IBM 2007 Annual Report Download - page 100

98
Notes to Consolidated Financial Statements
International Business Machines Corporation and Subsidiary Companies
Management Discussion ..................................14
Consolidated Statements ..................................58
Notes ........................................................... 64
A-F ...................................................................64
G-M ..................................................................84
N-S ............................................................. 94
N. Contingencies and Commitments ..............94
O. Taxes ...................................................... 97
P. Research, Development
and Engineering .................................... 99
Q. 2005 Actions .......................................... 99
R. Earnings Per Share of Common Stock ....101
S. Rental Expense and
Lease Commitments .................................101
T-W ................................................................102
For income tax return purposes, the company has available foreign,
domestic and capital loss carryforwards, the tax effect of which is
$799 million, as well as state tax credit carryforwards of approxi-
mately $480 million. Substantially all of these carryforwards are
available for at least two years or are available for 10 years or more.
The company has certain foreign tax loss carryforwards that have
not been reflected in the gross deferred tax asset balance. These
losses, the potential tax benefit of which is approximately $1.1 billion,
have not been recorded in the Consolidated Statement of Financial
Position as the company has not determined if it will claim these
losses. The company is currently evaluating whether to claim these
losses and expects to make a decision within the next 12 months.
The valuation allowance at December 31, 2007, principally applies
to certain foreign and state loss carryforwards, and state credit car-
ryforwards, that, in the opinion of management, are more likely than
not to expire unutilized. However, to the extent that tax benefits
related to these carryforwards are realized in the future, the reduc-
tion in the valuation allowance will reduce income tax expense. The
year-to-year increase of $262 million was primarily driven by an
additional allowance related to the recognition of certain state tax
credit carryforwards not previously recorded as deferred tax assets.
The company adopted the provisions of FIN 48 on January 1,
2007. The cumulative effect of adopting FIN 48 was a decrease in tax
reserves and an increase of $117 million to the January 1, 2007
Retained earnings balance. A reconciliation of the beginning and
ending amount of unrecognized tax benefits is as follows:
($ in millions)
Balance at January 1, 2007 $2,414
Additions based on tax positions
related to the current year 745
Additions for tax positions of prior years 195
Reductions for tax positions of prior years
(including impacts due to a lapse in statute) (144)
Settlements (116)
Balance at December 31, 2007 $3,094
The liability at December 31, 2007 of $3,094 can be reduced by $496
million of offsetting tax benefits associated with the correlative
effects of potential transfer pricing adjustments, state income taxes
and timing adjustments. The net amount of $2,598, if recognized,
would favorably affect the company’s effective tax rate.
Interest and penalties related to income tax liabilities are included
in income tax expense. During the year ended December 31, 2007,
the company recognized $85 million in interest and penalties. The
company has $195 million for the payment of interest and penalties
accrued at December 31, 2007 and had $126 million accrued on
January 1, 2007 upon adoption of FIN 48.
During the first quarter of 2007, the U.S. Internal Revenue
Service (IRS) commenced its audit of the company’s U.S. income tax
returns for 2004 and 2005. The company anticipates that this audit
will be completed by the end of 2008.
Within the next 12 months, the company believes it is reasonably
possible that the total amount of unrecognized tax benefits associated
with certain positions may be significantly reduced. The potential
decrease in the amount of unrecognized tax benefits is primarily
associated with the possible resolution of the company’s U.S. income
tax audit for 2004 and 2005. Specific positions that may be resolved,
and that may significantly reduce the related amount of unrecog-
nized tax benefits, include various transfer pricing matters and claims
for tax incentives, as well as various other foreign tax matters. The
company estimates that the unrecognized tax benefits at December
31, 2007 could be reduced by approximately $800 million.
In December 2006, the company and the IRS reached resolution
of the company’s U.S. income tax audit for 2001 through 2003. The
settlement of this audit resulted in a decrease in the 2006 effective tax
rate of 3 points due to the release of previously recorded tax reserves.
In the fourth quarter of 2006, as a continuation of its global strat-
egy, the company aligned, through an intercompany transfer, certain
non-U.S. intellectual property rights with existing non-U.S. rights
currently owned by one of the company’s non-U.S. manufacturing
subsidiaries. This transfer resulted in a one-time increase in the 2006
effective tax rate of 4 points.
With limited exception, the company is no longer subject to U.S.
federal, state and local or non-U.S. income tax audits by taxing
authorities for years through 2001. The years subsequent to 2001
contain matters that could be subject to differing interpretations of
applicable tax laws and regulations as it relates to the amount and/or
timing of income, deductions and tax credits. Although the outcome
of tax audits is always uncertain, the company believes that adequate
amounts of tax and interest have been provided for any adjustments
that are expected to result for these years.