Kraft 2005 Annual Report Download - page 27

MERRILL CORPORATION ABLIJDE// 7-MAR-06 14:42 DISK126:[06CHI5.06CHI1135]DI1135A.;10
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DISK024:[PAGER.PSTYLES]UNIVERSAL.BST;51
KRAFT FOODS-FSC CERTIFIED-10K/AR Proj: P1102CHI06 Job: 06CHI1135 File: DI1135A.;10
Merrill Corporation/Chicago [phone] Page Dim: 8.250 X 10.750Copy Dim: 38. X 54.3
generally include accrued dividends, taxes and service fees. The increase from 2004 primarily reflects
the timing of payments. Interest on intercompany borrowings is based on the applicable London
Interbank Offered Rate.
Income Taxes. The Company accounts for income taxes in accordance with Statement of
Financial Accounting Standards (‘‘SFAS’’) No. 109, ‘‘Accounting for Income Taxes.’’ The U.S. accounts
of the Company are included in the consolidated federal income tax return of Altria Group, Inc. Income
taxes are generally computed on a separate company basis. To the extent that foreign tax credits, capital
losses and other credits generated by the Company, which cannot currently be utilized on a separate
company basis, are utilized in Altria Group, Inc.’s consolidated federal income tax return, the benefit is
recognized in the calculation of the Company’s provision for income taxes. Based on the Company’s
current estimate, this benefit is calculated to be approximately $225 million, $70 million and $100 million
for the years ended December 31, 2005, 2004 and 2003, respectively. The increase in 2005 is driven
primarily by dividend repatriations and certain legal entity reorganizations. The benefit is dependent on a
variety of tax attributes that have a tendency to vary year to year. The Company makes payments to, or is
reimbursed by, Altria Group, Inc. for the tax effects resulting from its inclusion in Altria Group, Inc.’s
consolidated federal income tax return including current taxes payable and net changes in tax
provisions. The provision for income taxes is based on domestic and international statutory income tax
rates and tax planning opportunities available to the Company in the jurisdictions in which it operates.
Significant judgment is required in determining income tax provisions and in evaluating tax positions.
The Company establishes additional provisions for income taxes when, despite the belief that existing
tax positions are fully supportable, there remain certain positions that are likely to be challenged and that
may not be sustained on review by tax authorities. The Company evaluates and potentially adjusts these
provisions in light of changing facts and circumstances. The consolidated tax provision includes the
impact of changes to accruals that are considered appropriate. Upon the closure of current and future
tax audits in various jurisdictions, significant income tax accrual reversals could continue to occur, which
could trigger cash reimbursements from Altria Group, Inc.
In October, 2004, the American Jobs Creation Act (‘‘the Jobs Act’’) was signed into law. The Jobs
Act includes a deduction for 85% of certain foreign earnings that are repatriated. In 2005, the Company
repatriated approximately $500 million of earnings under the provisions of the Jobs Act. Deferred taxes
had previously been provided for a portion of the dividends to be remitted. The reversal of the deferred
taxes more than offset the tax costs to repatriate the earnings and resulted in a net tax reduction of
$28 million in the consolidated income tax provision during 2005, the majority of which was recorded
during the second quarter.
The Jobs Act also provides tax relief to U.S. domestic manufacturers by providing a tax deduction
related to a percentage of the lesser of ‘‘qualified production activities income’’ or taxable income. The
deduction, which was 3% in 2005, increases to 9% by 2010. In accordance with SFAS No. 109, the
Company will recognize these benefits in the year earned. The tax benefit in 2005 was approximately
$25 million.
The Company is regularly audited by federal, state and foreign tax authorities, and these audits are
at various stages at any given time. The Company anticipates several domestic and foreign audits will
close in 2006 with expected favorable settlements. Any tax contingency reserves in excess of additional
assessed liabilities will be reversed at the time the audits close.
Consolidation. The consolidated financial statements include Kraft Foods Inc., as well as its
wholly-owned and majority-owned subsidiaries. Investments in which Kraft Foods Inc. exercises
significant influence (20%—50% ownership interest), are accounted for under the equity method of
accounting. Investments in which Kraft Foods Inc. has an ownership interest of less than 20%, or does
not exercise significant influence, are accounted for with the cost method of accounting. All
intercompany transactions and balances between and among Kraft’s subsidiaries have been eliminated.
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