Cisco 2010 Annual Report Download - page 18

Management’s Discussion and Analysis of Financial Condition and Results of Operations
Income Taxes
We are subject to income taxes in the United States and numerous foreign jurisdictions. Our effective tax rates differ from the
statutory rate, primarily due to the tax impact of state taxes, foreign operations, research and development (R&D) tax credits, tax
audit settlements, nondeductible compensation, international realignments, and transfer pricing adjustments. Our effective tax rate
was 17.5%, 20.3%, and 21.5% in fiscal 2010, 2009, and 2008, respectively.
Significant judgment is required in evaluating our uncertain tax positions and determining our provision for income taxes.
Although we believe our reserves are reasonable, no assurance can be given that the final tax outcome of these matters will not be
different from that which is reflected in our historical income tax provisions and accruals. We adjust these reserves in light of
changing facts and circumstances, such as the closing of a tax audit or the refinement of an estimate. To the extent that the final
tax outcome of these matters is different than the amounts recorded, such differences will impact the provision for income taxes in
the period in which such determination is made. The provision for income taxes includes the impact of reserve provisions and
changes to reserves that are considered appropriate, as well as the related net interest.
Significant judgment is also required in determining any valuation allowance recorded against deferred tax assets. In assessing
the need for a valuation allowance, we consider all available evidence, including past operating results, estimates of future taxable
income, and the feasibility of tax planning strategies. In the event that we change our determination as to the amount of deferred
tax assets that can be realized, we will adjust our valuation allowance with a corresponding impact to the provision for income
taxes in the period in which such determination is made.
Our provision for income taxes is subject to volatility and could be adversely impacted by earnings being lower than anticipated
in countries that have lower tax rates and higher than anticipated in countries that have higher tax rates; by changes in the valuation
of our deferred tax assets and liabilities; by expiration of or lapses in the R&D tax credit laws; by transfer pricing adjustments
including the effect of acquisitions on our intercompany R&D cost sharing arrangement and legal structure; by tax effects of
nondeductible compensation; by tax costs related to intercompany realignments; by changes in accounting principles; or by
changes in tax laws and regulations including possible U.S. changes to the taxation of earnings of our foreign subsidiaries, the
deductibility of expenses attributable to foreign income, or the foreign tax credit rules. Significant judgment is required to determine
the recognition and measurement attributes prescribed in the accounting guidance for uncertainty in income taxes. The accounting
guidance for uncertainty in income taxes applies to all income tax positions, including the potential recovery of previously paid
taxes, which if settled unfavorably could adversely impact our provision for income taxes or additional paid-in capital. Further, as a
result of certain of our ongoing employment and capital investment actions and commitments, our income in certain countries is
subject to reduced tax rates and in some cases is wholly exempt from tax. Our failure to meet these commitments could adversely
impact our provision for income taxes. In addition, we are subject to the continuous examination of our income tax returns by the
Internal Revenue Service (IRS) and other tax authorities. We regularly assess the likelihood of adverse outcomes resulting from
these examinations to determine the adequacy of our provision for income taxes. There can be no assurance that the outcomes
from these continuous examinations will not have an adverse impact on our operating results and financial condition.
Loss Contingencies
We are subject to the possibility of various losses arising in the ordinary course of business. We consider the likelihood of loss or
impairment of an asset or the incurrence of a liability, as well as our ability to reasonably estimate the amount of loss, in
determining loss contingencies. An estimated loss contingency is accrued when it is probable that an asset has been impaired or a
liability has been incurred and the amount of loss can be reasonably estimated. We regularly evaluate current information available
to us to determine whether such accruals should be adjusted and whether new accruals are required.
Third parties, including customers, have in the past and may in the future assert claims or initiate litigation related to exclusive
patent, copyright, trademark, and other intellectual property rights to technologies and related standards that are relevant to us.
These assertions have increased over time as a result of our growth and the general increase in the pace of patent claims
assertions, particularly in the United States. If any infringement or other intellectual property claim made against us by any third
party is successful, or if we fail to develop non-infringing technology or license the proprietary rights on commercially reasonable
terms and conditions, our business, operating results, and financial condition could be materially and adversely affected.
Reclassifications
Certain immaterial reclassifications have been made to amounts for prior years in order to conform to the current year’s
presentation. These immaterial reclassifications relate to net sales for similar groups of products, and gross margin by theater, and
are undertaken as we endeavor to refine the presentation of these respective categories.
16 Cisco Systems, Inc.