9Income taxes

The income tax expense of continuing operations amounted to EUR 284 million (2019: EUR 337 million, 2018 EUR 193 million).

The components of income before taxes and income tax expense are as follows:

Philips Group

Income tax expense

in millions of EUR

	2018	2019	2020
Income before taxes of continuing operations¹⁾	1,505	1,528	1,499
Current tax (expense) benefit	(314)	(324)	(475)
Deferred tax (expense) benefit	121	(13)	190
Income tax expense of continuing operations	(193)	(337)	(284)

¹⁾Income before tax excludes the result of investments in associates.

Income tax expense of continuing operations excludes the tax expense of the discontinued operations of EUR 10 million (2019: EUR 9 million tax benefit, 2018: EUR 14 million tax benefit).

The components of income tax expense of continuing operations are as follows:

Philips Group

Current income tax expense

in millions of EUR

	2018	2019	2020
Current year tax (expense) benefit	(318)	(322)	(485)
Prior year tax (expense) benefit	4	(2)	10
Current tax (expense)	(314)	(324)	(475)

Philips Group

Deferred income tax expense

In millions of EUR

	2018	2019	2020
Changes to recognition of tax loss and credit carry forwards	(2)	59	-
Changes to recognition of temporary differences	4	(32)	19
Prior year tax (expense) benefit	15	(7)	(8)
Tax rate changes	(26)	2	13
Origination and reversal of temporary differences, tax losses and tax credits	130	(35)	166
Deferred tax (expense) benefit	121	(13)	190

Philips’ operations are subject to income taxes in various foreign jurisdictions. The statutory income tax rate varies per country, which results in a difference between the weighted average statutory income tax rate and the Netherlands’ statutory income tax rate of 25.0% (2019: 25.0% 2018: 25.0%).

A reconciliation of the weighted average statutory income tax rate to the effective income tax rate of continuing operations is as follows:

Philips Group

Effective income tax rate

in %

	2018	2019	2020
Weighted average statutory income tax rate in %	24.9	25.2	25.0
Recognition of previously unrecognized tax loss and credit carryforwards	(0.4)	(3.9)	(0.4)
Unrecognized tax loss and credit carryforwards	0.5	0.1	0.4
Changes to recognition of temporary differences	(0.3)	2.1	(1.3)
Non-taxable income and tax incentives	(11.9)	(9.5)	(10.8)
Non-deductible expenses	3.7	5.3	5.8
Withholding and other taxes	4.5	3.7	0.5
Tax rate changes	1.8	(0.1)	(0.9)
Prior year tax	(1.3)	0.6	(0.1)
Tax expense (benefit) due to change in uncertain tax treatments	(8.6)	(1.6)	0.9
Others, net	(0.1)	0.2	(0.1)
Effective income tax rate	12.8	22.1	19.0

The effective income tax rate is lower than the weighted average statutory income tax rate in 2020 mainly due to recurring favorable tax incentives relating to R&D investments and export activities, and one-off benefits from a decrease in tax rate and non-taxable results from participations, presented under Withholding and other taxes and Non-taxable income and tax incentives respectively.

The decrease in effective income tax rate compared to 2019 is mainly due to these one-off benefits. This effect is partly offset by lower non-cash benefits from business integration compared to 2019.

Deferred tax assets and liabilities

Deferred tax assets are recognized for temporary differences, unused tax losses, and unused tax credits to the extent that realization of the related tax benefits is probable. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income in the countries where the deferred tax assets originated and during the periods when the deferred tax assets become deductible. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income, and tax planning strategies in making this assessment.

Net deferred tax assets relate to the following underlying assets and liabilities and tax loss carryforwards (including tax credit carryforwards) and their movements during the years 2020 and 2019 respectively are presented in the tables below.

The net deferred tax assets of EUR 1,761 million (2019: EUR 1,721 million) consist of deferred tax assets of EUR 1,820 million (2019:EUR 1,865 million) and deferred tax liabilities of EUR 59 million (2019: EUR 143 million). Of the total deferred tax assets of EUR 1,820 million at December 31, 2020 (2019: EUR 1,865 million), EUR 35 million (2019: EUR 239 million) is recognized in respect of entities in various countries where there have been tax losses in the current or preceding period. Management’s projections support the assumption that it is probable that the results of future operations will generate sufficient taxable income to utilize these deferred tax assets.

At December 31, 2020 the temporary differences associated with investments, including potential income tax consequences on dividends, for which no deferred tax liabilities are recognized, aggregate to EUR 275 million (2019: EUR 327 million).

Philips Group

Deferred tax assets and liabilities

in millions of EUR

	Balance as of January 1, 2020	recognized in income statement	other¹⁾	Balance as of December 31, 2020	Assets	Liabilities
Intangible assets	132	147	(39)	240	379	(140)
Property, plant and equipment	58	(22)	(4)	32	65	(32)
Inventories	252	77	(16)	313	317	(4)
Other assets	56	37	4	97	135	(38)
Pensions and other employee benefits	269	4	(27)	245	251	(6)
Other liabilities	334	81	(30)	384	436	(52)
Deferred tax assets on tax loss carryforwards	620	(133)	(38)	449	449
Set-off deferred tax positions					(212)	212
Net deferred tax assets	1,721	190	(151)	1,761	1,820	(59)

¹⁾Other includes the movements of assets and liabilities recognized in equity and OCI, which includes foreign currency translation differences, acquisitions and divestments.

Philips Group

Deferred tax assets and liabilities

in millions of EUR

	Balance as of January 1, 2019	recognized in income statement	other¹⁾	Balance as of December 31, 2019	Assets	Liabilities
Intangible assets	(162)	317	(23)	132	280	(148)
Property, plant and equipment	12	38	8	58	67	(9)
Inventories	257	(6)	1	252	259	(7)
Other assets	50	(15)	21	56	90	(33)
Pensions and other employee benefits	267	4	(1)	269	270	(1)
Other liabilities	428	(119)	25	334	436	(102)
Deferred tax assets on tax loss carryforwards	824	(231)	27	620	620
Set-off deferred tax positions					(156)	156
Net deferred tax assets	1,676	(13)	59	1,721	1,865	(143)

¹⁾Other includes the movements of assets and liabilities recognized in equity and OCI, which includes foreign currency translation differences, acquisitions and divestments.

The company has available tax loss and credit carryforwards, which expire as follows:

Philips Group

Expiry years of net operating loss and credit carryforwards

in millions of EUR

	Total Balance as of December 31, 2019	Unrecognized balance as of December 31, 2019	Total Balance as of December 31, 2020	Unrecognized balance as of December 31, 2020
Within 1 year	3	-	5	1
1 to 2 years	6	3	1,546	1,541
2 to 3 years	1,680	1,679	13	3
3 to 4 years	14	7	235	-
4 to 5 years	519	3	23	-
Later	1,173	12	1,026	24
Unlimited	1,746	1,123	1,428	951
Total	5,141	2,826	4,276	2,520

At December 31, 2020, the amount of deductible temporary differences for which no deferred tax asset has been recognized in the balance sheet was EUR 33 million (2019: EUR 31 million).

Tax risks

Philips is exposed to tax risks and uncertainty over tax treatments. For particular tax treatments that are not expected to be accepted by tax authorities, Philips either recognizes a liability or reflects the uncertainty in the recognition and measurement of its current and deferred tax assets and tax attributes. For the measurement of the uncertainty, Philips uses the most likely amount or the expected value of the tax treatment. The expected liabilities resulting from the uncertain tax treatments are included in non-current tax liabilities (2020: EUR 291 million, 2019: EUR 186 million, increase due to lower tax losses or similar tax carryforwards that can be used if uncertain tax treatments were settled for the presumed amount at balance sheet date). The positions include, among others, the following:

Transfer pricing risks

Philips has issued transfer pricing directives, which are in accordance with international guidelines such as those of the Organization of Economic Co-operation and Development. In order to reduce the transfer pricing uncertainties, monitoring procedures are carried out by Group Tax to safeguard the correct implementation of the transfer pricing directives. However, tax disputes can arise due to inconsistent transfer pricing regimes and different views on "at arm's length" pricing.

Tax risks on general and specific service agreements and licensing agreements

Due to the centralization of certain activities (such as research and development, IT and group functions), costs are also centralized. As a consequence, these costs and/or revenues must be allocated to the beneficiaries, i.e. the various Philips entities. For that purpose, service contracts such as intra-group service agreements and licensing agreements are signed with a large number of group entities. Tax authorities review these intra-group service and licensing agreements, and may reject the implemented intra-group charges. Furthermore, buy in/out situations in the case of (de)mergers could affect the cost allocation resulting from the intragroup service agreements between countries. The same applies to the specific service agreements.

Tax risks due to disentanglements and acquisitions

When a subsidiary of Philips is disentangled, or a new company is acquired, tax risks may arise. Philips creates merger and acquisition (M&A) teams for these disentanglements or acquisitions. In addition to representatives from the involved business, these teams consist of specialists from various group functions and are formed, among other things, to identify tax risks and to reduce potential tax claims.

Tax risks due to permanent establishments

A permanent establishment may arise when a Philips entity has activities in another country, tax claims could arise in both countries on the same income.