Income Taxes

Domestic and foreign income (loss) before income taxes and details of the income tax expense (benefit) are as follows (amounts in millions):



	For the Years Ended December 31,
	2018			2017			2016
Income before income tax expense:
Domestic	$	432		$	185		$	228
Foreign	1,445			966			878
	$	1,877		$	1,151		$	1,106
Income tax expense (benefit):
Current:
Federal	$	(228	)	$	696		$	(15	)
State	(15		)	26			16
Foreign	280			335			150
Total current	37			1,057			151
Deferred:
Federal	(98		)	(111		)	40
State	106			(32		)	(13		)
Foreign	19			(36		)	(38		)
Total deferred	27			(179		)	(11		)

Income tax expense	$	64		$	878		$	140

The items accounting for the difference between income taxes computed at the U.S. federal statutory income tax rate and the income tax expense (benefit) at the effective tax rate for each of the years are as follows (amounts in millions):



	For the Years Ended December 31,
	2018					2017					2016
Federal income tax provision at statutory rate	$	394		21	%	$	403		35	%	$	387		35	%
State taxes, net of federal benefit	36			2		4			—		9			1
Research and development credits	(46		)	(2	)	(26		)	(2	)	(36		)	(3	)
Foreign rate differential	(198		)	(11	)	(271		)	(24	)	(239		)	(22	)
Change in tax reserves	265			14		291			25		210			19
Audit settlements	(115		)	(6	)	—			—		—			—
Net operating loss tax attribute assumed from the Purchase Transaction	—			—		(36		)	(3	)	(114		)	(10	)
Excess tax benefits related to share-based payments	(58		)	(3	)	(113		)	(10	)	(81		)	(7	)
U.S. Tax Reform Act	(285		)	(15	)	636			55		—			—
Change in valuation allowance	61			3		—			—		—			—
Other	10			—		(10		)	—		4			—
Income tax expense	$	64		3	%	$	878		76	%	$	140		13	%

The Company’s tax rate is affected by the tax rates in the jurisdictions in which the Company operates, some of which have a statutory tax rate less than the U.S. rate of 21% , and the relative amount of income earned in each jurisdiction.

On June 27, 2018, we entered into a closing agreement with the Internal Revenue Service (“IRS”) to resolve certain intercompany transfer pricing arrangements for tax periods starting in 2009 (the “Closing Agreement”). The primary adjustments related to the Closing Agreement were recognized in the second quarter of 2018 and consisted of a tax expense of $70 million and a reduction in unrecognized tax benefits of $437 million. In addition, we recognized $185 million of tax benefits related to other tax adjustments resulting from the changes in U.S. tax attributes and taxable income caused by the primary adjustments. The Closing Agreement resulted in federal and state cash tax payments totaling approximately $345 million, of which federal tax payments of $334 million were made in October 2018.

On December 22, 2017, the U.S. Tax Reform Act was enacted. The U.S. Tax Reform Act, among other things, reduced the U.S. corporate income tax rate from 35% to 21%, beginning in 2018, and implemented the Transition Tax.

On December 22, 2017, the Securities and Exchange Commission (“SEC”) staff issued Staff Accounting Bulletin No. 118 (“SAB 118”), which provides guidance on how to account for the effects of the U.S. Tax Reform Act under ASC 740. SAB 118 enabled companies to record a provisional amount for the effects of the U.S. Tax Reform Act based on a reasonable estimate, subject to adjustment during a measurement period of up to one year, until accounting is complete. During the fourth quarter of 2017, we recorded provisional amounts of $636 million for the effects of the U.S. Tax Reform Act in accordance with SAB 118. In addition, as of December 31, 2017, we no longer considered the available cash balances related to undistributed earnings held outside of the U.S. by our foreign subsidiaries to be indefinitely reinvested.

In the fourth quarter of 2018, we completed our analysis of the effect of the U.S. Tax Reform Act. For the year ended December 31, 2018, we recorded an additional tax benefit of $285 million for the effects of the U.S. Tax Reform Act. This is primarily related to the election to record deferred U.S. taxes with respect to earnings of our foreign subsidiaries subject to global intangible low-taxed income (“GILTI”) and the adjustment for the remeasurement of certain deferred tax assets and liabilities as a result of the U.S. corporate income tax rate reduction. The aggregate U.S. Tax Reform Act impact for 2017 and 2018 is a net tax expense of $351 million, which consists of a $570 million tax expense related to the Transition Tax partially offset by a net benefit of $219 million, mainly related to the adoption of GILTI deferred tax accounting and remeasurement of deferred tax assets and liabilities.

In 2013, in connection with the October 11, 2013 repurchase of approximately 429 million shares of our common stock from Vivendi (“Purchase Transaction”), we assumed certain tax attributes, generally consisting of net operating loss (“NOL”) carryforwards of approximately $760 million, which represent a potential tax benefit of approximately $266 million. The Company also obtained indemnification from Vivendi against losses attributable to the disallowance of claimed utilization of such NOL carryforwards of up to $200 million in unrealized tax benefits in the aggregate, limited to taxable years ending on or prior to December 31, 2016. No benefit for these tax attributes or indemnification was recorded upon the close of the Purchase Transaction. As of December 31, 2017, we had utilized approximately $760 million of the original NOL and had recorded an indemnification asset of $200 million in “Other assets.” Correspondingly, the same amount was recorded as a reduction to the consideration paid for the shares repurchased in “Treasury stock.”

Deferred income taxes reflect the net tax effects of temporary differences between the amounts of assets and liabilities for accounting purposes and the amounts used for income tax purposes. The components of the net deferred tax assets (liabilities) are as follows (amounts in millions):



	As of December 31,
	2018			2017
Deferred tax assets:
Allowance for sales returns and price protection	$	25		$	47
Accrued expenses	26			31
Deferred revenue	136			245
Tax attributes carryforwards	81			71
Share-based compensation	69			59
Acquired intangibles	43			149
U.S. deferred taxes on foreign earnings	263			—
Other	28			61
Deferred tax assets	671			663
Valuation allowance	(61		)	—
Deferred tax assets, net of valuation allowance	610			663
Deferred tax liabilities:
Acquired intangibles	(140		)	(146		)
Capitalized software development expenses	(57		)	(55		)
Other	(26		)	(24		)
Deferred tax liabilities	(223		)	(225		)
Net deferred tax assets	$	387		$	438

As of December 31, 2018, we had gross tax credit carryforwards of $172 million for state purposes. The tax credit carryforwards are presented in “Deferred tax assets” net of unrealized tax benefits that would apply upon the realization of uncertain tax positions. In addition, we had foreign NOL carryforwards of $22 million at December 31, 2018, attributed mainly to losses in France which can be carried forward indefinitely.

We evaluate deferred tax assets each period for recoverability. We record a valuation allowance for assets that do not meet the threshold of “more likely than not” to be realized in the future. To make that determination, we evaluate the likelihood of realization based on the weight of all positive and negative evidence available. As of December 31, 2017, we had a deferred tax asset for California research and development credit carryforwards (“CA R&D Credits”), which can be carried forward indefinitely. The Closing Agreement impacts historical and prospective filings in certain states, including California, and after considering the impact of the Closing Agreement on its prospective California taxable income, we determined that our remaining CA R&D Credits no longer met the threshold of more likely than not to be realized in the future. As such, for the year ended December 31, 2018, we recorded a full valuation allowance of $61 million. We will reassess this determination quarterly and record a tax benefit if and when future evidence allows for a partial or full release of this valuation allowance.

As of December 31, 2017, we no longer consider the available cash balances related to undistributed earnings held outside of the U.S. by our foreign subsidiaries to be indefinitely reinvested. As of December 31, 2018, we recorded net deferred tax liability related to undistributed foreign earnings of $16 million. In addition, we have elected to record deferred U.S. taxes with respect to earnings of our foreign subsidiaries subject to GILTI and recorded a $263 million deferred tax asset.

Activision Blizzard’s 2009 through 2017 tax years remain open to examination by certain major taxing jurisdictions to which we are subject. During February 2018, we were notified by the IRS that our tax returns for our 2012 through 2016 tax years will be subject to examination. In September 2018, the IRS concluded its examination of our 2009 through 2011 tax years. We also have several state and non-U.S. audits pending, including the French and Swedish audits discussed below. In addition, as part of purchase price accounting for our 2016 acquisition of King, we assumed $74 million of uncertain tax positions primarily related to pre-acquisition transfer pricing matters. We are currently in negotiations with the tax authorities in the relevant jurisdictions, which include the UK and Sweden, with respect to King’s transfer pricing for both pre- and post-acquisition tax years. While the outcome of these negotiations remains uncertain, they could result in an agreement that changes the allocation of profits and losses between these and other relevant jurisdictions or a failure to reach an agreement that results in unilateral adjustments to the amount and timing of taxable income in the jurisdictions in which King operates.

In December 2018, we received a decision from the Swedish Tax Agency (“STA”) informing us of an audit assessment to a Swedish subsidiary of King for the 2016 tax year. The STA decision described the basis for issuing a transfer pricing assessment of approximately 3.5kr billion (approximately $400 million), primarily concerning an alleged intercompany asset transfer. We disagree with the STA’s decision and intend to vigorously contest it. We plan to pursue all remedies available to us to successfully resolve the matter, including administrative remedies with the STA, multilateral procedures with other relevant taxing jurisdictions, and, if necessary, judicial remedies. Further, we may be required to pay the full assessment to the STA in advance of the final resolution of the matter. While we believe our tax provisions at December 31, 2018, are appropriate, until such time as this matter is ultimately resolved we could be subject to significant additional tax liabilities.

In December 2017, we received a Notice of Reassessment from the French Tax Authority (“FTA”) related to transfer pricing for intercompany transactions involving one of our French subsidiaries for the 2011 through 2013 tax years. The total assessment, including penalties and interest, was approximately €571 million (approximately $652 million). We disagree with the proposed assessment and intend to vigorously contest it. We plan to pursue all remedies available to us to successfully resolve this matter, including administrative remedies with the FTA and, if necessary, judicial remedies. While we believe our tax provisions at December 31, 2018, are appropriate, until such time as this matter is ultimately resolved we could be subject to significant additional tax liabilities. In addition to the risk of additional tax for the 2011 through 2013 tax years, if litigation regarding this matter were adversely determined and/or if the FTA were to seek adjustments of a similar nature for subsequent years, we could be subject to significant additional tax liabilities.

In addition, certain of our subsidiaries are under examination or investigation, or may be subject to examination or investigation, by tax authorities in various jurisdictions. These proceedings may lead to adjustments or proposed adjustments to our taxes or provisions for uncertain tax positions. Such proceedings may have a material adverse effect on the Company’s consolidated financial position, liquidity, or results of operations in the earlier of the period or periods in which the matters are resolved and in which appropriate tax provisions are taken into account in our financial statements. If we were to receive a materially adverse assessment from a taxing jurisdiction, we would plan to vigorously contest it and consider all of our options, including the pursuit of judicial remedies.

As of December 31, 2018, we had approximately $917 million of gross unrecognized tax benefits, $812 million of which would affect our effective tax rate, if recognized. A reconciliation of total gross unrecognized tax benefits is as follows (amounts in millions):



	For the Years Ended December 31,
	2018			2017			2016
Unrecognized tax benefits balance at January 1	$	1,138		$	846		$	552
Gross increase for tax positions taken during a prior year	94			66			89
Gross decrease for tax positions taken during a prior year	(123		)	—			(17		)
Gross increase for tax positions taken during the current year	132			229			240
Settlement with taxing authorities	(312		)	(1		)	(18		)
Lapse of statute of limitations	(12		)	(2		)	—
Unrecognized tax benefits balance at December 31	$	917		$	1,138		$	846

As of December 31, 2018, 2017, and 2016, we had approximately $87 million, $121 million, and $71 million, respectively, of accrued interest and penalties related to uncertain tax positions. For the years ended December 31, 2018, 2017, and 2016, we recorded $11 million, $28 million, and $17 million, respectively, of interest expense related to uncertain tax positions.

The final resolution of the Company’s global tax disputes is uncertain. There is significant judgment required in the analysis of disputes, including the probability determination and estimation of the potential exposure. Based on current information, in the opinion of the Company’s management, the ultimate resolution of these matters is not expected to have a material adverse effect on the Company’s consolidated financial position, liquidity or results of operations, except as noted above.