INCOME TAXES

The Company is subject to income taxes in the U.S. and numerous foreign jurisdictions. The Company files U.S. federal, U.S. state, and foreign income tax returns. For U.S. federal, and in general for U.S. state tax returns, the fiscal 2011 and later tax years remain open for examination by tax authorities. The U.S. Internal Revenue Service (IRS) is currently auditing Microchip and SMSC's 2011 and 2012 tax years. For foreign tax returns, the Company is generally no longer subject to income tax examinations for years prior to fiscal 2006.

Significant judgment is required in evaluating the Company's uncertain tax positions and determining its provision for income taxes. Although the Company believes that it has appropriately reserved for its uncertain tax positions, no assurance can be given that the final tax outcome of these matters will not be different than expectations. The Company will adjust these reserves in light of changing facts and circumstances, such as the closing of a tax audit, the refinement of an estimate, the closing of a statutory audit period or changes in applicable tax law. To the extent that the final tax outcome of these matters is different than the amounts recorded, such differences will impact the provision for income taxes in the period in which such determination is made. The provision for income taxes includes the impact of reserve provisions and changes to the reserves that are considered appropriate, as well as related net interest.

The Company recognizes liabilities for anticipated tax audit issues in the U.S. and other domestic and international tax jurisdictions based on its estimate of whether, and the extent to which, additional tax payments are more likely than not. The Company believes that it has appropriate support for the income tax positions taken and to be taken on its tax returns and that its accruals for tax liabilities are adequate for all open years based on an assessment of many factors including past experience and interpretations of tax law applied to the facts of each matter.

The Company believes it maintains appropriate reserves to offset any potential income tax liabilities that may arise upon final resolution of matters for open tax years. If such reserve amounts ultimately prove to be unnecessary, the resulting reversal of such reserves would result in tax benefits being recorded in the period the reserves are no longer deemed necessary. If such amounts prove to be less than an ultimate assessment, a future charge to expense would be recorded in the period in which the assessment is determined. Although the timing of the resolution and/or closure of audits is highly uncertain, the Company does not believe that it is reasonably possible that the unrecognized tax benefits would materially change in the next 12 months.

The following table summarizes the activity related to the Company's gross unrecognized tax benefits from April 1, 2011 to March 31, 2014 (amounts in thousands):



	Year Ended March 31,
	2014			2013			2012
Beginning balance	$	152,845		$	70,490		$	58,125
Increases related to acquisitions	341			45,624			—
Decreases related to settlements with tax authorities	(15,016		)	—			—
Decreases related to statute of limitation expirations	(4,069		)	(5,751		)	(2,153		)
Increases related to current year tax positions	14,669			42,328			11,992
Increases related to prior year tax positions	1,108			154			2,526
Ending balance	$	149,878		$	152,845		$	70,490

As of March 31, 2014, the Company had accrued approximately $0.3 million related to the potential payment of interest on the Company's uncertain tax positions. As of March 31, 2013, the Company had accrued approximately $3.2 million related to the potential payment of interest on the Company's uncertain tax positions. Interest was included in the provision for income taxes. The Company has accrued for approximately $29.7 million and $30.6 million in penalties related to its uncertain tax positions related to its international locations as of March 31, 2014 and March 31, 2013, respectively. Interest and penalties charged or (credited) to operations during the years ended March 31, 2014, 2013 and 2012 related to the Company's uncertain tax positions were $0.2 million, $0.8 million and $0.9 million, respectively.

The income tax provision consists of the following (amounts in thousands):



	Year Ended March 31,
	2014			2013			2012
Current expense:
Federal	$	992		$	33,856		$	7,611
State	64			2,350			544
Foreign	30,697			16,950			21,174
Total current	$	31,753		53,156			29,329
Deferred expense (benefit):
Federal	$	14,445		(16,004		)	14,942
State	929			(1,111		)	1,067
Foreign	(10,054		)	(11,253		)	(2,348		)
Total deferred	5,320			(28,368		)	13,661
	$	37,073		$	24,788		$	42,990

The tax benefit associated with the Company's equity incentive plans reduced taxes currently payable by $1.4 million and $11.0 million for the years ended March 31, 2014 and 2012, respectively. These amounts were credited to additional paid-in capital in each of these fiscal years. There was no tax benefit associated with the Company's equity incentive plans for the year ended March 31, 2013.

The provision for income taxes differs from the amount computed by applying the statutory federal tax rate to income before income taxes. The sources and tax effects of the differences in the total income tax provision are as follows (amounts in thousands):



	Year Ended March 31,
	2014			2013			2012
Computed expected income tax provision	$	151,324		$	53,262		$	132,894
State income taxes, net of federal benefits	686			(2,054		)	1,280
Research and development tax credits - current year	(4,875		)	(8,263		)	(3,750		)
Research and development tax credits - prior years	1,600			(3,347		)	(5,894		)
Foreign income taxed at lower than the federal rate	(116,003		)	(61,377		)	(97,169		)
Increases related to current and prior year tax positions	16,809			44,661			14,518
Decreases related to prior year tax positions ⁽¹⁾	(14,581		)	(7,154		)	(2,153		)
Withholding taxes	6,212			7,267			6,995
Other	(4,099		)	1,793			(3,731		)
	$	37,073		$	24,788		$	42,990

⁽¹⁾ The release of prior year tax positions during fiscal 2014 increased each of the current year basic and diluted net income per common share by $0.07. The release of prior year tax positions during fiscal 2013 increased the current year basic and diluted net income per common share by $0.04 and $0.03, respectively. The release of prior year tax positions during fiscal 2012 increased each of the current year basic and diluted net income per common share by $0.01.

Pretax income from foreign operations was $404.1 million, $234.3 million and $328.5 million for the years ended March 31, 2014, 2013 and 2012, respectively. Unremitted foreign earnings that are considered to be permanently invested outside the U.S., and on which no deferred taxes have been provided, amounted to approximately $2.4 billion at March 31, 2014. The Company has the ability and intent to indefinitely reinvest its foreign earnings. Should the Company elect in the future to repatriate a portion of the foreign earnings so invested, the Company would incur income tax expense on such repatriation, net of any available deductions and foreign tax credits. This would result in additional income tax expense beyond the computed effective tax rate in such periods.

During the year ended March 31, 2014, the Company settled an IRS examination of fiscal years 2009 and 2010. In addition, the Company benefited from the expiration of the statute of limitations and other releases related to previously accrued tax reserves. The total tax benefit associated with these items resulted in a reduction of income tax provision of approximately $14.6 million and a decrease in the effective tax rate of 3.4%.

In January 2013, the U.S. Congress retroactively reinstated the research and development tax credit from January 1, 2012. As a result, the Company recognized a one-time tax benefit of $8.1 million in the year ended March 31, 2013 related to the reinstatement of the credit for calendar year 2012.

The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities are as follows (amounts in thousands):



	March 31,
	2014			2013
Deferred tax assets:
Deferred intercompany profit	$	9,623		$	13,679
Deferred income on shipments to distributors	28,596			28,776
Inventory valuation	6,072			9,148
Net operating loss carryforward	110,598			77,959
Share-based compensation	24,494			27,757
Income tax credits	124,395			112,686
Accrued expenses and other	28,227			17,241
Gross deferred tax assets	332,005			287,246
Valuation allowances	(93,811		)	(88,637		)
Deferred tax assets, net of valuation allowances	238,194			198,609
Deferred tax liabilities:
Property, plant and equipment, principally due to differences in depreciation	(1,942		)	(8,515		)
Junior convertible debentures	(530,338		)	(486,878		)
Other	(13,740		)	(10,779		)
Deferred tax liabilities	(546,020		)	(506,172		)
Net deferred tax liability	$	(307,826	)	$	(307,563	)

Reported as:
Current deferred tax assets	$	67,490		$	80,687
Non-current deferred tax liability	(375,316		)	(388,250		)
Net deferred tax liability	$	(307,826	)	$	(307,563	)

In addition to the deferred tax assets listed above, the Company has unrecorded tax benefits of $29.8 million attributable to the difference between the amount of the financial statement expense and the allowable tax deduction associated with share-based compensation. As a result of net operating loss (NOL) carryforwards, the Company was not able to recognize the excess tax benefits of share-based compensation deductions because the deductions did not reduce income tax payable. Although not recognized for financial reporting purposes, this unrecorded tax benefit is available to reduce future income and is incorporated into the disclosed amounts of the Company's federal and state NOL carryforwards, discussed below. If subsequently realized, the benefit will be recorded to contributed capital.

The Company had federal, state and foreign NOL carryforwards with an estimated tax effect of $110.6 million available at March 31, 2014. The federal and state NOL carryforwards expire at various times between 2015 and 2034. The Company believes that it is more likely than not that the benefit from certain foreign and state NOL carryforwards will not be realized. In recognition of this risk, at March 31, 2014, the Company has provided a valuation allowance of $20.5 million. The Company also has state tax credits with an estimated tax effect of $54.3 million available at March 31, 2014. These state tax credits expire at various times between 2015 and 2034. The Company believes that it is more likely than not that the full benefit from these state tax credits will not be realized, and therefore has provided a valuation allowance of $51.4 million. The Company has U.S foreign tax credits with an estimated tax effect of $21.9 million that expire at various times between 2015 and 2024. The Company believes it is more likely than not that the benefit from these credits will not be fully realized and has provided a valuation allowance of $21.8 million. At March 31, 2014, the Company had credits for increasing research activity in the amount of $44.4 million that expire at various times between 2021 and 2034. In addition, the Company had $3.7 million of alternative minimum tax credits that do not expire. At March 31, 2014, the Company had alternative minimum tax NOL carryforwards of approximately $308.0 million that expire between 2032 and 2034.

The Company's Thailand manufacturing operations currently benefit from numerous tax holidays granted to the Company based on its investment in property, plant and equipment in Thailand. The Company's tax holiday periods in Thailand expire at various times in the future, however, the Company actively seeks to acquire new tax holidays. The Company does not expect the future expiration of any of its tax holiday periods in Thailand to have a material impact on its effective tax rate. The aggregate dollar benefits derived from these tax holidays approximated $16.8 million, $12.0 million and $6.5 million in fiscal 2014, 2013 and 2012, respectively. The benefit the tax holiday had on diluted net income per share approximated $0.08 in fiscal 2014, $0.06 in fiscal 2013 and $0.03 in fiscal 2012.

On September 13, 2013, the IRS and the Treasury Department released final regulations under Section 162(a) and 263(a) on the deduction and capitalization of expenditures related to tangible property. The new regulations apply to tax years beginning on or after January 1, 2014; therefore they had no material impact on fiscal 2014. The Company believes that no material impact will result from these new regulations (specifically given the Company’s NOL position), but the Company is in the process of evaluating the full impact of these changes.