17. Income Taxes

Following are the domestic and international components of pre-tax income from continuing operations:


	2011		2010		2009
	(in millions)
Domestic	$	321	$	158	$	(23	)
International		114		99		96
Total pre-tax income	$	435	$	257	$	73

The income tax provision consists of the following:


	2011		2010			2009
	(in millions)
Current:
Federal	$	93	$	(28	)	$	(6	)
State and local		11		4			—
International		24		28			30
Total current tax provision		128		4			24
Deferred:
Federal		16		79			(3	)
State and local		6		4			—
International		7		1			5
Total deferred tax provision		29		84			2
Total income tax provision	$	157	$	88		$	26

Provision has been made in the accompanying Consolidated Statements of Operations for additional income taxes applicable to dividends received or expected to be received 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 $771 million and $679 million at January 28, 2012 and January 29, 2011, 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 from continuing operations is as follows:


	2011			2010			2009
Federal statutory income tax rate		35.0	%		35.0	%		35.0	%
State and local income taxes, net of federal tax benefit		3.1			2.3			0.2
International income taxed at varying rates		(0.3	)		1.0			1.3
Foreign tax credits		(1.3	)		(2.0	)		(7.4	)
Decrease in valuation allowance		—			(0.4	)		—
Domestic/foreign tax settlements		0.3			(2.3	)		(2.8	)
Federal tax credits		(0.6	)		(0.7	)		(2.0	)
Canadian tax rate changes		—			—			6.0
Other, net		(0.2	)		1.4			5.7
Effective income tax rate		36.0	%		34.3	%		36.0	%

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:


	2011			2010
	(in millions)
Deferred tax assets:
Tax loss/credit carryforwards and capital loss	$	18		$	31
Employee benefits		77			67
Property and equipment		166			173
Straight-line rent		27			27
Goodwill and other intangible assets		21			23
Other		32			32
Total deferred tax assets		341			353
Valuation allowance		(5	)		(6	)
Total deferred tax assets, net		336			347
Deferred tax liabilities:
Inventories		71			63
Other		8			6
Total deferred tax liabilities		79			69
Net deferred tax asset	$	257		$	278
Balance Sheet caption reported in:
Deferred taxes	$	284		$	296
Other current assets		2			2
Accrued and other current liabilities		(24	)		(20	)
Other liabilities		(5	)		—
	$	257		$	278

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 2010. The Company is participating in the IRS’s Compliance Assurance Process (“CAP”) for 2011, which is expected to conclude during 2012. The Company has started the CAP for 2012. 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.

As of January 28, 2012, the Company has a valuation allowance of $5 million to reduce its deferred tax assets to an amount that is more likely than not to be realized. The valuation allowance primarily relates to the deferred tax assets arising from a capital loss associated with the 2008 impairment of the Northern Group note receivable, state tax loss carryforwards, and state tax credits. A full valuation allowance is required for the capital loss because the Company does not anticipate realizing capital gains to utilize this loss. The valuation allowance for state tax loss and credit carryforwards decreased in 2011 principally due to anticipated expirations of those attributes.

Based upon the level of historical taxable income and projections for future taxable income, which are based upon the Company’s strategic long-range plans, over the periods in which the temporary differences are anticipated to reverse, 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, 2012. However, the amount of the deferred tax asset considered realizable could be adjusted in the future if estimates of taxable income are revised.

At January 28, 2012, the Company has state operating loss carryforwards with a potential tax benefit of $11 million that expire between 2012 and 2030. The Company will have, when realized, a capital loss with a potential benefit of $3 million arising from a note receivable. This loss will carryforward for 5 years after realization. The Company has U.S. state and Canadian provincial credit carryforwards that total $2 million, expiring between 2012 and 2021. The Company has international operating loss carryforwards with a potential tax benefit of $2 million, expiring between 2012 and 2031.

At January 28, 2012 and January 29, 2011, the Company had $65 million and $62 million, respectively of gross unrecognized tax benefits, and $64 million and $61 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 expense in each of 2011, 2010, and 2009. The total amount of accrued interest and penalties was $4 million, $3 million, and $5 million in 2011, 2010, and 2009, respectively.

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


	2011			2010			2009
	(in millions)
Unrecognized tax benefits at beginning of year	$	62		$	70		$	58
Foreign currency translation adjustments		(1	)		3			6
Increases related to current year tax positions		7			4			4
Increases related to prior period tax positions		1			3			4
Decreases related to prior period tax positions		—			(7	)		(2	)
Settlements		(3	)		(9	)		—
Lapse of statute of limitations		(1	)		(2	)		—
Unrecognized tax benefits at end of year	$	65		$	62		$	70

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 of these issues 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.