 28, 2013 and December 29, 2012, respectively, $170 million and $184 million of which, if recognized, would impact the effective income tax rate. A reconciliation of the beginning and ending amount of unrecognized tax benefits follows:



	2013			2012
Beginning of Year	$	309		$	348
Additions on tax positions - current year	19			50
Additions for tax positions - prior years	55			23
Reductions for tax positions - prior years	(102		)	(90		)
Reductions for settlements	(23		)	(6		)
Reductions due to statute expiration	(16		)	(16		)
Foreign currency translation adjustment	1			—
End of Year	$	243		$	309

The Company believes it is reasonably possible its unrecognized tax benefits may decrease by approximately $26 million in the next twelve months, including approximately $20 million which, if recognized upon audit settlement or statute expiration, would affect the 2014 effective tax rate. Each of these positions is individually insignificant.

The Company’s income tax returns are subject to examination in the U.S. federal jurisdiction and numerous foreign jurisdictions. The following table summarizes our major jurisdictions and the tax years that are either currently under audit or remain open and subject to examination:



Jurisdiction		Open Tax Years
U.S. Federal		2004 – 2013
China		2010 – 2013
United Kingdom		2010 – 2013
Mexico		2006 – 2013
Australia		2009 – 2013

In addition, the Company is subject to various U.S. state income tax examinations, for which, in the aggregate, we had significant unrecognized tax benefits at December 28, 2013, each of which is individually insignificant.

The accrued interest and penalties related to income taxes at December 28, 2013 and December 29, 2012 are set forth below:



	2013		2012
Accrued interest and penalties	$	64	$	50

During 2013, 2012 and 2011, a net expense of $18 million, net benefit of $3 million and net benefit of $2 million, respectively, for interest and penalties was recognized in our Consolidated Statements of Income as components of its income tax provision.

Internal Revenue Service Proposed Adjustments

On June 23, 2010, the Company received a Revenue Agent Report (RAR) from the Internal Revenue Service (the "IRS") relating to its examination of our U.S. federal income tax returns for fiscal years 2004 through 2006. The IRS has proposed an adjustment to increase the taxable value of rights to intangibles used outside the U.S. that YUM transferred to certain of its foreign subsidiaries. The proposed adjustment would result in approximately $700 million of additional taxes plus net interest to date of approximately $255 million for fiscal years 2004-2006. On January 9, 2013, the Company received an RAR from the IRS for fiscal years 2007 and 2008. As expected, the IRS proposed an adjustment similar to their proposal for 2004-2006 that would result in approximately $270 million of additional taxes plus net interest to date of approximately $40 million for fiscal years 2007 and 2008. Furthermore, the Company expects the IRS to make similar claims for years subsequent to fiscal 2008. The potential additional taxes for 2009 through 2013, computed on a similar basis to the 2004-2008 additional taxes, would be approximately $140 million plus net interest to date of approximately $10 million.

We believe we have properly reported our taxable income and paid taxes consistent with all applicable laws and intend to vigorously defend our position, including through litigation, if we are unable to settle with the IRS through administrative proceedings. As the final resolution of the proposed adjustments remains uncertain, there can be no assurance that payments due upon final resolution of this issue will not exceed our currently recorded reserve and such payments could have a material adverse effect on our financial position. Additionally, if increases to our reserves are deemed necessary due to future developments related to this issue, such increases could have a material adverse effect on our results of operations as they are recorded. The Company does not expect resolution of this matter within twelve months and cannot predict with certainty the timing of such resolution.