Income Taxes



	Years Ended March 31,
(In millions)	2016		2015		2014
Income from continuing operations before income taxes
U.S.	$	2,319	$	1,893	$	1,554
Foreign	931		764		617
Total income from continuing operations before income taxes	$	3,250	$	2,657	$	2,171

Income tax expense related to continuing operations consists of the following:



	Years Ended March 31,
(In millions)	2016			2015			2014
Current
Federal	$	658		$	453		$	484
State	96			90			64
Foreign	90			101			193
Total current	844			644			741

Deferred
Federal	95			195			24
State	42			53			10
Foreign	(73		)	(77		)	(18		)
Total deferred	64			171			16
Income tax expense	$	908		$	815		$	757

During 2016, 2015 and 2014, income tax expense related to continuing operations was $908 million, $815 million and $757 million, which included net discrete tax benefits of $42 million and $33 million in 2016 and 2015 and net discrete tax expenses of $94 million in 2014. Discrete tax benefits in 2016 included a $19 million benefit related to enacted tax law changes in foreign jurisdictions and a $25 million benefit due to the reversal of a tax reserve related to the treatment of share-based compensation expense in an intercompany cost-sharing agreement. Discrete tax benefit in 2015 included a $55 million benefit related to an agreement reached with the Internal Revenue Service (“IRS”) to settle all outstanding issues relating to years 2003 through 2006. Discrete tax expense for 2014 primarily related to a $122 million charge regarding an unfavorable decision from the Tax Court of Canada with respect to transfer pricing issues.

Our reported income tax rates were 27.9%, 30.7%, and 34.9% in 2016, 2015 and 2014. The fluctuations in our reported income tax rates are primarily due to changes within our business mix, including varying proportions of income attributable to foreign countries that have lower income tax rates and discrete items.

The reconciliation between our effective tax rate on income from continuing operations and statutory tax rate is as follows:



	Years Ended March 31,
(In millions)	2016			2015			2014
Income tax expense at federal statutory rate	$	1,137		$	930		$	760
State income taxes net of federal tax benefit	92			81			57
Foreign income taxed at various rates	(295		)	(247		)	(177		)
Canadian litigation	(8		)	—			122
Controlled substance distribution reserve	—			58			—
Unrecognized tax benefits and settlements	(6		)	10			(6		)
Tax credits	(18		)	(10		)	(6		)
Other, net	6			(7		)	7
Income tax expense	$	908		$	815		$	757

At March 31, 2016, undistributed earnings of our foreign operations totaling $5,831 million were considered to be permanently reinvested. No deferred tax liability has been recognized on the basis difference created by such earnings since it is our intention to utilize those earnings in the foreign operations as well as to fund certain research and development activities for an indefinite period of time. The determination of the amount of deferred taxes on these earnings is not practicable because the computation would depend on a number of factors that cannot be known until a decision to repatriate the earnings is made.

Deferred tax balances consisted of the following:



	March 31,
(In millions)	2016			2015
Assets
Receivable allowances	$	110		$	83
Deferred revenue	77			72
Compensation and benefit related accruals	710			681
Net operating loss and credit carryforwards	367			316
Other	275			266
Subtotal	1,539			1,418
Less: valuation allowance	(267		)	(229		)
Total assets	1,272			1,189
Liabilities
Inventory valuation and other assets	(2,619		)	(2,333		)
Fixed assets and systems development costs	(326		)	(324		)
Intangibles	(981		)	(1,073		)
Other	(21		)	(61		)
Total liabilities	(3,947		)	(3,791		)
Net deferred tax liability	$	(2,675	)	$	(2,602	)

Current net deferred tax asset ⁽¹⁾	$	—		$	27
Current net deferred tax liability ⁽¹⁾	—			(1,820		)
Long-term deferred tax asset	59			50
Long-term deferred tax liability	(2,734		)	(859		)
Net deferred tax liability	$	(2,675	)	$	(2,602	)


(1)	Upon the adoption of the amended accounting guidance, we reclassified current net deferred tax liabilities and current net deferred tax assets as noncurrent on our consolidated balance sheet as of March 31, 2016. Our March 31, 2015 balances were not retrospectively reclassified.

We assess the available positive and negative evidence to determine whether deferred tax assets are more likely than not to be realized. As a result of this assessment, valuation allowances have been recorded on certain deferred tax assets in various tax jurisdictions. The valuation allowance was approximately $267 million and $229 million in 2016 and 2015. The increase of $38 million in valuation allowances in the current year relate primarily to net operating losses incurred in certain tax jurisdictions for which no tax benefit was recognized.

We have federal, state and foreign net operating loss carryforwards of $35 million, $1,790 million and $889 million. Federal and state net operating losses will expire at various dates from 2017 through 2036. Substantially all of our foreign net operating losses have indefinite lives.

We received reassessments from the Canada Revenue Agency (“CRA”) related to a transfer pricing matter impacting years 2003 through 2013. During 2016, we reached an agreement to settle the transfer pricing matter for years 2003 through 2013 and recorded a net discrete tax benefit of $8 million.

We are subject to the continuous examination of our income tax returns by the IRS and other authorities. The IRS is currently examining our U.S. corporation income tax returns for 2007 through 2009 and may issue a Revenue Agent Report during the first quarter of 2017. We believe that adequate amounts have been reserved for any adjustments that may ultimately result from these examinations.

The following table summarizes the activity related to our gross unrecognized tax benefits for the last three years:



	Years Ended March 31,
(In millions)	2016			2015			2014
Unrecognized tax benefits at beginning of period	$	616		$	647		$	560
Additions based on tax positions related to prior years	116			62			106
Reductions based on tax positions related to prior years	(62		)	(18		)	(23		)
Additions based on tax positions related to current year	28			27			23
Reductions based on settlements	(141		)	(65		)	(4		)
Reductions based on the lapse of the applicable statutes of limitations	(6		)	(12		)	(7		)
Exchange rate fluctuations	4			(25		)	(8		)
Unrecognized tax benefits at end of period	$	555		$	616		$	647

As of March 31, 2016, we had $555 million of unrecognized tax benefits, of which $380 million would reduce income tax expense and the effective tax rate, if recognized. During the next twelve months, it is reasonably possible that audit resolutions and the expiration of statutes of limitations could potentially reduce our unrecognized tax benefits by up to $125 million. However, this amount may change as we continue to have ongoing negotiations with various taxing authorities throughout the year.

We report interest and penalties on income taxes as income tax expense. We recognized income tax expense of $12 million in 2016, income tax benefit of $24 million in 2015 and income tax expense of $48 million in 2014, related to interest and penalties in our consolidated statements of operations. The income tax benefit for interest and penalties recognized in 2015 was primarily due to the lapses of statutes of limitations. As of March 31, 2016 and 2015, we had accrued $77 million and $122 million cumulatively in interest and penalties on unrecognized tax benefits.

We file income tax returns in the U.S. federal jurisdiction, various U.S. state jurisdictions and various foreign jurisdictions. We are subject to audit by the IRS for fiscal years 2007 through the current fiscal year. We are generally subject to audit by taxing authorities in various U.S. states and in foreign jurisdictions for fiscal years 2006 through the current fiscal year.