Income Tax Provisions

For financial reporting purposes, earnings before income taxes consists of the following:



	2012		2011		2010 (53 Weeks)
		(In thousands)
United States	$	1,606,928	$	1,639,258	$	1,679,867
Foreign		177,074		188,196		169,722
Total	$	1,784,002	$	1,827,454	$	1,849,589

The income tax provision for each fiscal year consists of the following:



	2012		2011		2010 (53 Weeks)
	(In thousands)
United States federal income taxes	$	540,861	$	556,663	$	533,832
State and local income taxes		77,064		60,081		80,492
Foreign income taxes		44,492		58,680		55,282
Total	$	662,417	$	675,424	$	669,606

The current and deferred components of the income tax provisions for each fiscal year are as follows:



	2012		2011		2010 (53 Weeks)
		(In thousands)
Current	$	840,745	$	840,173	$	791,120
Deferred		(178,328)		(164,749)		(121,514)
Total	$	662,417	$	675,424	$	669,606

The deferred tax provisions result from the effects of net changes during the year in deferred tax assets and liabilities arising from temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes.

Internal Revenue Service Settlement

Sysco’s affiliate, Baugh Supply Chain Cooperative (BSCC), was a cooperative taxed under subchapter T of the United States Internal Revenue Code, the operation of which has resulted in a deferral of tax payments. The Internal Revenue Service (IRS), in connection with its audits of the company’s 2003 through 2006 federal income tax returns, proposed adjustments that would have accelerated amounts that the company had previously deferred and would have resulted in the payment of interest on those deferred amounts. Sysco reached a settlement with the IRS in the first quarter of fiscal 2010 to cease paying U.S. federal taxes related to BSCC on a deferred basis, pay the amounts that were recorded within deferred taxes related to BSCC over a three-year period and make a one-time payment of $41.0 million, of which approximately $39.0 million was non-deductible. The settlement addressed the BSCC deferred tax issue as it related to the IRS audit of the company’s 2003 through 2006 federal income tax returns, and settled the matter for all subsequent periods, including the 2007 and 2008 federal income tax returns already under audit. As a result of the settlement, the company agreed to pay the amounts owed in the following schedule:



	(In thousands)
Fiscal 2010	$	528,000
Fiscal 2011		212,000
Fiscal 2012		212,000

As noted in the table above, payments related to the settlement were $212.0 million, $212.0 million and $528.0 million in fiscal 2012, fiscal 2011 and fiscal 2010, respectively. The company had previously accrued interest for a portion of the exposure pertaining to the IRS proposed adjustments and as a result of the settlement with the IRS, Sysco recorded an income tax benefit of approximately $29.0 million in the first quarter of fiscal 2010.

Sysco’s deferred taxes were impacted by the timing of these installment payments. Sysco reclassified amounts due within one year from deferred taxes to accrued income taxes at the beginning of each of fiscal 2012, 2011, and 2010. Additionally, beginning in fiscal 2009, the company is not deferring taxes for federal purposes according to its agreement with the IRS.

Deferred Tax Assets and Liabilities

Significant components of Sysco’s deferred tax assets and liabilities are as follows:



	June 30, 2012		July 2, 2011
	(In thousands)
Deferred tax liabilities:
Deferred supply chain distributions	$	-	$	276,001
Excess tax depreciation and basis differences of assets		473,947		384,702
Goodwill and intangible assets		186,921		175,747
Other		19,756		35,497
Total deferred tax liabilities		680,624		871,947
Deferred tax assets:
Net operating tax loss carryforwards		21,609		32,648
Benefit on unrecognized tax benefits		23,287		23,463
Pension		362,391		162,212
Share-based compensation		63,522		61,273
Deferred compensation		36,639		37,659
Self-insured liabilities		41,030		40,454
Receivables		51,607		52,614
Inventory		59,619		54,853
Other		40,257		56,465
Total deferred tax assets		699,961		521,641
Total net deferred tax (assets) liabilities	$	(19,337)	$	350,306

The company had state net operating tax loss carryforwards as of June 30, 2012 and July 2, 2011. The net operating tax loss carryforwards outstanding as of June 30, 2012 expire in fiscal years 2013 through 2031. There were no valuation allowances recorded for the state tax loss carryforwards as of June 30, 2012 and July 2, 2011 because management believes it is more likely than not that these benefits will be realized based on utilization forecasts.

Effective Tax Rates

Reconciliations of the statutory federal income tax rate to the effective income tax rates for each fiscal year are as follows:



	2012		2011		2010
United States statutory federal income tax rate	35.00	%	35.00	%	35.00	%
State and local income taxes, net of any applicable federal income tax benefit	2.65		1.96		2.89
Foreign income taxes	(1.07)		(0.50)		(0.31)
Impact of uncertain tax benefits	0.12		0.51		(1.46)
Impact of adjusting carrying value of corporate-owned life insurance policies to their cash surrender values	(0.08)		(0.61)		(0.45)
Other	0.51		0.60		0.53
	37.13	%	36.96	%	36.20	%

The effective tax rate for fiscal 2012 was 37.13%. Indefinitely reinvested earnings taxed at foreign statutory rates less than our domestic tax rate had the impact of reducing the effective tax rate.

The effective tax rate of 36.96% for fiscal 2011 was favorably impacted primarily by two items. First, the company recorded a tax benefit of approximately $17.0 million for the reversal of valuation allowances previously recorded on state net operating loss carryforwards. Second, the company adjusted the carrying values of the company’s COLI policies to their cash surrender values. The gain of $28.2 million recorded in fiscal 2011 was primarily non-taxable for income tax purposes, and had the impact of decreasing income tax expense for the period by $11.1 million. Partially offsetting these favorable impacts was the recording of $9.3 million in tax and interest related to various federal, foreign and state uncertain tax positions.

The effective tax rate of 36.20% for fiscal 2010 was favorably impacted primarily by two items. First, as discussed above, the company recorded an income tax benefit of approximately $29.0 million resulting from the one-time reversal of previously accrued interest related to the settlement with the IRS. Second, the gain of $21.6 million recorded to adjust the carrying value of COLI policies to their cash surrender values in fiscal 2010 was non-taxable for income tax purposes, and had the impact of decreasing income tax expense for the period by $8.3 million.

Uncertain Tax Positions

A reconciliation of the beginning and ending amount of gross unrecognized tax benefits, excluding interest and penalties, is as follows:



	2012		2011
		(In thousands)
Unrecognized tax benefits at beginning of year	$	72,091	$	89,851
Additions for tax positions related to prior years		2,479		21,099
Reductions for tax positions related to prior years		(2,154)		(11,955)
Additions for tax positions related to the current year		-		-
Reductions for tax positions related to the current year		-		-
Reductions due to settlements with taxing authorities		(2,831)		(25,294)
Reductions due to lapse of applicable statute of limitations		(1,431)		(1,610)
Unrecognized tax benefits at end of year	$	68,154	$	72,091

As of June 30, 2012, $15.9 million of the gross liability for unrecognized tax benefits was netted within prepaid income taxes relating to a payment that occurred during fiscal 2011; however, the liability is considered outstanding until the matters have been settled with the respective jurisdiction. As of June 30, 2012, the gross amount of liability for accrued interest and penalties related to unrecognized tax benefits was $36.6 million, of which $8.7 million was netted within prepaid income taxes relating to a payment that occurred during fiscal 2011; however, the liability is considered outstanding until the matters have been settled with the respective jurisdiction. The expense recorded for interest and penalties related to unrecognized tax benefits in fiscal 2012 was $4.7 million.

As of July 2, 2011, $15.9 million of the gross liability for unrecognized tax benefits was netted within prepaid income taxes relating to a payment that occurred during fiscal 2011; however, the liability is considered outstanding until the matters have been settled with the respective jurisdiction. As of July 2, 2011, the gross amount of liability for accrued interest and penalties related to unrecognized tax benefits was $33.2 million, of which $8.7 million was netted within prepaid income taxes relating to a payment that occurred during fiscal 2011; however, the liability is considered outstanding until the matters have been settled with the respective jurisdiction. The expense recorded for interest and penalties related to unrecognized tax benefits in fiscal 2011 was $7.2 million.

If Sysco were to recognize all unrecognized tax benefits recorded as of June 30, 2012, approximately $37.1 million of the $68.2 million reserve would reduce the effective tax rate. If Sysco were to recognize all unrecognized tax benefits recorded as of July 2, 2011, approximately $40.1 million of the $72.1 million reserve would reduce the effective tax rate. It is reasonably possible that the amount of the unrecognized tax benefits with respect to certain of the company’s unrecognized tax positions will increase or decrease in the next twelve months either because Sysco’s positions are sustained on audit or because the company agrees to their disallowance. Items that may cause changes to unrecognized tax benefits primarily include the consideration of various filing requirements in various states and the allocation of income and expense between tax jurisdictions. In addition, the amount of unrecognized tax benefits recognized within the next twelve months may decrease due to the expiration of the statute of limitations for certain years in various jurisdictions; however, it is possible that a jurisdiction may open an audit on one of these years prior to the statute of limitations expiring. At this time, an estimate of the range of the reasonably possible change cannot be made.

The IRS is auditing Sysco’s 2009 and 2010 federal income tax returns. As of June 30, 2012, Sysco’s tax returns in the majority of the state and local jurisdictions and Canada are no longer subject to audit for the years before 2007. However, some jurisdictions have audits open prior to 2007, with the earliest dating back to 2002. Certain tax jurisdictions require partial to full payment on audit assessments or the posting of letters of credit in order to proceed to the appeals process. Although the outcome of tax audits is generally uncertain, the company believes that adequate amounts of tax, including interest and penalties, have been accrued for any adjustments that may result from those open years.

Other

Undistributed income of certain consolidated foreign subsidiaries at June 30, 2012 amounted to $910.6 million for which no deferred U.S. income tax provision has been recorded because Sysco intends to permanently reinvest such income in those foreign operations. An estimate of any U.S. or foreign withholding taxes that may be applicable upon actual or deemed repatriation is not practical due to the complexities associated with the hypothetical calculation.