Income Taxes

U.S. and foreign income before taxes are set forth below:



	2015		2014		2013
U.S.	$	471	$	506	$	464
Foreign	1,316		921		1,087
	$	1,787	$	1,427	$	1,551

The details of our income tax provision (benefit) are set forth below:



		2015			2014			2013
Current:	Federal	$	287		$	255		$	159
	Foreign	263			321			330
	State	28			2			22
		$	578		$	578		511

Deferred:	Federal	$	(143	)	$	(67	)	42
	Foreign	54			(106		)	(53		)
	State	—			1			(13		)
		$	(89	)	$	(172	)	$	(24	)
		$	489		$	406		$	487

The reconciliation of income taxes calculated at the U.S. federal statutory rate to our effective tax rate is set forth below:



	2015					2014					2013
U.S. federal statutory rate	$	625		35.0	%	$	500		35.0	%	$	543		35.0	%
State income tax, net of federal tax benefit	12			0.7		8			0.6		3			0.2
Statutory rate differential attributable to foreign operations	(210		)	(11.8	)	(168		)	(11.7	)	(177		)	(11.4	)
Adjustments to reserves and prior years	12			0.7		(5		)	(0.3	)	49			3.1
Change in valuation allowances	54			3.0		35			2.4		23			1.5
Other, net	(4		)	(0.3	)	36			2.5		46			3.0
Effective income tax rate	$	489		27.3	%	$	406		28.5	%	$	487		31.4	%

Statutory rate differential attributable to foreign operations. This item includes local taxes, withholding taxes, and shareholder-level taxes, net of foreign tax credits. The favorable impact is primarily attributable to a majority of our income being earned outside of the U.S. where tax rates are generally lower than the U.S. rate.

Adjustments to reserves and prior years. This item includes: (1) changes in tax reserves, including interest thereon, established for potential exposure we may incur if a taxing authority takes a position on a matter contrary to our position; and (2) the effects of reconciling income tax amounts recorded in our Consolidated Statements of Income to amounts reflected on our tax returns, including any adjustments to the Consolidated Balance Sheets. The impact of certain effects or changes may offset items reflected in the 'Statutory rate differential attributable to foreign operations' line.

In 2014, this item was favorably impacted by the resolution of uncertain tax positions in certain foreign jurisdictions.

In 2013 the Company recorded incremental reserves related to an IRS-proposed adjustment to increase the taxable value of rights to intangibles used outside the U.S. that YUM transferred to certain of its foreign subsidiaries. The Company and the IRS reached a final agreement on this valuation issue, which impacted tax returns for fiscal years 2004 - 2013, during 2014. As a result of this agreement, we closed out our 2004 - 2006 and 2007-2008 audit cycles and made cash payments in 2014 to the IRS of $200 million, which were effectively fully reserved, to settle all issues for these audit cycles. The agreement also resolved the valuation issue for all later impacted years. While additional cash payments related to the valuation issue will be required upon the closure of the examinations of future impacted fiscal years, the amounts will not be significant and have been fully reserved.

Change in valuation allowances. This item relates to changes for deferred tax assets generated or utilized during the current year and changes in our judgment regarding the likelihood of using deferred tax assets that existed at the beginning of the year. The impact of certain changes may offset items reflected in the 'Statutory rate differential attributable to foreign operations' line.

In 2015, $54 million of net tax expense was driven by $30 million for valuation allowances recorded against deferred tax assets generated in the current year and $24 million in net tax expense resulting from a change in judgment regarding the future use of certain deferred tax assets that existed at the beginning of the year.

In 2014, $35 million of net tax expense was driven by $41 million for valuation allowances recorded against deferred tax assets generated during the current year, partially offset by $6 million in net tax benefit resulting from a change in judgment regarding the future use of certain deferred tax assets that existed at the beginning of the year.

In 2013, $23 million of net tax expense was driven by $32 million for valuation allowances recorded against deferred tax assets generated during the current year, partially offset by a $9 million net tax benefit resulting from a change in judgment regarding the future use of certain deferred tax assets that existed at the beginning of the year.

Other. This item primarily includes the impact of permanent differences related to current year earnings as well as U.S. tax credits and deductions.

In years 2014 and 2013, this item was negatively impacted by the $160 million and $222 million, respectively, of non-cash impairments of Little Sheep goodwill, which resulted in no related tax benefit. See Note 4.

The details of 2015 and 2014 deferred tax assets (liabilities) are set forth below:



	2015			2014
Operating losses	$	239		$	271
Tax credit carryforwards	282			162
Employee benefits	154			238
Share-based compensation	126			119
Self-insured casualty claims	36			42
Lease-related liabilities	112			119
Various liabilities	82			73
Property, plant and equipment	33			39
Deferred income and other	86			102
Gross deferred tax assets	1,150			1,165
Deferred tax asset valuation allowances	(250		)	(228		)
Net deferred tax assets	$	900		$	937
Intangible assets, including goodwill	$	(130	)	$	(148	)
Property, plant and equipment	(56		)	(63		)
Other	(70		)	(104		)
Gross deferred tax liabilities	$	(256	)	$	(315	)
Net deferred tax assets (liabilities)	$	644		$	622



Reported in Consolidated Balance Sheets as:
Deferred income taxes	$	676		$	653
Other liabilities and deferred credits	(32		)	(31		)
	$	644		$	622

We have investments in foreign subsidiaries where the carrying values for financial reporting exceed the tax basis. We have not provided deferred tax on the portion of the excess that we believe is indefinitely reinvested, as we have the ability and intent to indefinitely postpone these basis differences from reversing with a tax consequence. We estimate that our total temporary difference upon which we have not provided deferred tax is approximately $2.3 billion at December 26, 2015. A determination of the deferred tax liability on this amount is not practicable. A portion of the above temporary difference relates to carrying value for financial reporting in excess of tax basis for the investment in our China business.

In October, 2015 YUM announced its intent to separate its China business into an independent publicly-traded company by the end of 2016. This transaction is intended to qualify as a tax-free reorganization for U.S. income tax purposes. As such, any reversal of this temporary difference would not result in U.S. tax.

Additionally, the China State Administration of Taxation (SAT) recently issued Bulletin 7 on Income arising from Indirect Transfers of Assets by Non-resident Enterprises. Pursuant to Bulletin 7, an "indirect transfer" of People’s Republic of China (PRC) taxable assets, including equity interests in a PRC resident enterprise, by a non-resident enterprise, may be recharacterized and treated as a direct transfer of PRC taxable assets, if such arrangement does not have reasonable commercial purpose and the transferor has avoided payment of PRC enterprise income tax. As a result, gains derived from such an indirect transfer may be subject to PRC enterprise income tax of 10%.

We have evaluated the potential applicability of Bulletin 7 to our plan to separate our China business in a tax-free restructuring and believe it is more likely than not that Bulletin 7 does not apply. We believe that the restructuring has reasonable commercial purpose.

If Bulletin 7 is deemed to apply, tax could be assessed on the difference between the fair market value and the tax basis of the separated China business. As our tax basis in the China business is minimal, the amount of such a tax could be significant and have a material adverse effect on our results of operations and our financial condition.

At December 26, 2015, the Company has foreign operating and capital loss carryforwards of $0.6 billion and U.S. state operating loss, capital loss and tax credit carryforwards of $1.0 billion and U.S. federal capital loss and tax credit carryforwards of $0.3 billion. These losses are being carried forward in jurisdictions where we are permitted to use tax losses from prior periods to reduce future taxable income and will expire as follows:



	Year of Expiration
	2016		2017-2020		2021-2035		Indefinitely		Total
Foreign	$	5	$	211	$	98	$	305	$	619
U.S. state	53		26		876		—		955
U.S. federal	64		—		277		—		341
	$	122	$	237	$	1,251	$	305	$	1,915

We recognize the benefit of positions taken or expected to be taken in tax returns in the financial statements when it is more likely than not that the position would be sustained upon examination by tax authorities. A recognized tax position is measured at the largest amount of benefit that is greater than fifty percent likely of being realized upon settlement.

The Company had $98 million and $115 million of unrecognized tax benefits at December 26, 2015 and December 27, 2014, respectively, $89 million and $98 million of which are temporary in nature and if recognized, would not impact the effective income tax rate. A reconciliation of the beginning and ending amount of unrecognized tax benefits follows:



	2015			2014
Beginning of Year	$	115		$	243
Additions on tax positions - current year	—			19
Additions for tax positions - prior years	5			31
Reductions for tax positions - prior years	(13		)	(20		)
Reductions for settlements	(7		)	(144		)
Reductions due to statute expiration	(2		)	(13		)
Foreign currency translation adjustment	—			(1		)
End of Year	$	98		$	115

In 2014, the reduction in unrecognized tax benefits was primarily attributable to the resolution of the dispute with the IRS regarding the valuation of rights to intangibles transferred to certain foreign subsidiaries.

The Company believes it is reasonably possible its unrecognized tax benefits may decrease by approximately $6 million in the next 12 months, including approximately $4 million which, if recognized upon audit settlement or statute expiration, would affect the 2016 effective tax rate. Each of these positions is individually insignificant.

The Company’s income tax returns are subject to examination in the U.S. federal jurisdiction and numerous foreign jurisdictions.

The Company has settled audits with the IRS through fiscal year 2008. Our operations in certain foreign jurisdictions remain subject to examination for tax years as far back as 2005, some of which years are currently under audit by local tax authorities. In addition, the Company is subject to various U.S. state income tax examinations, for which, in the aggregate, we had significant unrecognized tax benefits at December 26, 2015, each of which is individually insignificant.

The accrued interest and penalties related to income taxes at December 26, 2015 and December 27, 2014 are set forth below:



	2015		2014
Accrued interest and penalties	$	15	$	5

During 2015, 2014 and 2013, a net expense of $5 million, $11 million and $18 million, respectively, for interest and penalties was recognized in our Consolidated Statements of Income as components of its income tax provision.