17. Income Taxes

The domestic and international components of pre-tax income are as follows:



	2016		2015		2014
	($ in millions)
Domestic	$	779	$	668	$	654
International		225		169		155
Total pre-tax income	$	1,004	$	837	$	809

Domestic pre-tax income includes the results of non-U.S. businesses that are operated in branches owned directly by the U.S. which, therefore, are subject to U.S. income tax.

The income tax provision consists of the following:



	2016		2015		2014
Current:	($ in millions)
Federal	$	249	$	212	$	195
State and local		44		37		34
International		48		53		40
Total current tax provision		341		302		269
Deferred:
Federal		(6)		(8)		16
State and local		1		(1)		3
International		4		3		1
Total deferred tax provision		(1)		(6)		20
Total income tax provision	$	340	$	296	$	289

Provision has been made in the accompanying Consolidated Statements of Operations for additional income taxes applicable to dividends received or expected to be received, if any, from international subsidiaries. The amount of unremitted earnings of international subsidiaries for which no such tax is provided and which is considered to be permanently reinvested in the subsidiaries totaled $1,249 million and $1,087 million at January 28, 2017 and January 30, 2016, respectively. The determination of the amount of the deferred tax liability related to permanently reinvested earnings is not practicable.

A reconciliation of the significant differences between the federal statutory income tax rate and the effective income tax rate on pre-tax income is as follows:



	2016		2015		2014
Federal statutory income tax rate	35.0	%	35.0	%	35.0	%
State and local income taxes, net of federal tax benefit	3.1		2.8		3.2
International income taxed at varying rates	(3.7)		(2.1)		(1.9)
Foreign tax credits	(1.9)		(2.8)		(2.5)
Domestic/foreign tax settlements	(0.1)		(0.1)		(0.6)
Federal tax credits	(0.2)		(0.2)		(0.2)
Other, net	1.7		2.8		2.7
Effective income tax rate	33.9	%	35.4	%	35.7	%

Deferred income taxes are provided for the effects of temporary differences between the amounts of assets and liabilities recognized for financial reporting purposes and the amounts recognized for income tax purposes. Items that give rise to significant portions of the Company’s deferred tax assets and deferred tax liabilities are as follows:



	2016		2015
Deferred tax assets:	($ in millions)
Tax loss/credit carryforwards and capital loss	$	12	$	8
Employee benefits		76		97
Property and equipment		110		121
Straight-line rent		51		39
Other		47		34
Total deferred tax assets	$	296	$	299
Valuation allowance		(7)		(5)
Total deferred tax assets, net	$	289	$	294
Deferred tax liabilities:
Merchandise inventories		104		104
Goodwill and other intangible assets		21		20
Other		6		6
Total deferred tax liabilities	$	131	$	130
Net deferred tax asset	$	158	$	164
Balance Sheet caption reported in:
Deferred taxes	$	161	$	234
Other current assets		—		5
Accrued and other current liabilities		—		(62)
Other liabilities		(3)		(13)
	$	158	$	164

Based upon the level of historical taxable income and projections for future taxable income, which are based upon the Company’s long-range strategic plans, management believes it is more likely than not that the Company will realize the benefits of these deductible differences, net of the valuation allowances at January 28, 2017, over the periods in which the temporary differences are anticipated to reverse. However, the amount of the deferred tax asset considered realizable could be adjusted in the future if estimates of taxable income are revised.

As of January 28, 2017, the Company has a valuation allowance of $7 million to reduce its deferred tax assets to an amount that is more likely than not to be realized. A valuation allowance of $4 million relates to the deferred tax assets arising from a capital loss associated with an impairment of the Northern Group note receivable in 2008. The Company does not anticipate realizing capital gains to utilize the capital loss associated with the note receivable impairment. A valuation allowance of $3 million was recorded against tax loss carryforwards of certain foreign entities. Based on the history of losses and the absence of prudent and feasible business plans for generating future taxable income in these entities, the Company believes it is more likely than not that the benefit of these loss carryforwards will not be realized.

At January 28, 2017, the Company has U.S. state operating loss carryforwards with a potential tax benefit of $1 million that expire between 2021 and 2035. The Company will have, when realized, a capital loss with a potential benefit of $4 million arising from a note receivable. This loss will carryforward for 5 years after realization. The Company has U.S. state credits of $1 million that expire in 2024. The Company has international operating loss carryforwards with a potential tax benefit of $7 million, a portion of which will expire between 2017 and 2025 and a portion of which will never expire. The state and international operating loss carryforwards do not include unrecognized tax benefits.

The Company operates in multiple taxing jurisdictions and is subject to audit. Audits can involve complex issues that may require an extended period of time to resolve. A taxing authority may challenge positions that the Company has adopted in its income tax filings. Accordingly, the Company may apply different tax treatments for transactions in filing its income tax returns than for income tax financial reporting. The Company regularly assesses its tax positions for such transactions and records reserves for those differences.

The Company’s U.S. Federal income tax filings have been examined by the Internal Revenue Service through 2015. The Company is participating in the IRS’s Compliance Assurance Process (“CAP”) for 2016, which is expected to conclude during 2017. The Company has started the CAP for 2017. Due to the recent utilization of net operating loss carryforwards, the Company is subject to state and local tax examinations effectively including years from 1996 to the present. To date, no adjustments have been proposed in any audits that will have a material effect on the Company’s financial position or results of operations.

At January 28, 2017 and January 30, 2016, the Company had $38 million of gross unrecognized tax benefits, and $38 million and $37 million, respectively, of net unrecognized tax benefits that would, if recognized, affect the Company’s annual effective tax rate. The Company has classified certain income tax liabilities as current or noncurrent based on management’s estimate of when these liabilities will be settled. Interest expense and penalties related to unrecognized tax benefits are classified as income tax expense. The Company recognized $1 million of interest income in 2016. Interest was not significant for 2015 and 2014. The total amount of accrued interest and penalties was $1 million, $2 million, and $2 million in 2016, 2015, and 2014, respectively.

The following table summarizes the activity related to unrecognized tax benefits:



	2016		2015		2014
	($ in millions)
Unrecognized tax benefits at beginning of year	$	38	$	40	$	48
Foreign currency translation adjustments		1		(2)		(6)
Increases related to current year tax positions		8		4		3
Increases related to prior period tax positions		1		2		1
Decreases related to prior period tax positions		(2)		—		(1)
Settlements		(7)		(1)		(1)
Lapse of statute of limitations		(1)		(5)		(4)
Unrecognized tax benefits at end of year	$	38	$	38	$	40

It is reasonably possible that the liability associated with the Company’s unrecognized tax benefits will increase or decrease within the next twelve months. These changes may be the result of foreign currency fluctuations, ongoing audits, or the expiration of statutes of limitations. Settlements could increase earnings in an amount ranging from $0 to $5 million based on current estimates. Audit outcomes and the timing of audit settlements are subject to significant uncertainty. Although management believes that adequate provision has been made for such issues, the ultimate resolution could have an adverse effect on the earnings of the Company. Conversely, if these issues are resolved favorably in the future, the related provision would be reduced, generating a positive effect on earnings. Due to the uncertainty of amounts and in accordance with its accounting policies, the Company has not recorded any potential impact of these settlements.