Income taxes

12 Months Ended

Dec. 31, 2011

Income taxes [Abstract]

Income taxes

4. Income taxes

The provision for income taxes includes the following for the years ended December 31, 2011, 2010 and 2009 (in millions):

	2011			2010			2009
Current provision:
Federal	$	618		$	636		$	325
State		58			52			85
Foreign		148			153			155
Total current provision		824			841			565
Deferred (benefit) provision:
Federal		(340	)		(196	)		92
State		(16	)		43			(59	)
Foreign		(1	)		2			1
Total deferred (benefit) provision		(357	)		(151	)		34
Total provision	$	467		$	690		$	599

Deferred income taxes reflect the temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes, tax credit carryforwards and the tax effects of net operating loss carryforwards.

Significant components of our deferred tax assets and liabilities are as follows as of December 31, 2011 and 2010 (in millions):

	2011			2010
Deferred income tax assets:
Intercompany inventory related items	$	387		$	306
Expense accruals		751			626
Acquired net operating loss and credit carryforwards		192			147
Expenses capitalized for tax		167			188
Stock-based compensation		241			269
Deferred revenue		133			117
Other		72			72
Total deferred income tax assets		1,943			1,725
Valuation allowance		(126	)		(80	)
Net deferred income tax assets		1,817			1,645
Deferred income tax liabilities:
Acquired intangibles		(832	)		(739	)
Fixed assets		(219	)		(181	)
Unremitted foreign earnings		(61	)		(118	)
Other		(110	)		(142	)
Total deferred income tax liabilities		(1,222	)		(1,180	)
Total deferred income taxes, net	$	595		$	465

The valuation allowance for deferred tax assets increased by $46 million in 2011, due primarily to valuation allowances established as part of the BioVex and Dun Laoghaire acquisitions and the Company’s expectation that some state R&D credits will not be utilized, offset partially by the release of valuation allowance related to the expiration of state investment credits. The valuation allowance for deferred tax assets decreased by $12 million in 2010, due primarily to the utilization and expiration of certain acquired net operating loss carryforwards. Valuation allowances are provided when we believe our deferred tax assets are not recoverable based on an assessment of estimated future taxable income that incorporates ongoing, prudent and feasible tax planning strategies.

At December 31, 2011, we had $44 million of tax credit carryforwards available to reduce future federal income taxes for which a full valuation allowance has been provided. In addition, we had $176 million of tax credit carryforwards available to reduce future state income taxes and have provided a valuation allowance for $67 million of those state tax credit carryforwards. The majority of the state tax credit carryforwards have no expiry; the remainder expires between 2012 and 2025.

The reconciliation of the total gross amounts of UTBs (excluding interest, penalties, foreign tax credits and the federal tax benefit of state taxes related to UTBs) for the years ended December 31, 2011, 2010 and 2009, is as follows (in millions):

	2011			2010			2009
Balance at beginning of year	$	920		$	1,140		$	1,113
Additions based on tax positions related to the current year		283			305			302
Reductions for tax positions of prior years		(7	)		(110	)		(215	)
Settlements		(221	)		(415	)		(60	)
Balance at end of year	$	975		$	920		$	1,140

Substantially all of the UTBs as of December 31, 2011, if recognized, would affect our effective tax rate.

During the year ended December 31, 2011, we settled our examination with the Internal Revenue Service (IRS) related to certain transfer pricing tax positions for the years ended December 31, 2007, 2008 and 2009. As a result of these developments, we remeasured our UTBs accordingly.

During the year ended December 31, 2010, we settled our examination with the IRS related to certain transfer pricing tax positions for the years ended December 31, 2007 and 2008. In addition, we also settled issues under appeal with the IRS for the years ended December 31, 2005 and 2006, primarily related to the impact of transfer pricing adjustments on the repatriation of funds. During the year ended December 31, 2010, the IRS also agreed to Competent Authority relief for certain transfer pricing tax positions for the years ended December 31, 2002, through December 31, 2006. As a result of these developments, we remeasured our UTBs accordingly.

During the year ended December 31, 2009, we settled the examination of our U.S. income tax returns with the IRS for certain matters, primarily related to transfer pricing tax positions, for the years ended December 31, 2005 and 2006. Also during the year ended December 31, 2009, we settled the examination of our California state income tax returns for certain matters for the years ended December 31, 2004 and 2005. As a result of these developments, we remeasured our UTBs accordingly.

As of December 31, 2011, we believe it is reasonably possible that our gross liabilities for UTBs may decrease by approximately $270 million within the succeeding twelve months due to the resolution of federal and state audits.

Interest and penalties related to UTBs are included in our provision for income taxes. During 2011, 2010 and 2009, we accrued approximately $23 million, $41 million and $57 million, respectively, of interest and penalties through the income tax provision in the Consolidated Statements of Income. At December 31, 2011 and 2010, accrued interest and penalties associated with UTBs totaled approximately $105 million and $90 million, respectively.

The reconciliation between the federal statutory tax rate applied to income before income taxes and our effective tax rate for the years ended December 31, 2011, 2010 and 2009, is as follows:

	2011		2010		2009
Federal statutory tax rate		35.0 %		35.0 %		35.0 %
Foreign earnings, including earnings invested indefinitely		(19.4)%		(19.1)%		(19.6)%
State taxes		0.7 %		1.6 %		1.1 %
Credits, Puerto Rico Excise Tax		(6.5)%		0.0 %		0.0 %
Credits, primarily research and experimentation		(1.5)%		(0.9)%		(0.8)%
Legal settlements		2.2 %		0.0 %		0.0 %
Audit settlements		0.0 %		(3.1)%		(4.2)%
Other, net		0.8 %		(0.5)%		0.0 %
Effective tax rate		11.3 %		13.0 %		11.5 %

We do not provide for U.S. income taxes on undistributed earnings of our foreign operations that are intended to be invested indefinitely outside of the United States. Substantially all of the benefit from foreign earnings on our effective tax rate results from foreign income associated with the Company’s operation conducted in Puerto Rico that is subject to a tax incentive grant that expires in 2020. At December 31, 2011, the cumulative amount of these earnings was approximately $19.5 billion. If these earnings were repatriated to the United States, we would be required to accrue and pay approximately $6.9 billion of additional income taxes based on the current tax rates in effect.

Our total foreign income before income taxes was approximately $2.6 billion, $3.1 billion and $3.1 billion for the years ended December 31, 2011, 2010 and 2009, respectively.

Commencing January 1, 2011, Puerto Rico imposes a temporary excise tax on the acquisition of goods and services from a related manufacturer in Puerto Rico. The excise tax is imposed over a six year period beginning in 2011 with the excise tax rate declining in each year (4% in 2011, 3.75% in 2012, 2.75% in 2013, 2.5% in 2014, 2.25% in 2015, and 1% in 2016). We account for the excise tax as a manufacturing cost that is capitalized in inventory and expensed in cost of sales when the related products are sold. For U.S. income tax purposes, the excise tax results in foreign tax credits that are generally recognized in our provision for income taxes in the year in which the excise tax is incurred.

One or more of our legal entities file income tax returns in the U.S. federal jurisdiction, various U.S. state jurisdictions and certain foreign jurisdictions. Our income tax returns are routinely audited by the tax authorities in those jurisdictions. Significant disputes may arise with these tax authorities involving issues of the timing and amount of deductions, the use of tax credits and allocations of income among various tax jurisdictions because of differing interpretations of tax laws and regulations. We are no longer subject to U.S. federal income tax examinations for tax years ending on or before December 31, 2006, or to California state income tax examinations for tax years ending on or before December 31, 2003.

Income taxes paid during the years ended December 31, 2011, 2010 and 2009, totaled $595 million, $1,344 million and $497 million, respectively.