Income Taxes



	Years Ended March 31,
(In millions)	2017		2016		2015
Income from continuing operations before income taxes
U.S.	$	5,772	$	2,319	$	1,893
Foreign	1,119		931		764
Total income from continuing operations before income taxes	$	6,891	$	3,250	$	2,657

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



	Years Ended March 31,
(In millions)	2017			2016			2015
Current
Federal	$	524		$	658		$	453
State	86			96			90
Foreign	122			90			101
Total current	732			844			644

Deferred
Federal	767			95			195
State	164			42			53
Foreign	(49		)	(73		)	(77		)
Total deferred	882			64			171
Income tax expense	$	1,614		$	908		$	815

During 2017, 2016 and 2015, income tax expense related to continuing operations was $1,614 million, $908 million and $815 million, which included net discrete tax benefits of $82 million, $42 million and $33 million. Our discrete tax benefits during 2017 include a tax benefit of $54 million related to the adoption of the amended accounting guidance on employee share-based compensation.

In 2016, we recognized a $19 million discrete tax benefit due to a reduction in our deferred tax liabilities as a result of enacted tax law changes in certain foreign jurisdictions and a $25 million discrete tax benefit associated with the U.S. Tax Court’s decision in Altera Corp. v. Commissioner related to the treatment of share-based compensation expense in an intercompany cost-sharing agreement. Discrete tax benefits 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.

Our reported income tax rates were 23.4%, 27.9%, and 30.7% in 2017, 2016 and 2015. 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, discrete items and the impact of an intercompany sale of software.

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)	2017			2016			2015
Income tax expense at federal statutory rate	$	2,411		$	1,137		$	930
State income taxes net of federal tax benefit	153			92			81
Foreign income taxed at various rates	(326		)	(295		)	(247		)
Unrecognized tax benefits and settlements	57			(14		)	10
Controlled substance distribution reserve	—			—			58
Non-deductible goodwill impairment	106			—			—
Share-Based Compensation excess tax deduction	(54		)	—			—
Net tax benefit on intellectual property transfer	(137		)	—			—
Rate differential on gain from Change Healthcare Net Asset Exchange	(587		)	—			—
Other, net	(9		)	(12		)	(17		)
Income tax expense	$	1,614		$	908		$	815

The non-cash pre-tax charge of $290 million to impair the carrying value of goodwill related to our EIS business within our Technology Solutions segment, described in Financial Note 3, “Goodwill Impairment,” had an unfavorable impact on our effective tax rate in 2017 given that the majority of this charge was not deductible for tax purposes.

In March 2016, amended guidance was issued for employee share-based payment awards. Under the amended guidance, all excess tax benefits (“windfalls”) and deficiencies (“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 APIC. As a result, a tax benefit of $54 million was recognized in 2017.

On December 19, 2016, we sold various software and ancillary intellectual property relating to our Technology Solutions business 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 ancillary intellectual property 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 being recognized over the tax lives of the assets. As a result, a net tax benefit of $137 million was recognized prior to the contribution of a portion of these assets to Change Healthcare as described in Financial Note 2, “Healthcare Technology Net Asset Exchange”.

On March 1, 2017, we contributed assets to Change Healthcare as described in Financial Note 2, “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.

Deferred tax balances consisted of the following:



	March 31,
(In millions)	2017			2016
Assets
Receivable allowances	$	124		$	110
Deferred revenue	19			77
Compensation and benefit related accruals	593			710
Net operating loss and credit carryforwards	594			367
Long-term contractual obligations	107			—
Other	222			275
Subtotal	1,659			1,539
Less: valuation allowance	(503		)	(267		)
Total assets	1,156			1,272
Liabilities
Inventory valuation and other assets	(2,818		)	(2,619		)
Fixed assets and systems development costs	(224		)	(326		)
Intangibles	(921		)	(981		)
Change Healthcare Equity Investment	(773		)	—
Other	(70		)	(21		)
Total liabilities	(4,806		)	(3,947		)
Net deferred tax liability	$	(3,650	)	$	(2,675	)

Long-term deferred tax asset	28			59
Long-term deferred tax liability	(3,678		)	(2,734		)
Net deferred tax liability	$	(3,650	)	$	(2,675	)

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 $503 million and $267 million in 2017 and 2016. The increase of $236 million in valuation allowances in the current year relate 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 $126 million, $2,099 million and $1,367 million. Federal and state net operating losses will expire at various dates from 2018 through 2038. Substantially all of our foreign net operating losses have indefinite lives. In addition, we have foreign capital loss carryforwards of $624 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)	2017			2016			2015
Unrecognized tax benefits at beginning of period	$	555		$	616		$	647
Additions based on tax positions related to prior years	7			116			62
Reductions based on tax positions related to prior years	(67		)	(62		)	(18		)
Additions based on tax positions related to current year	105			28			27
Reductions based on settlements	(113		)	(141		)	(65		)
Reductions based on the lapse of the applicable statutes of limitations	—			(6		)	(12		)
Exchange rate fluctuations	(1		)	4			(25		)
Unrecognized tax benefits at end of period	$	486		$	555		$	616

As of March 31, 2017, we had $486 million of unrecognized tax benefits, of which $342 million would reduce income tax expense and the effective tax rate, if recognized. 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 benefit of $6 million in 2017, income tax expense of $12 million in 2016 and income tax benefit of $24 million in 2015, related to interest and penalties in our consolidated statements of operations. The income tax benefit for interest and penalties recognized in 2015 and 2017 was primarily due to the lapses of statutes of limitations. As of March 31, 2017 and 2016, we had accrued $45 million and $77 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. During the first quarter of 2017, we reached an agreement with the Internal Revenue Service (“IRS”) to settle all outstanding issues relating to the fiscal years 2007 through 2009. This settlement did not have a material impact on our provision for income taxes. We are subject to audit by the IRS for fiscal years 2010 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.

At March 31, 2017, undistributed earnings of our foreign operations totaling $6,877 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 to support our foreign operations and acquisitions. The determination of the amount of deferred taxes on these earnings depends on judgment regarding withholding taxes, applicable tax laws and factual circumstances in effect at the time of any future distribution. Therefore, the Company believes it is not practicable at this time to reliably determine the amount of unrecognized deferred tax liability related to its undistributed earnings.