Income Taxes

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



	2014		2013		2012
U.S.	$	506	$	464	$	504
Foreign	921		1,087		1,641
	$	1,427	$	1,551	$	2,145

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



		2014			2013			2012
Current:	Federal	$	255		$	159		$	160
	Foreign	321			330			314
	State	2			22			35
		$	578		$	511		509

Deferred:	Federal	$	(67	)	$	42		91
	Foreign	(106		)	(53		)	(57		)
	State	1			(13		)	(6		)
		(172		)	(24		)	28
		$	406		$	487		$	537

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



	2014					2013					2012
U.S. federal statutory rate	$	500		35.0	%	$	543		35.0	%	$	751		35.0	%
State income tax, net of federal tax benefit	8			0.6		3			0.2		4			0.2
Statutory rate differential attributable to foreign operations	(168		)	(11.7	)	(177		)	(11.4	)	(165		)	(7.7	)
Adjustments to reserves and prior years	(5		)	(0.3	)	49			3.1		(47		)	(2.2	)
Change in valuation allowances	35			2.4		23			1.5		14			0.6
Other, net	36			2.5		46			3.0		(20		)	(0.9	)
Effective income tax rate	$	406		28.5	%	$	487		31.4	%	$	537		25.0	%

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.

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 2014, this item was favorably impacted by the resolution of uncertain tax positions in certain foreign jurisdictions.

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

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

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 2014, $35 million of net tax expense was driven by $41 million for vauation allowances recorded against deferred tax assets generated during the current year, partially offset by $6 million in 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 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.

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 years 2014 and 2013, this item was negatively impacted by the $160 million and $222 million, respectively, of non-cash impairments of Little Sheep goodwill, which resulted in no related tax benefit. See Note 4.

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. See Note 4.

The details of 2014 and 2013 deferred tax assets (liabilities) are set forth below:



	2014			2013
Operating losses and tax credit carryforwards	$	433		$	310
Employee benefits	238			182
Share-based compensation	119			118
Self-insured casualty claims	42			48
Lease-related liabilities	119			120
Various liabilities	73			88
Property, plant and equipment	39			42
Deferred income and other	102			58
Gross deferred tax assets	1,165			966
Deferred tax asset valuation allowances	(228		)	(203		)
Net deferred tax assets	$	937		$	763
Intangible assets, including goodwill	$	(148	)	$	(233	)
Property, plant and equipment	(63		)	(93		)
Other	(104		)	(55		)
Gross deferred tax liabilities	$	(315	)	$	(381	)
Net deferred tax assets (liabilities)	$	622		$	382



Reported in Consolidated Balance Sheets as:
Deferred income taxes – current	$	93		$	123
Deferred income taxes – long-term	571			399
Accounts payable and other current liabilities	(2		)	(2		)
Other liabilities and deferred credits	(40		)	(138		)
	$	622		$	382

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 $2.0 billion at December 27, 2014. A determination of the deferred tax liability on this amount is not practicable.

At December 27, 2014, the Company has foreign operating and capital loss carryforwards of $0.7 billion and U.S. state operating loss, capital loss and tax credit carryforwards of $1.0 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
	2015		2016-2019		2020-2034		Indefinitely		Total
Foreign	$	62	$	192	$	96	$	324	$	674
U.S. state	18		90		888		—		996
U.S. federal	—		89		157		—		246
	$	80	$	371	$	1,141	$	324	$	1,916

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 $115 million and $243 million of unrecognized tax benefits at December 27, 2014 and December 28, 2013, respectively, $17 million and $170 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:



	2014			2013
Beginning of Year	$	243		$	309
Additions on tax positions - current year	19			19
Additions for tax positions - prior years	31			55
Reductions for tax positions - prior years	(20		)	(102		)
Reductions for settlements	(144		)	(23		)
Reductions due to statute expiration	(13		)	(16		)
Foreign currency translation adjustment	(1		)	1
End of Year	$	115		$	243

In 2014, the reduction in unrecognized tax benefits is primarily attributable to the resolution of the dispute with the IRS regarding the valuation of rights to intangibles transferred to certain foreign subsidiaries. See discussion below in the Internal Revenue Service Adjustments for details.

The Company believes it is reasonably possible its unrecognized tax benefits may decrease by approximately $5 million in the next 12 months, including approximately $3 million which, if recognized upon audit settlement or statute expiration, would affect the 2015 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 Company has settled audits with the IRS through fiscal year 2008. Our operations in certain foreign jurisdictions remain subject to examination for tax years as far back as 2004, some of which years are currently under audit by local tax authorities. 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 27, 2014, each of which is individually insignificant.

The accrued interest and penalties related to income taxes at December 27, 2014 and December 28, 2013 are set forth below:



	2014		2013
Accrued interest and penalties	$	5	$	64

During 2014, 2013 and 2012, a net expense of $11 million, net expense of $18 million and net benefit of $3 million, respectively, for interest and penalties was recognized in our Consolidated Statements of Income as components of its income tax provision.

Internal Revenue Service 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 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. On January 9, 2013, the Company received a RAR from the IRS for fiscal years 2007 and 2008 proposing a similar adjustment. The valuation issue impacted tax returns for fiscal years 2004 through 2013.

On July 31, 2014, the Company reached a final agreement with the IRS Appeals Division regarding the valuation issue. As a result of this agreement, we closed out our 2004-2006 and 2007-2008 audit cycles and made cash payments to the IRS of $200 million, which were effectively fully reserved, to settle all issues for these audit cycles. The agreement also resolves the valuation issue for all later, impacted years. While additional cash payments related to the valuation issue will be required upon the closure of the examinations of fiscal years 2009 - 2013, the amounts will not be significant.