Petsmart 2005 Annual Report Download - page 43

Income Taxes
We establish deferred income tax assets and liabilities for temporary differences between the financial
reporting bases and the income tax bases of our assets and liabilities at enacted tax rates expected to be in effect
when such assets or liabilities are realized or settled. We record a valuation allowance on the deferred income tax
assets to reduce the total to an amount we believe is more likely than not to be realized. Valuation allowances at
January 29, 2006 and January 30, 2005 were principally to offset certain deferred income tax assets for operating
and capital loss carryforwards.
We accrue for potential income tax contingencies when it is probable that a liability to a taxing authority has
been incurred and the amount of the liability can be reasonably estimated, based upon our view of the likely
outcomes of current and future audits. We adjust our accrual for income tax contingencies for changes in
circumstances and additional uncertainties, such as amendments to existing tax law, both legislated and concluded
through the various jurisdictions’ tax court systems. At January 29, 2006, we had an accrual for income tax
contingencies of $14.0 million. If the amounts ultimately settled with tax authorities are greater than the accrued
contingencies, we must record additional income tax expense in the period in which the assessment is determined.
To the extent amounts are ultimately settled for less than the accrued contingencies, or we determine that a liability
to a taxing authority is no longer probable, the contingency is reversed as a reduction of income tax expense in the
period the determination is made.
During the third quarter of fiscal 2005, we recorded a reduction to income tax expense of approximately
$6.1 million. The period of assessment, during which additional tax may be imposed for years prior to 2002, has
expired for several jurisdictions. As a result, we determined that approximately $6.5 million of tax contingency
reserves are no longer probable of assertion and have reduced them accordingly, with approximately $6.1 million as
a reduction in expense and approximately $0.4 million as an increase to additional paid-in capital. We also recorded
additional tax expense during the third quarter of fiscal 2005 of approximately $2.3 million resulting from a
correction of our deferred tax assets related to equity-based compensation recognized for periods prior to fiscal
2002. In the fourth quarter of 2005, we recorded additional tax expense of $2.0 million resulting from an adjustment
to deferred tax assets and liabilities.
In the second quarter of fiscal 2004, we completed an analysis of our net operating loss carryovers related to
our fiscal 2000 purchase of PetSmart.com, based on guidance issued from the Internal Revenue Service. As a result,
we expect to utilize an additional $22.1 million of net operating losses previously considered unavailable. We
recorded a total tax benefit of $7.7 million in the second quarter of fiscal 2004 related to the additional net operating
loss utilization.
We operate in multiple tax jurisdictions and could be subject to audit in any of these jurisdictions. These audits
can involve complex issues that may require an extended period of time to resolve and may cover multiple years.
The Internal Revenue Service is currently examining our tax returns for fiscal 2002, 2003 and 2004. While the
examination has not been finalized, no issues have been identified that would have a material impact on our
financial position or results of operations.
During fiscal 2005, we raised an affirmative issue with the Internal Revenue Service with respect to the
characterization of certain losses. Final agreement has not been reached with the Internal Revenue Service on this
issue and, therefore, no benefit has been reflected in the consolidated financial statements related to this item.
Management currently estimates that the range of potential benefit will be between zero and approximately
$1.9 million. Any amount ultimately sustained would be reflected as a reduction of income tax expense in the fiscal
quarter in which final agreement is reached with the Internal Revenue Service.
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