Income taxes



The components of profit before taxes were:
	Years ended December 31,
(Millions of dollars)	2016			2015		2014
U.S.	$	(2,053	)	$	636	$	276
Non-U.S.	2,192			2,803		2,876
	$	139		$	3,439	$	3,152

Profit before taxes, as shown above, is based on the location of the entity to which such earnings are attributable. Where an entity’s earnings are subject to taxation, however, may not correlate solely to where an entity is located. Thus, the income tax provision shown below as U.S. or non-U.S. may not correspond to the earnings shown above.



The components of the provision (benefit) for income taxes were:
	Years ended December 31,
(Millions of dollars)	2016			2015			2014
Current tax provision (benefit):
U.S.¹	$	(90	)	$	525		$	715
Non-U.S.	718			656			883
State (U.S.)	(5		)	42			48
	623			1,223			1,646

Deferred tax provision (benefit):
U.S.¹	(544		)	(367		)	(763		)
Non-U.S.	(108		)	66			(116		)
State (U.S.)	221			(6		)	(75		)
	(431		)	(307		)	(954		)
Total provision (benefit) for income taxes	$	192		$	916		$	692
¹ Includes U.S. taxes related to non-U.S. profits.

We paid net income tax and related interest of $522 million, $1,143 million and $1,595 million in 2016, 2015 and 2014, respectively.

Reconciliation of the U.S. federal statutory rate to effective rate:



	Years ended December 31,
(Millions of dollars)	2016					2015					2014
Taxes at U.S. statutory rate	$	49		35.0	%	$	1,203		35.0	%	$	1,103		35.0	%
(Decreases) increases resulting from:
Non-U.S. subsidiaries taxed at other than 35%	(119		)	(85.6	)%	(236		)	(6.9	)%	(223		)	(7.1	)%
Nondeductible goodwill	191			137.4	%	—			—	%	—			—	%
State and local taxes, net of federal	(1		)	(0.7	)%	24			0.7	%	(17		)	(0.5	)%
Interest and penalties, net of tax	24			17.2	%	12			0.4	%	12			0.4	%
U.S. research and production incentives	(52		)	(37.4	)%	(95		)	(2.7	)%	(125		)	(4.0	)%
ESOP dividend tax benefit	(27		)	(19.4	)%	(27		)	(0.8	)%	(25		)	(0.8	)%
Other—net	(14		)	(10.1	)%	(7		)	(0.2	)%	11			0.4	%
	51			36.4	%	874			25.5	%	736			23.4	%

Prior year tax and interest adjustments	—			—	%	42			1.2	%	(21		)	(0.7	)%
Valuation allowances	141			101.4	%	—			—	%	(23		)	(0.7	)%
Provision (benefit) for income taxes	$	192		137.8	%	$	916		26.7	%	$	692		22.0	%

The negative impact on the effective tax rate from the portion of the Surface Mining & Technology goodwill impairment not deductible for tax purposes is reported in the effective tax rate reconciliation line item above labeled "Nondeductible goodwill". Included in the line item above labeled "Non-U.S. subsidiaries taxed at other than 35%" are the effects of indefinitely reinvested earnings of non-U.S. subsidiaries taxed at local tax rates, changes in the amount of unrecognized tax benefits associated with these earnings, losses at non-U.S. subsidiaries without local tax benefits due to valuation allowances, and other permanent differences between tax and U.S. GAAP results. The indefinitely reinvested profits of Caterpillar SARL (CSARL), primarily taxable in Switzerland, contribute the most significant amount of this line item. Although not individually significant by jurisdiction, pre-tax permanent differences due to nondeductible net foreign exchange losses of non-U.S. subsidiaries were approximately $130 million in 2016 and 2015 and less than $10 million in 2014.

The provision for income taxes for 2016 also includes an increase in the valuation allowance for U.S. state deferred tax assets resulting in a $141 million non-cash charge, net of federal deferred tax adjustment at 35 percent. The primary driver of the increase is recent U.S. GAAP losses expected to recur in 2017 in certain state jurisdictions and the weight given this negative objective evidence under income tax accounting guidance.

The provision for income taxes for 2015 included a $42 million net charge to increase unrecognized tax benefits by $68 million offset by a benefit of $26 million to record U.S. refund claims related to prior tax years currently under examination. In the audit of 2007 to 2009 including the loss carryback to 2005, the U.S. Internal Revenue Service (IRS) disallowed approximately $125 million of foreign tax credits that arose as a result of certain financings unrelated to CSARL. Decisions of the U.S. Court of Appeals for the Second Circuit involving other taxpayers in 2015 caused us to conclude the benefits of this uncertain tax position were no longer more likely than not to be sustained based on technical merits resulting in an increase of $68 million to unrecognized tax benefits. We will continue to monitor ongoing court cases involving other taxpayers for information that may impact our analysis of this tax position.

The provision for income taxes for 2014 included a benefit of $23 million for the release of a valuation allowance against the deferred tax assets of a non-U.S. subsidiary and a net benefit of $21 million to adjust prior years' U.S. taxes and interest. The net benefit for prior years' U.S. taxes and interest included a $33 million benefit to reflect a settlement with the IRS related to 1992 through 1994 which resulted in a $16 million benefit to remeasure previously unrecognized tax benefits and a $17 million benefit to adjust related interest, net of tax. This benefit of $33 million was offset by a net charge of $12 million to adjust prior years' U.S. taxes that included a charge of $55 million to correct for an error which resulted in an understatement of tax liabilities for prior years. Management has concluded that the error was not material to any period presented.

We have recorded income tax expense at U.S. tax rates on all profits, except for undistributed profits of non-U.S. subsidiaries of approximately $16 billion which are considered indefinitely reinvested. Upon distribution of these profits in the form of dividends or otherwise, we would be subject to both U.S. income taxes (subject to an adjustment for foreign tax credits) and in some instances withholding taxes payable to the various non-U.S. jurisdictions. Determination of the amount of unrecognized deferred tax liability related to indefinitely reinvested profits is not feasible primarily due to our legal entity structure and the complexity of U.S. and local tax laws. If management intentions or U.S. tax law changes in the future, there could be a significant negative impact on the provision for income taxes to record an incremental tax liability in the period the change occurs. At December 31, 2016, cash and short-term investments held by non-U.S. subsidiaries was approximately $5 billion.

Accounting for income taxes under U.S. GAAP requires that individual tax-paying entities of the company offset all deferred tax liabilities and assets within each particular tax jurisdiction and present them as a noncurrent deferred tax liability or asset in the Consolidated Financial Position. Amounts in different tax jurisdictions cannot be offset against each other. The amount of deferred income taxes at December 31, included on the following lines in Statement 3, are as follows:



	December 31,
(Millions of dollars)	2016		2015
Assets:
Noncurrent deferred and refundable income taxes	2,683		2,367
Liabilities:
Other liabilities	237		335
Deferred income taxes—net	$	2,446	$	2,032



Deferred income tax assets and liabilities:
	December 31,
(Millions of dollars)	2016			2015
Deferred income tax assets:
Pension	$	1,887		$	1,694
Postemployment benefits other than pensions	1,318			1,339
Tax carryforwards	1,999			1,098
Warranty reserves	339			359
Stock-based compensation	316			356
Inventory	93			129
Allowance for credit losses	209			203
Post sale discounts	207			185
Other employee compensation and benefits	262			269
Other—net	476			427
	7,106			6,059

Deferred income tax liabilities:
Capital and intangible assets	(2,455		)	(2,561		)
Bond discount	(223		)	(225		)
Translation	(368		)	(343		)
Other outside basis differences	(227		)	—
Undistributed profits of non-U.S. subsidiaries	(285		)	(82		)
	(3,558		)	(3,211		)
Valuation allowance for deferred tax assets	(1,102		)	(816		)
Deferred income taxes—net	$	2,446		$	2,032

At December 31, 2016, approximately $1,425 million of U.S. state tax net operating losses (NOLs) and $137 million of U.S. state tax credit carryforwards were available. The state NOLs primarily expire between 2017 and 2036. The state tax credit carryforwards primarily expire over the next five years with certain carryforwards set to expire over the next fifteen years. In total, we have established a valuation allowance of $442 million related to certain of these carryforwards along with other U.S. state deferred tax assets.

At December 31, 2016, approximately $920 million of U.S. foreign tax credits were available for carryforward. These credits expire between 2025 and 2027.

At December 31, 2016, amounts and expiration dates of net operating loss carryforwards in various non-U.S. taxing jurisdictions were:



(Millions of dollars)
2017		2018		2019		2020-2022		2023-2037		Unlimited		Total
$	3	$	64	$	159	$	470	$	168	$	3,191	$	4,055

At December 31, 2016, non-U.S. entities that have not yet demonstrated consistent and/or sustainable profitability to support the realization of net deferred tax assets have recorded valuation allowances of $660 million, including certain entities in Luxembourg.

A reconciliation of the beginning and ending amount of gross unrecognized tax benefits for uncertain tax positions, including positions impacting only the timing of tax benefits, follows.



Reconciliation of unrecognized tax benefits: ¹
	Years ended December 31,
(Millions of dollars)	2016			2015
Balance at January 1,	$	968		$	846

Additions for tax positions related to current year	73			73
Additions for tax positions related to prior years	55			118
Reductions for tax positions related to prior years	(36		)	(30		)
Reductions for settlements ²	(24		)	(30		)
Reductions for expiration of statute of limitations	(4		)	(9		)

Balance at December 31,	$	1,032		$	968

Amount that, if recognized, would impact the effective tax rate	$	963		$	934


¹	Foreign currency impacts are included within each line as applicable.


²	Includes cash payment or other reduction of assets to settle liability.

We classify interest and penalties on income taxes as a component of the provision for income taxes. We recognized a net provision for interest and penalties of $34 million, $20 million and $3 million during the years ended December 31, 2016, 2015 and 2014, respectively. The total amount of interest and penalties accrued was $120 million and $79 million as of December 31, 2016 and 2015, respectively.

In January 2015, we received a Revenue Agent's Report (RAR) from the IRS indicating the end of the field examination of our U.S. income tax returns for 2007 to 2009 including the impact of a loss carryback to 2005. The IRS field examination for 2010 to 2012 that began in 2015 is expected to be completed in 2017. In November 2016, we received notices of proposed adjustments from the IRS for the 2010 to 2012 exam. In both these audits, the IRS has proposed to tax in the United States profits earned from certain parts transactions by CSARL, based on the IRS examination team’s application of the “substance-over-form” or “assignment-of-income” judicial doctrines. We are vigorously contesting the proposed increases to tax and penalties for these years of approximately $2 billion. We believe that the relevant transactions complied with applicable tax laws and did not violate judicial doctrines. We have filed U.S. income tax returns on this same basis for years after 2012. Based on the information currently available, we do not anticipate a significant increase or decrease to our unrecognized tax benefits for this matter within the next 12 months. We currently believe the ultimate disposition of this matter will not have a material adverse effect on our consolidated financial position, liquidity or results of operations.

With the exception of a loss carryback to 2005, tax years prior to 2007 are generally no longer subject to U.S. tax assessment. In our major non-U.S. jurisdictions including Australia, Brazil, China, Germany, Japan, Switzerland, Singapore and the U.K., tax years are typically subject to examination for three to eight years. Due to the uncertainty related to the timing and potential outcome of audits, we cannot estimate the range of reasonably possible change in unrecognized tax benefits in the next 12 months.