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Notes to consolidated financial statements (audited)
International Business Machines Corporation and Subsidiary Companies
P. Taxes (audited)
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| (Dollars in millions) |
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| For The Year Ended December 31: |
2005 |
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2004 |
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2003 |
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| Income from continuing operations before income taxes: |
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| U.S. operations |
$ |
7,450 |
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$ |
4,400 |
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$ |
3,662 |
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| Non-U.S. operations |
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4,776 |
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6,269 |
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5,755 |
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| Total income from continuing operations before income taxes |
$ |
12,226 |
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$ |
10,669 |
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$ |
9,417 |
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The continuing operations provision for income taxes by geographic operations is as follows:
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| (Dollars in millions) |
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| For The Year Ended December 31: |
2005 |
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2004 |
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2003 |
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| U.S. operations |
$ |
2,988 |
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$ |
1,492 |
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$ |
937 |
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| Non-U.S. operations |
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1,244 |
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1,680 |
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1,892 |
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| Total continuing operations provision for income taxes |
$ |
4,232 |
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$ |
3,172 |
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$ |
2,829 |
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The components of the continuing operations provision for income taxes by taxing jurisdiction are as follows:
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| (Dollars in millions) |
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| For The Year Ended December 31: |
2005 |
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2004 |
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2003 |
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| U.S. federal: |
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| Current |
$ |
521 |
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$ |
(681 |
)* |
$ |
177 |
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| Deferred |
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1,811 |
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1,668 |
* |
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148 |
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2,332 |
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987 |
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325 |
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| U.S. state and local: |
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| Current |
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80 |
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36 |
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34 |
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| Deferred |
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183 |
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79 |
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145 |
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263 |
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115 |
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179 |
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| Non-U.S.: |
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| Current |
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1,446 |
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2,023 |
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1,828 |
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| Deferred |
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191 |
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47 |
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497 |
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1,637 |
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2,070 |
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2,325 |
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| Total continuing operations provision for income taxes |
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4,232 |
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3,172 |
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2,829 |
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| Provision for social security, real estate, personal property and other taxes** |
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3,501 |
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3,449 |
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3,372 |
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| Total taxes included in income from continuing operations |
$ |
7,733 |
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$ |
6,621 |
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$ |
6,201 |
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A reconciliation of the statutory U.S. federal tax rate to the company’s continuing operations effective tax rate is as follows:
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| For The Year Ended December 31: |
2005 |
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2004 |
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2003 |
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| Statutory rate |
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35 |
% |
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35 |
% |
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35 |
% |
| Foreign tax differential |
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(5 |
) |
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(5 |
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(5 |
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| “Act” repatriation* |
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4 |
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— |
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— |
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| State and local |
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1 |
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1 |
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1 |
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| Other |
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— |
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(1 |
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(1 |
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| Effective rate |
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35 |
% |
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30 |
% |
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30 |
% |
The effect of tax law changes on deferred tax assets and liabilities did not have a material impact on the company’s effective tax rate.
The significant components of deferred tax assets and liabilities that are recorded in the Consolidated Statement of Financial Position were as follows:
| (Dollars in millions) |
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| At December 31: |
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2005 |
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2004 |
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| Retirement-related benefits |
$ |
3,039 |
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$ |
3,908 |
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| Stock-based and other compensation |
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3,022 |
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3,122 |
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| Capitalized research and development |
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1,728 |
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1,794 |
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| Bad debt, inventory and |
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| warranty reserves |
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937 |
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1,050 |
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| Deferred income |
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611 |
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612 |
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| Foreign tax loss carryforwards |
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355 |
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298 |
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| Infrastructure reduction charges |
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335 |
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333 |
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| Capital loss carryforwards |
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220 |
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220 |
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| Alternative minimum tax credits |
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214 |
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1,032 |
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| State and local tax loss carryforwards |
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87 |
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95 |
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| Other |
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1,649 |
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2,265 |
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| Gross deferred tax assets |
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12,197 |
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14,729 |
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| Less: valuation allowance |
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562 |
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603 |
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| Net deferred tax assets |
$ |
11,635 |
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$ |
14,126 |
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| (Dollars in millions) |
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| At December 31: |
2005 |
|
2004 |
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| Retirement-related benefits |
$ |
7,267 |
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$ |
7,057 |
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| Leases |
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964 |
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622 |
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| Software development costs |
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348 |
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381 |
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| Other |
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1,502 |
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1,324 |
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| Gross deferred tax liabilities |
$ |
10,081 |
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$ |
9,384 |
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The valuation allowance at December 31, 2005, principally applies to certain foreign, state and local, and capital loss carryforwards 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 reduction in the valuation allowance will reduce income tax expense.
For income tax return purposes, the company has foreign, state and local, and capital loss carryforwards, the tax effect of which is $662 million. Substantially all of these carryforwards are available for at least three years or have an indefinite carryforward period. The company also has available alternative minimum tax credit carryforwards of approximately $214 million which have an indefinite carryforward period.
With limited exception, the company is no longer subject to U.S. federal, state and local or non-U.S. income tax audits by tax authorities for years before 1999. The years subsequent to 1998 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.
The IRS commenced its audit of the company’s U.S. income tax returns for 2001 through 2003 in the first quarter of 2005. As of December 31, 2005, the IRS has not proposed any significant adjustments. The company anticipates that this audit will be completed by the end of 2006. While it is not possible to predict the impact of this audit on income tax expense, the company does not anticipate having to make a significant cash tax payment.
On October 22, 2004, the President signed the American Jobs Creation Act of 2004 (the “Act”). The Act created a temporary incentive for the company to repatriate earnings accumulated outside the U.S. by allowing the company to reduce its taxable income by 85 percent of certain eligible dividends received from non-U.S. subsidiaries by the end of 2005. In order to benefit from this incentive, the company must reinvest the qualifying dividends in the U.S. under a domestic reinvestment plan approved by the Chief Executive Officer (CEO) and Board of Directors (BOD). During the third quarter of 2005, the company’s CEO and BOD approved a domestic reinvestment plan to repatriate $9.5 billion of foreign earnings under the Act. Accordingly, the company recorded income tax expense of $525 million associated with this repatriation. The additional tax expense consists of federal taxes ($493 million), state taxes, net of federal benefit ($22 million) and non-U.S. taxes ($10 million). The repatriation action resulted in a cash tax liability of approximately $225 million and the utilization of existing alternative minimum tax credits.
The company repatriated $3.1 billion under the Act in the third quarter and the remaining $6.4 billion in the fourth quarter of 2005. Uses of the repatriated funds included domestic expenditures relating to research and development, capital asset investments, as well as other permitted activities under the Act.
The company has not provided deferred taxes on $10.1 billion of undistributed earnings of non-U.S. subsidiaries at December 31, 2005, as it is the company’s policy to indefinitely reinvest these earnings in non-U.S. operations. However, the company periodically repatriates a portion of these earnings to the extent that it does not incur an additional U.S. tax liability. Quantification of the deferred tax liability, if any, associated with indefinitely reinvested earnings is not practicable.
For additional information on the trends related to the company’s ongoing effective tax rate, as well as the company’s cash tax position, refer to the “Looking Forward” section of the Management Discussion.
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