Income Tax Expense (Benefit)

Income Before Taxes

The domestic and foreign components of income before taxes were as follows:



	2018			2017		2016
	(in millions)
Foreign	$	2,398		$	560	$	516
Domestic	(313		)	209		(363		)
Income before taxes	$	2,085		$	769	$	153

Income Tax Expense (Benefit)

The components of the income tax expense (benefit) were as follows:



	2018			2017			2016
	(in millions)
Current:
Foreign	$	166		$	127		$	59
Domestic - Federal	1,597			229			2
Domestic - State	(5		)	4			(1		)
	1,758			360			60
Deferred:
Foreign	(39		)	56			(39		)
Domestic - Federal	(300		)	(44		)	(109		)
Domestic - State	(9		)	—			(1		)
	(348		)	12			(149		)
Income tax expense (benefit)	$	1,410		$	372		$	(89	)

The Tax Cuts and Jobs Act (“2017 Act”) was enacted on December 22, 2017. The 2017 Act includes a broad range of tax reform proposals affecting businesses, including a reduction in the U.S. federal corporate tax rate from 35% to 21%, a one-time mandatory deemed repatriation tax on earnings of certain foreign subsidiaries that were previously tax deferred and creates new taxes on certain foreign earnings.

For the year ended June 29, 2018, the Company has not finalized the accounting for the tax effects of the enactment of the 2017 Act. However, consistent with applicable SEC guidance, the Company has made a reasonable estimate of the effects on the Company’s existing deferred tax balances and the one-time mandatory deemed repatriation tax required by the 2017 Act and has recognized a provisional income tax expense of $1.57 billion for the one-time mandatory deemed repatriation tax and a provisional income tax benefit of $65 million related to the re-measurement of deferred tax assets and liabilities for the year ended June 29, 2018. For other elements of tax expense noted below, or where the Company has not made an election, the Company has not been able to make a reasonable estimate and continues to account for such items based on the provisions of the tax laws that were in effect immediately prior to the 2017 Act. As the Company finalizes the accounting for the tax effects of the enactment of the 2017 Act during the one-year measurement period permitted by applicable SEC guidance, the Company expects to reflect adjustments to the recorded provisional amounts and record additional tax effects of the 2017 Act.

Additional information regarding the significant provisions of the 2017 Act that are expected to impact the Company is provided below.

Re-measurement of deferred taxes

The provisional income tax benefit of $65 million recorded for the year ended June 29, 2018 related to the re-measurements of the Company’s deferred tax balances and is based primarily on the rates at which the deferred tax assets and liabilities are expected to reverse in the current and future fiscal years, which are generally 29% and 22%, respectively. However, the Company is still analyzing certain aspects of the 2017 Act and refining the calculations, which could potentially affect the measurement of these balances or potentially give rise to new deferred tax amounts. The Company is also analyzing the impact of the 2017 Act to the existing valuation allowance assessments from both a federal and state tax perspective, which could potentially affect the realizability of the existing deferred tax assets. In calculating the provisional amount, the Company utilized an estimate of the expected reversals of certain tax assets and liabilities, which will be revised in future quarters during the one-year measurement period as additional information becomes available. The provisional income tax benefit for the year ended June 29, 2018 reflects a revision to the Company’s initial provisional estimate resulting in income tax expense of $23 million for refinements to the expected reversals of deferred tax assets and liabilities.

Mandatory deemed repatriation tax

In connection with the transition from a global to a territorial U.S. tax system, companies are required to pay a mandatory deemed repatriation tax. For the year ended June 29, 2018, the Company recorded a provisional amount for the mandatory deemed repatriation tax liability of $1.57 billion for foreign subsidiaries and $131 million of this amount is classified as a current tax liability. The calculation of the mandatory deemed repatriation tax liability is provisional and based upon preliminary estimates of post-1986 earnings and profits. In addition, the mandatory deemed repatriation tax is based on a provisional amount of foreign earnings held in cash and other specified assets, which are taxed at 15.5% and 8%, respectively, and is payable over an 8-year period. On August 1, 2018, U.S. Treasury issued proposed regulations as guidance for the mandatory deemed repatriation tax. The Company will continue to evaluate the impact of this guidance through the end of the one-year measurement period. As such, the provisional amount may change during the one-year measurement period when the Company finalizes the calculation of post-1986 foreign earnings and profits and the amount of foreign earnings held in cash or other specified assets. The provisional income tax expense for the year ended June 29, 2018 reflects a revision to the Company’s initial provisional estimate resulting in income tax benefits of $18 million for the required utilization of the 2018 generated foreign tax credits and $73 million for potential cash tax payments arising from certain unrecognized tax benefits that would partially offset the mandatory deemed repatriation tax.

Although the mandatory deemed repatriation tax has removed U.S. federal taxes on distributions to the U.S., the Company continues to evaluate the expected manner of recovery to determine whether or not to continue to assert indefinite reinvestment on a part or all the foreign undistributed earnings. This requires the Company to re-evaluate the existing short and long-term capital allocation policies in light of the 2017 Act and calculate the tax cost that is incremental to the deemed repatriation tax (e.g., foreign withholding, state income taxes, and additional U.S. tax on currency transaction gains or losses) of repatriating cash to the U.S. While the provisional tax expense for the year ended June 29, 2018 is based upon an assumption that foreign undistributed earnings are indefinitely reinvested, the Company’s plan may change upon the completion of long-term capital allocation plans in light of the 2017 Act and completion of the calculation of the incremental tax effects on the repatriation of foreign undistributed earnings. In the event the Company determines not to continue to assert the permanent reinvestment of part or all of foreign undistributed earnings, such a determination could result in the accrual and payment of additional federal, foreign, state and local taxes.

Deferred taxes on foreign earnings

As a result of the shift to a territorial system for U.S. taxation, the new minimum tax on certain foreign earnings (“global intangible low-tax income”) provision of the 2017 Act imposes a tax on foreign earnings and profits in excess of a deemed return on tangible assets of foreign subsidiaries. This provision is effective for tax years beginning on or after January 1, 2018, which for the Company would be the fiscal year beginning on June 30, 2018 (fiscal year 2019). The Company has not progressed sufficiently in the analysis of this provision to make an election either to account for the effects of this provision either as a component of future income tax expense in the period the tax arises or as a component of deferred taxes on the related investments. Accordingly, no deferred tax assets and liabilities have been established for timing differences between foreign U.S. GAAP income and foreign earnings and profits that would be expected to reverse under the new minimum tax in future years. Additionally, the Company has not yet completed the calculation of post-1986 foreign earnings and profits for the mandatory repatriation tax, which would be the starting point for the measurement of deferred tax assets and liabilities in order to record any provisional amounts.

Undistributed Foreign Earnings

The Company has previously asserted all of its unremitted earnings offshore were permanently reinvested and had not recorded any deferred taxes related to any outside basis differences associated with its foreign subsidiaries. The estimated remaining net undistributed earnings from foreign subsidiaries at June 29, 2018 is estimated to be approximately $17 billion. While the Company has included a provisional estimate of the mandatory deemed repatriation tax on these earnings, the Company is currently evaluating how the 2017 Act will impact the Company's existing assertion of indefinite reinvestment and determining a reasonable estimate of the remaining tax liability, if any, for any outside basis differences after consideration of the mandatory repatriation tax. As such, no change has been made with respect to this assertion for the year ended June 29, 2018. The Company will complete its analysis of the impact of the 2017 Act on its indefinite reinvestment assertion and record amounts, such as any remaining outside basis differences, foreign withholding taxes, state income taxes, and additional U.S. tax on currency transaction gains or losses, if necessary, during the measurement period.

Deferred Taxes

Temporary differences and carryforwards, which give rise to a significant portion of deferred tax assets and liabilities were as follows:



	June 29, 2018			June 30, 2017
	(in millions)
Deferred tax assets:
Sales related reserves and accrued expenses not currently deductible	$	53		$	84
Accrued compensation and benefits not currently deductible	145			252
Net operating loss carryforward	443			292
Business credit carryforward	448			283
Long-lived assets	161			236
Other	118			141
Total deferred tax assets	1,368			1,288
Deferred tax liabilities:
Long-lived assets	(491		)	(874		)
Unremitted earnings of certain non-U.S. entities	(5		)	(38		)
Other	(43		)	(11		)
Total deferred tax liabilities	(539		)	(923		)
Valuation allowances	(614		)	(518		)
Deferred tax assets (liabilities), net	$	215		$	(153	)

The change from a net deferred tax liability to a net deferred tax asset is primarily due to an increase in the deferred tax asset for the 2018 generation of net operating losses and business credits of $316 million, the 2018 reversal of the deferred tax liability associated purchase accounting intangibles of $90 million, and the re-measurement of the Company’s deferred tax balances of $65 million due to the 2017 Act.

The net deferred tax asset valuation allowance increased by $96 million and $224 million in 2018 and 2017, respectively. The valuation allowance increase in 2018 is primarily attributable to the 2018 generation of foreign net operating loss carryforwards of $54 million and state tax credits of $33 million, which the Company does not anticipate being able to utilize. The assessment of valuation allowances against deferred tax assets requires estimations and significant judgment. The Company continues to assess and adjust its valuation allowance based on operating results and market conditions. After weighing both the positive and negative evidence available, including but not limited to, earnings history, projected future outcomes, industry and market trends and the nature of each of the deferred tax assets, the Company determined that it is able to realize most of its deferred tax assets with the exception of certain loss and credit carryforwards.

In addition to the deferred tax assets presented above, the Company had benefits related to net operating loss benefits from stock-based compensation deductions of $20 million as of June 30, 2017. The reduction in NOL benefits from stock-based compensation deductions was due to the adoption of ASU 2016-09 during the first quarter of 2018. See Part II, Item 8, Note 2, Recent Accounting Pronouncements, of the Notes to Consolidated Financial Statements included in this Annual Report on Form 10‑K.

Effective Tax Rate

Under the 2017 Act, the reduction of the U.S. federal corporate tax rate from 35% to 21% is effective January 1, 2018, requiring companies to use a blended rate for their fiscal 2018 tax year by applying a pro-rated percentage of the number of days before and after the January 1, 2018 effective date. This results in the use of an estimated annual effective tax rate of approximately 28% for the Company’s U.S. federal corporate tax rate for fiscal year 2018. For fiscal year 2019 and beyond, the Company will utilize the enacted U.S. federal corporate tax rate of 21%.

Reconciliation of the U.S. Federal statutory rate to the Company’s effective tax rate is as follows:



	2018		2017		2016
U.S. Federal statutory rate	28	%	35	%	35	%
Tax rate differential on international income	(34	)	(27	)	(103	)
Tax effect of U.S. non-deductible convertible debt costs	—		—		13
Tax effect of U.S. non-deductible acquisition costs	—		—		10
Tax effect of U.S. foreign income inclusion	1		4		9
Tax effect of U.S. non-deductible stock-based compensation	1		1		9
Tax effect of U.S. permanent differences	(1	)	(1	)	1
State income tax, net of federal tax	—		1		(1	)
Impact of 2017 Act:
One-time mandatory deemed repatriation tax	75		—		—
Re-measurement of deferred taxes	(3	)	—		—
Change in valuation allowance	5		29		16
Unremitted earnings of certain non-U.S. entities	—		5		—
Tax related to SanDisk integration	—		12		—
Retroactive extension of Federal R&D credit	—		—		(9	)
Income tax credits	(4	)	(12	)	(43	)
Other	—		1		5
Effective tax rate	68	%	48	%	(58	)%

Tax Holidays and Carryforwards

A substantial portion of the Company’s manufacturing operations in Malaysia, the Philippines, Singapore and Thailand operate under various tax holidays and tax incentive programs which expired or will expire in whole or in part at various dates from 2018 through 2030. Certain of the holidays may be extended if specific conditions are met. The net impact of these tax holidays and tax incentives was an increase to the Company’s net earnings by $519 million, or $1.69 per diluted share, $467 million, or $1.58 per diluted share, and $500 million, or $2.07 per diluted share, in 2018, 2017, and 2016, respectively.

As of June 29, 2018, the Company had varying amounts of federal and state NOL/tax credit carryforwards that do not expire or, if not used, expire in various years. Following is a summary of the Company’s federal and state NOL/tax credit carryforwards and the related expiration dates of these NOL/tax credit carryforwards:



Jurisdiction	NOL/Tax Credit Carryforward Amount		Expiration
	(in millions)
Federal NOL (Pre 2017 Act Generation)	$	766	2020 to 2037
Federal NOL (Post 2017 Act Generation)	704		No expiration
State NOL	850		2022 to 2038
Federal tax credits	155		2019 to 2038
State tax credits	550		No expiration

The federal and state NOLs and credits relating to various acquisitions are subject to limitations under Sections 382 and 383 of the Internal Revenue Code. The Company expects the total amount of federal NOLs ultimately realized will be reduced by $448 million and state NOLs ultimately realized will be reduced by $435 million. The Company expects the total amount of federal credits ultimately realized will be reduced by $39 million and state tax credit carryforwards ultimately realized will be reduced by $550 million.

The Company had varying amounts of foreign NOL carryforwards that do not expire or, if not used, expire in various years, depending on the country. The major jurisdictions that the Company receives foreign NOL carryforwards and the related amounts and expiration dates of these NOL carryforwards are as follows:



Jurisdiction	NOL Carryforward Amount		Expiration
	(in millions)
Japan	$	141	2024 to 2026
Belgium	86		No expiration
China	129		2023 to 2024
Malaysia	117		No expiration
Spain	56		No expiration

The Company expects the total amount of NOL carryforwards in Japan ultimately realized will be reduced by $84 million. The Company expects the NOL carryforwards in Belgium, China and Spain will not be ultimately realized.

Uncertain Tax Positions

With the exception of certain unrecognized tax benefits that are directly associated with the tax position taken, unrecognized tax benefits are presented gross in the Consolidated Balance Sheets. Interest and penalties related to unrecognized tax benefits are recognized in liabilities recorded for uncertain tax positions and are recorded in the provision for income taxes. Accrued interest and penalties included in the Company’s liability related to unrecognized tax benefits as of June 29, 2018, June 30, 2017 and July 1, 2016 was $110 million, $89 million and $75 million, respectively.

The following is a tabular reconciliation of the total amounts of unrecognized tax benefits excluding accrued interest and penalties:



	2018			2017			2016
	(in millions)
Unrecognized tax benefit, beginning balance	$	522		$	491		$	350
Gross increases related to current year tax positions	38			35			46
Gross increases related to prior year tax positions	30			3			6
Gross decreases related to prior year tax positions	(9		)	(8		)	(15		)
Settlements	(19		)	(8		)	(8		)
Lapse of statute of limitations	(11		)	(19		)	(8		)
Acquisitions	—			28			120
Unrecognized tax benefit, ending balance	$	551		$	522		$	491

The Company’s unrecognized tax benefits are primarily included within long-term liabilities in the Consolidated Balance Sheets. The entire balance of unrecognized tax benefits as of June 29, 2018, June 30, 2017 and July 1, 2016, if recognized, would affect the effective tax rate.

The Company files U.S. Federal, U.S. state and foreign tax returns. For both federal and state tax returns, with few exceptions, the Company is subject to examination for fiscal years 2010 through 2017. The Company is no longer subject to examination by the IRS for periods prior to 2010, although carry forwards generated prior to those periods may still be adjusted upon examination by the IRS or state taxing authority if they either have been or will be used in a subsequent period. In the major foreign jurisdictions, the Company could be subject to examination in China for calendar years 2008 through 2017, in Ireland for calendar years 2014 through 2017, in India for fiscal years 2013 through 2017, in Israel for fiscal years 2013 through 2017 and in Japan for fiscal years 2011 through 2017.

The IRS previously completed its field examination of the Company’s federal income tax returns for fiscal years 2006 through 2009 and proposed certain adjustments. As previously disclosed, the Company received Revenue Agent Reports from the IRS, proposing adjustments relating to transfer pricing with the Company’s foreign subsidiaries and intercompany payable balances. The Company disagrees with the proposed adjustments and in September 2015, filed a protest with the IRS Appeals Office and received the IRS rebuttal in July 2016. The Company and the IRS Appeals Office did not reach a settlement on the disputed matters. On June 28, 2018, the IRS issued a statutory notice of deficiency with respect to the unagreed issues, seeking to increase the Company’s U.S. taxable income by an amount that would result in additional federal tax through fiscal year 2009 totaling approximately $516 million, subject to interest. The Company intends to file a Petition with the U.S. Tax Court. The Company believes that its tax positions are properly supported and will vigorously contest the position taken by the IRS. In September 2015, the IRS commenced an examination of the Company’s fiscal years 2010 through 2012.

The Company believes that adequate provision has been made for any adjustments that may result from tax examinations. However, the outcome of tax examinations cannot be predicted with certainty. If any issues addressed in the Company’s tax examinations are resolved in a manner not consistent with management’s expectations, the Company could be required to adjust its provision for income taxes in the period such resolution occurs. As of June 29, 2018, it was not possible to estimate the amount of change, if any, in the unrecognized tax benefits that is reasonably possible within the next twelve months. Any significant change in the amount of the Company’s liability for unrecognized tax benefits would most likely result from additional information or settlements relating to the examination of the Company’s tax returns.