NOTE 9: INCOME TAXES
Our operations are included in the consolidated federal income tax return of FedEx. Our income tax provision approximates the amount which would have been recorded on a separate return basis. The components of the provision for income taxes for the years ended May 31 were as follows (in millions):
| 2013 | 2012 | 2011 | ||||||||
| Current provision (benefit) | ||||||||||
| Domestic: | ||||||||||
| Federal | $ | (123) | $ | (510) | $ | (227) | ||||
| State and local | (6) | 6 | (1) | |||||||
| Foreign | 159 | 174 | 193 | |||||||
| 30 | (330) | (35) | ||||||||
| Deferred provision (benefit) | ||||||||||
| Domestic: | ||||||||||
| Federal | 180 | 753 | 447 | |||||||
| State and local | 9 | 6 | 6 | |||||||
| Foreign | (41) | - | (9) | |||||||
| 148 | 759 | 444 | ||||||||
| $ | 178 | $ | 429 | $ | 409 | |||||
Our current federal income tax expenses in 2013, 2012 and 2011 were significantly reduced by accelerated depreciation deductions we claimed under provisions of the American Taxpayer Relief Act of 2013 and the Tax Relief and the Small Business Jobs Acts of 2010. Those Acts, designed to stimulate new business investment in the U.S., accelerated our depreciation deductions for new qualifying investments, such as our Boeing 777 Freighter (“B777F”) aircraft. These were timing benefits only, in that depreciation accelerated into an earlier year is foregone in later years. Our 2013 current provision for federal income taxes was, therefore, higher than in 2012 and 2011.
Pre-tax (loss) earnings of foreign operations for 2013, 2012 and 2011 were $(84) million, $308 million and $452 million, respectively. These amounts represent only a portion of total results associated with international shipments and accordingly, do not represent our international or domestic results of operations.
A reconciliation of the statutory federal income tax rate to the effective income tax rate for the years ended May 31 was as follows:
| 2013 | 2012 | 2011 | ||||||||
| Statutory U.S. income tax rate | 35.0 | % | 35.0 | % | 35.0 | % | ||||
| Increase (decrease) resulting from: | ||||||||||
| Allocation of FedEx Office and Print Services, Inc. operating costs | 1.2 | 1.2 | 2.0 | |||||||
| State and local income taxes, net of federal benefit | 0.3 | 0.7 | 0.3 | |||||||
| Foreign operations | (4.7) | (3.3) | (3.4) | |||||||
| Non-deductible expenses | 5.4 | 2.5 | 2.7 | |||||||
| Other, net | (2.2) | (1.5) | (0.7) | |||||||
| Effective tax rate | 35.0 | % | 34.6 | % | 35.9 | % | ||||
Our 2012 rate was favorably impacted by the conclusion of the Internal Revenue Service (“IRS”) audit of our 2007-2009 consolidated income tax returns.
The significant components of deferred tax assets and liabilities as of May 31 were as follows (in millions):
| 2013 | 2012 | |||||||||||
| Deferred Tax Assets | Deferred Tax Liabilities | Deferred Tax Assets | Deferred Tax Liabilities | |||||||||
| Property, equipment, | ||||||||||||
| leases and intangibles | $ | 154 | $ | 2,795 | $ | 179 | $ | 2,506 | ||||
| Employee benefits | 566 | 10 | 520 | 10 | ||||||||
| Self-insurance accruals | 338 | - | 307 | - | ||||||||
| Other | 165 | 983 | 233 | 1,063 | ||||||||
| Net operating loss/credit | ||||||||||||
| carryforwards | 252 | - | 136 | - | ||||||||
| Valuation allowances | (161) | - | (104) | - | ||||||||
| $ | 1,314 | $ | 3,788 | $ | 1,271 | $ | 3,579 | |||||
The net deferred tax liabilities as of May 31 have been classified in the balance sheets as follows (in millions):
| 2013 | 2012 | ||||
| Current deferred tax asset | $ | 359 | $ | 329 | |
| Noncurrent deferred tax liability | (2,833) | (2,637) | |||
| $ | (2,474) | $ | (2,308) | ||
We have $840 million of net operating loss carryovers in various foreign jurisdictions and $120 million of state operating loss carryovers. The valuation allowances primarily represent amounts reserved for operating loss and tax credit carryforwards, which expire over varying periods starting in 2014. As a result of this and other factors, we believe that a substantial portion of these deferred tax assets may not be realized.
Permanently reinvested earnings of our foreign subsidiaries amounted to $1.3 billion at the end of 2013 and $985 million at the end of 2012. We have not recognized deferred taxes for U.S. federal income tax purposes on those earnings. In 2013, our permanent reinvestment strategy with respect to unremitted earnings of our foreign subsidiaries provided a 6.0% benefit to our effective tax rate. Were the earnings to be distributed, in the form of dividends or otherwise, these earnings could be subject to U.S. federal income tax and non-U.S. withholding taxes. Unrecognized foreign tax credits potentially could be available to reduce a portion of any U.S. tax liability. Determination of the amount of unrecognized deferred U.S. income tax liability is not practicable due to uncertainties related to the timing and source of any potential distribution of such funds, along with other important factors such as the amount of associated foreign tax credits. Cash in offshore jurisdictions associated with our permanent reinvestment strategy totaled $420 million at the end of 2013 and $410 million at the end of 2012.
As a U.S. airline, we are required by Federal Aviation Administration and other rules to conduct our air operations, domestic and international, through a U.S. company. However, we serve more than 220 countries and territories around the world, and are required to establish legal entities in many of them. Most of our entities in those countries are operating entities, engaged in picking up and delivering packages and performing other transportation services. In the meantime, we are continually expanding our global network to meet our customers' needs, which requires increasing investment outside the U.S. We typically use cash generated overseas to fund these investments and have a foreign holding company which manages our investments in several foreign operating companies, including new acquisitions made in 2013 in Poland, France and Brazil.
We are subject to taxation in the U.S. and various U.S. state, local and foreign jurisdictions. We are currently under examination by the IRS for the 2010 and 2011 tax years. It is reasonably possible that certain income tax return proceedings will be completed during the next 12 months and could result in a change in our balance of unrecognized tax benefits. The expected impact of any changes would not be material to our consolidated financial statements.
A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows (in millions):
| 2013 | 2012 | 2011 | |||||||
| Balance at beginning of year | $ | 45 | $ | 56 | $ | 59 | |||
| Increases for tax positions taken in the current year | 1 | 4 | 1 | ||||||
| Increases for tax positions taken in prior years | 3 | 2 | 6 | ||||||
| Decreases for tax positions taken in prior years | (2) | (30) | (3) | ||||||
| Settlements | (7) | (1) | (7) | ||||||
| Increases due to acquisitions | 4 | 15 | - | ||||||
| Decreases from lapse of statute of limitations | (2) | - | - | ||||||
| Changes due to currency translation | 2 | (1) | - | ||||||
| Balance at end of year | $ | 44 | $ | 45 | $ | 56 | |||
Our liabilities recorded for uncertain tax positions include $41 million at both May 31, 2013 and May 31, 2012 associated with positions that if favorably resolved would provide a benefit to our effective tax rate. We classify interest related to income tax liabilities as interest expense, and if applicable, penalties are recognized as a component of income tax expense. The balance of accrued interest and penalties was $27 million on May 31, 2013 and $28 million on May 31, 2012. Total interest and penalties included in our consolidated statements of income are immaterial.
It is difficult to predict the ultimate outcome or the timing of resolution for tax positions. Changes may result from the conclusion of ongoing audits, appeals or litigation in state, local, federal and foreign tax jurisdictions, or from the resolution of various proceedings between the U.S. and foreign tax authorities. Our liability for uncertain tax positions includes no matters that are individually or collectively material to us. It is reasonably possible that the amount of the benefit with respect to certain of our unrecognized tax positions will increase or decrease within the next 12 months, but an estimate of the range of the reasonably possible changes cannot be made. However, we do not expect that the resolution of any of our uncertain tax positions will be material.