Taxes on Income

The components of income before income tax expense are as follows (in millions):



	2012		2011		2010
Domestic	$	471.5	$	500.3	$	549.6
Foreign	356.9		381.8		331.6
	$	828.4	$	882.1	$	881.2

The components of income tax expense are as follows (in millions):



	2012			2011			2010
Current:
Federal	$	180.0		$	223.2		$	180.2
State	21.0			48.0			43.9
Foreign	97.2			156.4			97.8
	298.2			427.6			321.9
Deferred:
Federal	(33.2		)	(45.1		)	(20.7		)
State	(5.4		)	(16.0		)	(5.2		)
Foreign	2.6			(2.6		)	(5.4		)
	(36.0		)	(63.7		)	(31.3		)
	$	262.2		$	363.9		$	290.6

Reconciliation of the provision for income taxes at the U.S. federal statutory income tax rate to the Company’s income taxes is as follows (dollars in millions):



	2012			2011			2010
Statutory rate	35		%	35		%	35		%
Income tax expense using federal statutory rate	$	289.9		$	308.7		$	308.4
State taxes on income net of federal benefit	10.1			20.8			25.2
Canadian tax rate differential	—			(6.1		)	(23.1		)
Utilization of foreign tax credits	(25.1		)	(28.5		)	—
Taxes on foreign earnings not permanently reinvested	—			98.9			—
Other	(12.7		)	(29.9		)	(19.9		)
	$	262.2		$	363.9		$	290.6

Income tax expense increased by $98.9 million in 2011 as a result of repatriation taxes on a $1.1 billion dividend from the Company's Canadian subsidiary to the U.S. parent.

Safeway began to accrue repatriation taxes on the earnings of its Canadian subsidiary in the second quarter of 2011. As a result of this change in policy, income tax expense was reduced by $28.5 million in 2011 and $25.1 million in 2012 as Safeway will use foreign tax credits to reduce the U.S. tax on those earnings.

Significant components of the Company’s net deferred tax liability at year end are as follows (in millions):



	2012			2011
Deferred tax assets:
Pension liability	$	293.3		$	295.3
Workers’ compensation and other claims	189.7			189.2
Employee benefits	202.8			205.5
Accrued claims and other liabilities	80.0			74.9
Reserves not currently deductible	37.4			36.7
Foreign tax credit carryforwards	37.9			35.3
State tax credit carryforwards	27.7			20.7
Operating loss carryforwards	1.9			2.0
Other assets	10.8			14.2
	881.5			873.8
Valuation Allowance	(27.1		)	(29.1		)
	$	854.4		$	844.7

	2012			2011
Deferred tax liabilities:
Property	$	(662.4	)	$	(663.8	)
Inventory	(314.5		)	(312.9		)
Investments in foreign operations	(19.4		)	(9.5		)
	(996.3		)	(986.2		)
Net deferred tax liability	$	(141.9	)	$	(141.5	)

Deferred tax assets and liabilities are reported in the balance sheet as follows (in millions):



	2012			2011
Current deferred tax assets ⁽¹⁾	$	1.1		$	—
Noncurrent deferred tax assets ⁽²⁾	81.2			78.2
Current deferred tax liability	(45.7		)	(77.8		)
Noncurrent deferred tax liability	(178.5		)	(141.9		)
Net deferred tax asset (liability)	$	(141.9	)	$	(141.5	)

⁽¹⁾ Included in Prepaid Expenses and Other Current Assets.

⁽²⁾ Included in Other Assets.

At December 29, 2012, the Company had net operating loss carryforwards for federal income tax purposes of approximately $5.3 million which expire at various dates from 2023 to 2025. The Company also had state tax credit carryforwards of $42.6 million which have no expiration date.

At December 29, 2012, the Company had foreign tax credit carryforwards of $37.9 million which expire in 2021. A valuation allowance has been recorded against $27.1 million of these carryforwards. The valuation allowance is recorded when it becomes more likely than not that a portion of the deferred tax asset will not be realized.

At year-end 2012, no deferred tax liability has been recognized for the $1.3 billion of unremitted foreign earnings because the Company intends to utilize those earnings in the foreign operations for an indefinite period of time. If Safeway did not consider these earnings to be indefinitely reinvested, the deferred tax liability would have been in the range of $125 million to $160 million at year-end 2012.

A reconciliation of the beginning and ending amount of unrecognized tax benefits follows (in millions):



	2012			2011			2010
Balance at beginning of year	$	161.3		$	159.9		$	151.0
Additions based on tax positions related to the current year	2.7			17.8			4.3
Additions for tax positions of prior years	2.2			0.5			10.6
Reductions for tax positions of prior years	(46.9		)	(3.5		)	(4.7		)
Foreign currency translation	0.1			(0.1		)	0.4
Expiration of statute of limitations	—			—			(0.8		)
Settlements	—			(13.3		)	(0.9		)
Balance at end of year	$	119.4		$	161.3		$	159.9

As of December 29, 2012, December 31, 2011 and January 1, 2011, the balance of unrecognized tax benefits included tax positions of $42.9 million (net of tax), $43.1 million (net of tax) and $43.7 million (net of tax), respectively, that would reduce the Company’s effective income tax rate if recognized in future periods.

Income tax expense in 2012, 2011 and 2010 included benefits of $6.8 million (net of tax), $0.4 million (net of tax) and $0.5 million (net of tax), respectively, related to interest and penalties. As of December 29, 2012 and December 31, 2011, the Company’s accrual for net interest and penalties was a receivable of $3.3 million and a liability of $3.0 million, respectively.

The Company and its domestic subsidiaries file income tax returns with federal, state and local tax authorities within the United States. The Company’s foreign affiliates file income tax returns in various foreign jurisdictions, the most significant of which are Canada and certain of its provinces. With limited exceptions, including certain income tax refund claims, the Company is no longer subject to federal income tax examinations for fiscal years before 2006, and is no longer subject to state and local income tax examinations for fiscal years before 2003. With limited exceptions, including proposed deficiencies which the Company is protesting, Safeway’s Canadian affiliates are no longer subject to examination by Canada and certain of its provinces for fiscal years before 2006.

In 2007, the Company applied for a bilateral Advance Pricing Agreement between the Canada Revenue Agency and the Internal Revenue Service for the years 2007 through 2011. The Agreement would determine an arm's length royalty charge that the Company's Canadian subsidiary must pay for use of intellectual property and know-how developed by the Company. The Company submitted the case to binding arbitration in 2012 and expects the results of that arbitration to be known in 2013.

The Company previously had such a royalty agreement approved for the years 2000 through 2006. The Company has paid and accrued taxes in each country based on best estimates of potential outcomes of the Advance Pricing Agreement and binding arbitration process. The result of the process is likely to be an adjustment to royalties paid and increases in tax in one country and decreases in tax in the other country. In addition, the determination of the royalty charge could result in an increase or decrease in taxes provided on the repatriation of foreign earnings.

The Company anticipates that total unrecognized tax benefits will be reduced by approximately $33 million in the next 12 months primarily due to the anticipated settlement of state income tax matters with respect to the 2002 and 2003 impairment of the Company's investment in Dominick's.