Note S. Income Taxes

Income (loss) from continuing operations before income taxes and equity in net earnings of affiliated companies was as follows:


	Years ended September 30
	2012		2011			2010
	(Dollars in millions)
Income (loss) from continuing operations:
Domestic	$	13	$	(25	)	$	3
Foreign		232		228			163

Total	$	245	$	203		$	166

Tax provision (benefit) on income consisted of the following:


	Years ended September 30
	2012			2011			2010
	(Dollars in millions)
U.S. federal and state:
Current	$	(1	)	$	(7	)	$	(8	)
Deferred		(8	)		(51	)		(14	)

Total		(9	)		(58	)		(22	)

Foreign:
Current		62			57			51
Deferred		2			7			1

Total		64			64			52

Total U.S. and foreign	$	55		$	6		$	30

The provision (benefit) for income taxes differed from the provision for income taxes as calculated using the U.S. statutory rate as follows:


	Years ended September 30
	2012			2011			2010
	(Dollars in millions)
Computed tax expense at the federal statutory rate	$	86		$	70		$	58
Foreign income:
Impact of taxation at different rates, repatriation and other		(29	)		(29	)		(26	)
Impact of credit for extraordinary repatriation		—			(24	)		—
Impact of investment incentive credits		—			(2	)		(2	)
Impact of foreign losses for which a current tax benefit is not available		5			6			17
State taxes, net of federal effect		—			—			—
U.S. and state benefits from research and experimentation activities		(2	)		(3	)		(1	)
Tax audit settlements		(2	)		(12	)		(15	)
Release of state tax valuation allowance		(8	)		—			—
Permanent differences, net		5			—			(1	)

Total	$	55		$	6		$	30

Significant components of deferred income taxes were as follows:


	September 30
	2012			2011
	(Dollars in millions)
Deferred tax assets:
Property, plant & equipment	$	140		$	73
Pension and other benefits		94			87
Environmental liabilities		2			3
Inventory		12			12
Deferred expenses		12			11
State taxes		5			—
Net operating loss carry-forwards		194			125
Other tax carry-forwards		73			137
Other		45			28

Subtotal		577			476
Valuation allowances		(169	)		(138	)

Total deferred tax assets	$	408		$	338


	September 30
	2012		2011
	(Dollars in millions)
Deferred tax liabilities:
Property, plant & equipment	$	191	$	28
Intangible assets		107		—
Pension and other benefits		15		2
Unremitted earnings of non-U.S. subsidiaries		11		18
Inventory		10		3
Other		10		5

Total deferred tax liabilities	$	344	$	56

In fiscal 2012, Cabot recorded $11 million of net tax benefits including an $8 million state tax benefit from the release of a valuation allowance and $3 million related to settlements and other miscellaneous tax items in the tax provision.

In fiscal 2011, Cabot recorded $38 million net tax benefits including $24 million from the repatriation of high taxed income and $14 million related to tax settlements, the renewal of the U.S. research and experimentation credit, and investment incentive tax credits in the tax provision.

In fiscal 2010, Cabot recorded $17 million of net tax benefits related to tax settlements and investment incentive tax credits and a $1 million net tax charge for other miscellaneous items in the tax provision.

Approximately $840 million of net operating loss carryforwards (“NOLs”) and $73 million of other tax credit carryforwards remain at September 30, 2012. The benefits of these carryforwards are dependent upon taxable income during the carryforward period in the jurisdictions where they arose. Accordingly, a valuation allowance has been provided where management has determined that it is more likely than not that the carryforwards will not be utilized. The following table provides detail surrounding the expiration dates of these carryforwards:


	NOLs		Credits
	(Dollars in millions)
Expiration periods
2013 to 2019	$	329	$	3
2020 and thereafter		220		47
Indefinite carryforward		291		23

Total	$	840	$	73

As of September 30, 2012, provisions have not been made for U.S. income taxes or non-U.S. withholding taxes on approximately $1,073 million of undistributed earnings of non-U.S. subsidiaries, as these earnings are considered indefinitely reinvested. Cabot continually reviews the financial position and forecasted cash flows of its U.S. consolidated group and foreign subsidiaries in order to reaffirm the Company’s intent and ability to continue to indefinitely reinvest earnings of its foreign subsidiaries or whether such earnings will need to be repatriated in the foreseeable future. Such review encompasses not only operational needs but also future capital investments. From time to time, however, our intentions relative to specific indefinitely invested amounts change because of certain unique circumstances. For example, in 2011, the Company remitted certain high taxed earnings that had previously been considered indefinitely reinvested in order to preserve a tax benefit in advance of a tax law change.

These earnings could become subject to U.S. income taxes and non-U.S. withholding taxes if they were remitted as dividends, were loaned to Cabot Corporation or a U.S. subsidiary, or if Cabot should sell its stock in the subsidiaries.

As of September 30, 2012, Cabot had net deferred tax assets of $64 million, $49 million of which are in the U.S. The net deferred tax assets were significantly reduced during fiscal 2012 due to the utilization of deferred tax assets in the sale of the Supermetals Business and the recognition of deferred tax liabilities related to the Norit acquisition. Management believes that the Company’s history of generating domestic profits provides adequate evidence that it is more likely than not that all of the U.S. net deferred tax assets will be realized in the normal course of business. U.S. income from continuing operations adjusted for U.S. permanent differences was a profit of $86 million for the year ended September 30, 2012 and was a cumulative profit of $221 million for the three years ended September 30, 2012 including dividends from non-U.S. subsidiaries.

Realization of deferred tax asset is dependent on achieving future taxable income over an extended period of time. As of September 30, 2012, the Company would need to generate approximately $403 million in cumulative future U.S. taxable income at various times over approximately 20 years to realize all of its net U.S. deferred tax assets. The Company reviews its forecast in relation to actual results and expected trends on a quarterly basis. Failure to achieve operating income targets may change the Company’s assessment regarding the recoverability of Cabot’s deferred tax assets and such change could result in a valuation allowance being recorded against some or all of the Company’s deferred tax assets. Any increase in a valuation allowance would result in additional income tax expense, lower stockholders’ equity and could have a significant impact on Cabot’s earnings in future periods.

The valuation allowances at September 30, 2012 and 2011 represent management’s best estimate of the non-realizable portion of the deferred tax assets. The valuation allowance increased in certain tax jurisdictions by $31 million, $12 million, and $6 million in fiscal years 2012, 2011 and 2010, respectively, due to the uncertainty of the ultimate realization of certain future tax benefits and net operating losses generated or acquired that are included in deferred tax assets.

Cabot has filed its tax returns in accordance with the tax laws in each jurisdiction and recognizes tax benefits for uncertain tax positions when the position would more likely than not be sustained based on its technical merits and recognizes measurement adjustments when needed. As of September 30, 2012, the total amount of unrecognized tax benefits was $55 million, of which $39 million was recorded in the Company’s Consolidated Balance Sheet and $16 million of deferred tax assets, principally related to state net operating loss carryforwards, have not been recorded. In addition, accruals of $3 million and $15 million have been recorded for penalties and interest, respectively, as of September 30, 2012 and $3 million and $14 million, respectively, as of September 30, 2011. Total penalties and interest recorded in the tax provision in the Consolidated Statement of Operations was $3 million in each of fiscal years 2012, 2011, and 2010. If the unrecognized tax benefits were recognized at a given point in time, there would be approximately $44 million favorable impact on the Company’s tax provision before consideration of the impact of the potential need for valuation allowances.

A reconciliation of the beginning and ending amount of unrecognized tax benefits for fiscal 2012, 2011 and 2010 are as follows:


	Years ended September 30
	2012			2011			2010
	(Dollars in millions)
Balance at beginning of the year	$	65		$	75		$	81
Additions based on tax provisions related to the current year		4			2			6
Additions for tax positions of prior years		—			1			3
Reductions of tax provisions of prior years		(14	)		(13	)		(15	)

Balance at end of the year	$	55		$	65		$	75

Certain Cabot subsidiaries are under audit in jurisdictions outside of the U.S. In addition, certain statutes of limitations are scheduled to expire in the near future. It is reasonably possible that a further change in the unrecognized tax benefits may occur within the next twelve months related to the settlement of one or more of these audits or the lapse of applicable statutes of limitations; however, an estimated range of the impact on the unrecognized tax benefits cannot be quantified at this time.

Cabot files U.S. federal and state and non-U.S. income tax returns in jurisdictions with varying statutes of limitations. The 2007 through 2012 tax years generally remain subject to examination by the IRS and various tax years from 2004 through 2012 remain subject to examination by the respective state tax authorities. In significant non-U.S. jurisdictions, various tax years from 2001 through 2012 remain subject to examination by their respective tax authorities. As of September 30, 2012 Cabot’s significant non-U.S. jurisdictions include Canada, China, France, Germany, Italy, Japan, Malaysia, the Netherlands, and the United Kingdom.