INCOME TAXES

Cadence's income (loss) before provision (benefit) for income taxes included income (loss) from the United States and from foreign subsidiaries for fiscal 2012, 2011 and 2010, is as follows:



	2012		2011		2010
	(In thousands)
United States	$	61,865	$	39,175	$	(141,726	)
Foreign subsidiaries	126,406		56,251		78,958
Total income (loss) before provision (benefit) for income taxes	$	188,271	$	95,426	$	(62,768	)

Cadence's foreign subsidiaries are generally subject to lower statutory tax rates than the United States statutory federal income tax rate of 35%.

Cadence's provision (benefit) for income taxes was comprised of the following items for fiscal 2012, 2011 and 2010:



	2012			2011			2010
	(In thousands)
Current:
Federal	$	(588	)	$	(662	)	$	(143,045	)
State and local	(36,650		)	1,363			(3,475		)
Foreign	19,409			13,752			24,468
Total current	(17,829		)	14,453			(122,052		)

Deferred:
Federal	(203,731		)	(4,937		)	(59,880		)
State and local	(28,894		)	(524		)	(8,523		)
Foreign	(7,799		)	(2,350		)	4,212
Total deferred	(240,424		)	(7,811		)	(64,191		)

Tax expense (benefit) allocated to shareholders' equity	6,576			16,555			(3,063		)

Total provision (benefit) for income taxes	$	(251,677	)	$	23,197		$	(189,306	)

The provision (benefit) for income taxes differs from the amount estimated by applying the United States statutory federal income tax rate of 35% to income (loss) before provision (benefit) for income taxes for fiscal 2012, 2011 and 2010 as follows:



	2012			2011			2010
	(In thousands)
Provision computed at federal statutory income tax rate	$	65,895		$	33,400		$	(21,968	)
State and local income tax, net of federal tax effect	3,626			6,493			(3,970		)
Foreign income tax rate differential	(39,308		)	(6,676		)	(7,053		)
Non-deductible share-based compensation costs	7,785			1,651			11,129
Change in deferred tax asset valuation allowance	(301,542		)	(3,617		)	(26,550		)
Tax credits	(3,744		)	(12,588		)	(12,495		)
Repatriation of foreign earnings	(2,645		)	708			(407		)
Non-deductible research and development expense	1,968			—			3,199
Financing arrangements	—			—			(1,821		)
Withholding taxes	3,593			3,851			2,778
Tax settlements, domestic	(37,481		)	328			(147,109		)
Tax settlements, foreign	(804		)	(2,451		)	—
Interest and penalties not included in tax settlements	2,552			1,840			7,595
Increase (decrease) in unrecognized tax benefits not included in tax settlements	47,329			933			8,496
Other	1,099			(675		)	(1,130		)
Provision (benefit) for income taxes	$	(251,677	)	$	23,197		$	(189,306	)
Effective tax rate	(134		)%	24		%	302		%

The components of deferred tax assets and liabilities consisted of the following as of December 29, 2012 and December 31, 2011:



	As of
	December 29, 2012			December 31, 2011
	(In thousands)
Deferred tax assets:
Tax credit carryforwards	$	129,724		$	133,829
Intangible assets	56,512			70,314
Reserves and accruals	50,960			77,325
Capitalized research and development expense for income tax purposes	34,046			40,510
Share-based compensation costs	20,012			20,661
Operating loss carryforwards	24,429			56,330
Deferred income	27,237			17,840
Capital loss carryforwards	23,026			23,737
Depreciation and amortization	8,979			7,058
Investments	7,550			7,339
Other	4,185			3,723
Total deferred tax assets	386,660			458,666
Valuation allowance	(74,323		)	(375,864		)
Net deferred tax assets	312,337			82,802

Deferred tax liabilities:
Intangible assets	(70,086		)	(66,878		)
Undistributed foreign earnings	(13,113		)	(5,584		)
Other	(965		)	(6,700		)
Total deferred tax liabilities	(84,164		)	(79,162		)
Total net deferred tax assets	$	228,173		$	3,640

The operating loss carryforwards included in the components of deferred tax assets and liabilities do not include excess tax benefits associated with share-based compensation. The excess tax benefit from share-based compensation is not recognized until a tax deduction is realized on Cadence's income tax returns. As of December 29, 2012 and December 31, 2011, Cadence had unrealized share-based compensation deductions as follows:



	As of
	December 29, 2012		December 31, 2011
	(Tax Effected - In thousands)
Federal	$	2,170	$	2,343
California	457		457

Upon realization of these deductions on Cadence's income tax returns, the tax effect of these deductions will result in an increase to stockholders' equity rather than as a reduction of income tax expense.

Cadence regularly reviews its deferred tax assets for recoverability and establishes a valuation allowance if it is more likely than not that some portion of the deferred tax assets will not be realized. This analysis involves weighing both the positive and negative evidence concerning the realizability of the Company's deferred tax assets in each tax jurisdiction. During fiscal 2012, Cadence determined that there was sufficient positive evidence to release the year-end valuation allowance of $219.6 million that was previously reserved against a substantial portion of the United States federal and state deferred tax assets. The evidence that the Company relied on to make this determination included the following:


•	The magnitude and duration of Cadence's current profitability in the United States;


•	Cadence's four year history of approximately 90% of the aggregate value of its bookings being of a type that revenue is recurring, or ratable, in nature;


•	Cadence's existing revenue backlog as of December 29, 2012 that provides Cadence with an objective source of future revenues to be recognized in fiscal 2013 and subsequent periods; and


•	Cadence's expectation of having sufficient sources of income in the future to prevent the expiration of deferred tax assets.

Cadence maintained a valuation allowance of $74.3 million on certain federal, state and foreign deferred tax assets because the realization of these deferred tax assets require future income of a specific character or amount that Cadence considered uncertain. The valuation allowance primarily relates to the following:


•	State credits and foreign tax credits in foreign jurisdictions that are accumulating at a rate greater than our capacity to utilize the credits;


•	Federal and foreign deferred tax assets related to investments and capital losses that can only be utilized against gains that are capital in nature; and


•	Domestic foreign tax credits that have not been recognized for income tax purposes and can only be fully utilized if we have sufficient levels of foreign source income in the future.

After consideration of the valuation allowance, Cadence had total net deferred tax assets of $228.2 million as of December 29, 2012.

Cadence provides for United States income taxes on the earnings of foreign subsidiaries unless the earnings are considered indefinitely invested outside of the United States. Cadence intends to indefinitely reinvest $285.2 million of undistributed earnings of its foreign subsidiaries as of December 29, 2012, to meet the working capital and long-term capital needs of its foreign subsidiaries. The unrecognized deferred tax liability for these indefinitely reinvested foreign earnings was $55.8 million as of December 29, 2012.

As of December 29, 2012, Cadence's operating loss carryforwards were as follows:



	Amount		Expiration Periods
	(in thousands)
Federal	$	21,985	from 2021 through 2031
California	263,023		from 2013 through 2031
Other states (tax effected, net of federal benefit)	4,466		from 2013 through 2031

As of December 29, 2012, Cadence had tax credit carryforwards of:



	Amount		Expiration Periods
	(in thousands)
Federal ⁽¹⁾	$	94,213	from 2015 through 2032
California	32,103		do not expire until utilized
Other states	9,699		from 2013 through 2026
Foreign	8,340		do not expire until utilized

_____________

⁽¹⁾ This amount includes foreign tax credits that have not been recognized for income tax purposes. We have not included an expiration period for foreign tax credits that have not been recognized for income tax purposes.

Examinations by Tax Authorities

The IRS and other tax authorities regularly examine Cadence's income tax returns. Cadence's federal income tax returns beginning with the 2009 tax year remain subject to examination by the IRS. Cadence's California state income tax returns beginning with the 2004 tax year remain subject to examination by the California Franchise Tax Board, or FTB, and the FTB is currently examining Cadence's California state income tax returns for the tax years 2004 through 2006. Cadence's Israel income tax returns beginning with the 2007 tax year are subject to examination by the Israeli Tax Authority.

In October 2010, the Appeals Office of the IRS, or the Appeals Office provided Cadence with copies of the settlement agreements that resolved the previously disputed tax positions. As a result of this effective settlement, Cadence recognized a benefit for income taxes of $147.9 million in its consolidated income statement during fiscal 2010.

In 2009, the IRS completed its field examination of Cadence's federal income tax returns for the tax years 2003 through 2005 and issued a Revenue Agent's Report, or RAR, in which the IRS proposed to assess an aggregate deficiency for the three-year period of $60.7 million. The IRS contested Cadence's transfer pricing arrangements with its foreign subsidiaries and deductions for foreign trade income. In June 2011, the Appeals Office provided Cadence with copies of the settlement agreements that were executed by the Appeals Office, resolving the previously disputed tax positions. As a result of this effective settlement, Cadence recognized a benefit for income taxes of $5.7 million in its consolidated income statement during fiscal 2011.

In November 2011, the IRS completed its field examination of Cadence's federal income tax returns for the tax years 2006 through 2009 and issued examination reports, in which the IRS proposed to assess an aggregate deficiency for the four-year period of $4.1 million. Cadence determined that the certain tax positions were effectively settled and Cadence recognized a provision for income taxes of $3.9 million in its consolidated income statement during fiscal 2011.

In December 2012, the FTB completed its field examination of Cadence's California state income tax returns for the tax years 2001 through 2003 and issued a Notice of Proposed Assessment, or NPA, that resulted in tax refunds due to Cadence. Cadence determined that certain tax positions were effectively settled and Cadence recognized a benefit for income taxes of $36.7 million in its consolidated income statement during fiscal 2012.

Unrecognized Tax Benefits

The changes in Cadence's gross amount of unrecognized tax benefits during fiscal 2012, 2011 and 2010 are as follows:



	2012			2011			2010
	(In thousands)
Unrecognized tax benefits at the beginning of the fiscal year	$	98,812		$	131,545		$	324,837
Gross amount of the increases (decreases) in unrecognized tax benefits of tax positions taken during a prior year	2,194			(3,791		)	(130,313		)
Gross amount of the increases in unrecognized tax benefits as a result of tax positions taken during the current year	3,082			1,588			12,052
Amount of decreases in unrecognized tax benefits relating to settlements with taxing authorities, including the utilization of tax attributes	(11,768		)	(30,115		)	(74,890		)
Reductions to unrecognized tax benefits resulting from the lapse of the applicable statute of limitations	(189		)	(421		)	(109		)
Effect of foreign currency translation	247			6			(32		)
Unrecognized tax benefits at the end of the fiscal year	$	92,378		$	98,812		$	131,545

Total amounts of unrecognized tax benefits that, if upon resolution of the uncertain tax positions would reduce Cadence's effective tax rate	$	57,725		75,057			$	83,676

The total amounts of interest and penalties recognized in the consolidated income statements as provision (benefit) for income taxes for fiscal 2012, 2011 and 2010 were as follows:



	2012			2011			2010
	(In thousands)
Interest	$	(11,184	)	$	2,173		$	(46,268	)
Penalties	(1,862		)	(1,495		)	4,471

The total amounts of gross accrued interest and penalties recognized in the consolidated balance sheets as of December 29, 2012 and December 31, 2011 were as follows:



	As of
	December 29, 2012		December 31, 2011
	(In thousands)
Interest	$	24,427	$	35,368
Penalties	8,953		11,574

Cadence believes that it is reasonably possible that certain acquired unrecognized tax benefits recorded in a past business combination could decrease during fiscal 2013 because the statute of limitations for examination may expire. Cadence estimates the range of possible decrease to be as much as $12.0 million. Cadence also believes that it is reasonably possible that certain unrecognized tax benefits related to the FTB's examination of Cadence's California tax returns for the 2004 through 2006 tax years could decrease during fiscal 2013 if these tax positions are determined to be effectively settled. Cadence estimates the range of possible decrease to be as much as $13.4 million.