Income Taxes



	Years Ended March 31,
(In millions)	2019			2018			2017
Income from continuing operations before income taxes
U.S.	$	1,512		$	1,175		$	5,772
Foreign	(902		)	(936		)	1,119
Total income from continuing operations before income taxes	$	610		$	239		$	6,891

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



	Years Ended March 31,
(In millions)	2019			2018			2017
Current
Federal	$	(20	)	$	577		$	524
State	35			33			86
Foreign	152			205			122
Total current	167			815			732

Deferred
Federal	223			(767		)	767
State	44			17			164
Foreign	(78		)	(118		)	(49		)
Total deferred	189			(868		)	882
Income tax expense (benefit)	$	356		$	(53	)	$	1,614

We recorded income tax expense of $356 million, benefit of $53 million and expense of $1,614 million related to continuing operations in 2019, 2018 and 2017.

Our reported income tax expense rate for 2019 was 58.4% compared to income tax benefit rate of 22.2% for 2018 and an income tax expense rate of 23.4% in 2017. Fluctuations in our reported income tax rates are primarily due to the impact of the 2017 Tax Act, the impact of nondeductible impairment charges, and varying proportions of income attributable to foreign countries that have income tax rates different from the U.S. rate.

The reconciliation of income tax expense (benefit) and the amount computed by applying the statutory federal income tax rate of 21% for 2019, 31.6% for 2018 and 35% for 2017 to the income before income taxes is as follows:



	Years Ended March 31,
(In millions)	2019			2018			2017
Income tax expense at federal statutory rate	$	128		$	75		$	2,411
State income taxes net of federal tax benefit	70			50			153
Tax effect of foreign operations	(86		)	(146		)	(326		)
Unrecognized tax benefits and settlements	20			454			57
Non-deductible goodwill	357			585			106
Share-based compensation	4			(8		)	(54		)
Net tax benefit on intellectual property transfer	(42		)	(178		)	(137		)
Rate differential on gain from Change Healthcare Net Asset Exchange	—			—			(587		)
Impact of change in U.S. tax rate on temporary differences	(81		)	(1,324		)	—
Transition tax on foreign earnings	(5		)	457			—
Other, net⁽¹⁾	(9		)	(18		)	(9		)
Income tax expense (benefit)	$	356		$	(53	)	$	1,614


(1)	Our effective tax rates were impacted by other favorable U.S. federal permanent differences including research and development credits of $7 million, $11 million and $14 million in 2019, 2018 and 2017.

Our reported income tax expense rate for 2019 was unfavorably impacted by non-cash pre-tax charges of $1,776 million ($1,756 million after-tax) to impair the carrying value of goodwill for our European Pharmaceutical Solutions segment, given that these charges are generally not deductible for tax purposes. Our reported income tax benefit rate for 2018 was unfavorably impacted by non-cash charges of $1,738 million (pre-tax and after-tax) to impair the carrying value of goodwill, given that generally no tax benefit was recognized for these charges. Our reported income tax expense rate for 2017 was unfavorably impacted by the non-cash pre-tax charge of $290 million ($282 million after-tax) to impair the carrying value of goodwill, given that generally the majority of this charge was not deductible for income tax purposes. Refer to Financial Note 2, “Goodwill Impairment Charges,” for more information.

During 2019, we sold software between wholly-owned legal entities within the McKesson group that are based in different tax jurisdictions. The transferor entity recognized a gain on the sale of assets that was not subject to income tax in its local jurisdiction; such gain was eliminated upon consolidation. An entity based in the U.S. was the acquirer of the software and is entitled to amortize the purchase price of the assets for tax purposes. In accordance with the recently adopted amended accounting guidance on income taxes, a discrete tax benefit of $42 million was recognized in the second quarter of 2019 with a corresponding increase to a deferred tax asset for the future tax amortization.

On December 19, 2016, we sold various software relating to our technology businesses between wholly owned legal entities within the McKesson group that are based in different tax jurisdictions. The transferor entity recognized a gain on the sale of assets that was not subject to income tax in its local jurisdiction; such gain was eliminated upon consolidation. A McKesson entity based in the U.S. was the recipient of the software and is entitled to amortize the fair value of the assets for book and tax purposes. The tax benefit associated with the amortization of these assets is recognized over the tax lives of the assets. As a result, we recognized a net tax benefit of $178 million and $137 million in 2018 and 2017. We no longer recognize the tax benefit associated with this amortization in continuing operations upon adoption of the amended guidance related to intra-entity transfer of an asset other than inventory in 2019. Refer to Financial Note 1, “Significant Accounting Policies,” for more information.

On March 1, 2017, we contributed assets to Change Healthcare as described in Financial Note 5, “Healthcare Technology Net Asset Exchange”. While this transaction was predominantly structured as a tax free asset contribution for U.S. federal income tax purposes under Section 721(a) of the Internal Revenue Code, we recorded tax expense of $929 million on the gain. The tax expense was primarily driven by the recognition of a deferred tax liability on the excess book over tax basis in our equity investment in Change Healthcare.

In March 2016, amended guidance was issued for employee share-based payment awards. Under the amended guidance, all windfalls and shortfalls related to employee share-based compensation arrangements are recognized within income tax expense. We elected to early adopt this amended guidance in the first quarter of 2017. The primary impact of the adoption was the recognition of excess tax benefits in the income statement on a prospective basis, rather than additional paid-in capital. As a result, we recognized net tax expense of $4 million in 2019 and net tax benefits of $8 million and $54 million in 2018 and 2017.

Deferred tax balances consisted of the following:



	March 31,
(In millions)	2019			2018
Assets
Receivable allowances	$	70		$	58
Compensation and benefit related accruals	377			345
Net operating loss and credit carryforwards	885			811
Long-term contractual obligations	—			59
Other	216			279
Subtotal	1,548			1,552
Less: valuation allowance	(870		)	(751		)
Total assets	678			801
Liabilities
Inventory valuation and other assets	(2,016		)	(1,869		)
Fixed assets and systems development costs	(170		)	(158		)
Intangibles	(513		)	(644		)
Change Healthcare Equity Investment	(885		)	(814		)
Other	(34		)	(71		)
Total liabilities	(3,618		)	(3,556		)
Net deferred tax liability	$	(2,940	)	$	(2,755	)

Long-term deferred tax asset	$	58		$	49
Long-term deferred tax liability	(2,998		)	(2,804		)
Net deferred tax liability	$	(2,940	)	$	(2,755	)

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 $870 million and $751 million in 2019 and 2018. The increase of $119 million in valuation allowances in the current year relates primarily to net operating and capital losses incurred in certain tax jurisdictions for which no tax benefit was recognized.

We have federal, state and foreign net operating loss carryforwards of $92 million, $3,551 million and $2,143 million. Federal and state net operating losses will expire at various dates from 2019 through 2040. Substantially all our foreign net operating losses have indefinite lives. In addition, we have foreign capital loss carryforwards of $742 million with indefinite lives.

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



	Years Ended March 31,
(In millions)	2019			2018			2017
Unrecognized tax benefits at beginning of period	$	1,183		$	486		$	555
Additions based on tax positions related to prior years	78			47			7
Reductions based on tax positions related to prior years	(234		)	(124		)	(67		)
Additions based on tax positions related to current year	68			778			105
Reductions based on settlements	(13		)	(7		)	(113		)
Reductions based on the lapse of the applicable statutes of limitations	(25		)	—			—
Exchange rate fluctuations	(5		)	3			(1		)
Unrecognized tax benefits at end of period	$	1,052		$	1,183		$	486

As of March 31, 2019, we had $1,052 million of unrecognized tax benefits, of which $877 million would reduce income tax expense and the effective tax rate, if recognized. The decrease in unrecognized tax benefits in 2019 compared to 2018 is primarily attributable to a $171 million decrease, with a corresponding increase in taxes payable, due to the issuance of new tax regulations. The increase in unrecognized tax benefits in 2018 compared to 2017 is primarily attributable to provisional amounts relating to the application of certain provisions of the 2017 Tax Act, partially offset by a decrease in unrecognized tax benefit due to the resolution of the U.S. Internal Revenue Services (“IRS”) relating to the fiscal years 2010 through 2012. During the next twelve months, we do not expect any material reduction in our unrecognized tax benefits. However, this 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 $33 million in 2019 and income tax benefits of $1 million and $6 million in 2018 and 2017, representing interest and penalties, in our consolidated statements of operations. As of March 31, 2019 and 2018, we had accrued $68 million and $37 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. The IRS is currently examining our U.S. corporation income tax returns for 2013 through 2015. During the third quarter of 2018, we signed the Revenue Agent’s Report from the U.S. IRS relating to their audit of the fiscal years 2010 through 2012 and recorded a $39 million tax benefit due to the favorable resolution of various uncertain tax positions for those years. During the first quarter of 2017, we reached an agreement with the IRS to settle all outstanding issues relating to the fiscal years 2007 through 2009 without a material impact to our provision for income taxes. We are generally subject to audit by taxing authorities in various U.S. states and in foreign jurisdictions for fiscal years 2010 through the current fiscal year.

2017 Tax Act

On December 22, 2017, the U.S. government enacted the 2017 Tax Act, which was comprehensive new tax legislation. The SEC Staff issued guidance on income tax accounting for the 2017 Tax Act on December 22, 2017, which allows companies to record provisional amounts during a measurement period not to extend beyond one year of the enactment date. In accordance with this guidance, we recognized a tax benefit of $1,324 million in 2018 due to the re-measurement of certain deferred taxes to the lower U.S. federal tax rate mainly driven by a decrease in our deferred tax liabilities for inventories and investments. During 2019, we have not made any measurement period adjustments to this amount. Our reported income tax expense for 2019 included $81 million of tax benefits primarily related to a change in a tax method for inventory approved by the tax authorities and other elections made on our 2018 tax return filed after enactment of the 2017 Tax Act but prior to the reduction in U.S. tax rates. We recognized tax expense of $457 million in 2018 for the one-time transition tax on certain accumulated earnings and profits of our foreign subsidiaries resulting from the 2017 Tax Act. During 2019, we recognized a discrete tax benefit of $5 million in measurement period adjustments to the one-time transition tax on certain accumulated earnings and profits of our foreign subsidiaries. Our accounting for the impact of the 2017 Tax Act was completed as of the period ending December 31, 2018.

The 2017 Tax Act made broad and complex changes to the U.S. tax code that affected our fiscal year 2019 and 2018 in multiple ways, including but not limited to reducing the U.S. federal corporate tax rate from 35 percent to 21 percent; creating the base erosion anti-abuse tax; creating a new provision designed to tax global intangible low-tax income (“GILTI”); and generally eliminating U.S. federal income taxes on dividends from foreign subsidiaries. We have estimated the impact of these changes in our income tax provision for 2019.

The Company is allowed to make an accounting policy election of either recognizing deferred taxes for temporary differences expected to reverse as GILTI in future years or recognizing such taxes as a current period expense when incurred. We have elected to treat the tax effect of GILTI as a current period expense when incurred.

Undistributed earnings of our foreign operations totaling $4.9 billion were considered indefinitely reinvested. Following enactment of the 2017 Tax Act, the repatriation of cash to the United States is generally no longer taxable for federal income tax purposes. However, the repatriation of cash held outside the United States could be subject to applicable foreign withholding taxes and state income taxes. We may remit foreign earnings to this United States to the extent it is tax efficient to do so. We do not expect the tax impact from remitting these earnings to be material.