NOTE 10    INCOME TAXES

The components of the provision for income taxes are as follows:

(In millions)
Year Ended June 30	2003)		2004)		2005)
Current taxes:
U.S. federal	$(3,708)		$3,766)		$3,401)
U.S. state and local	153)		174)		152)
International	808)		1,056)		911)
Current taxes	4,669)		4,996)		4,464)
Deferred taxes	(1,146)		(968)		(90)
Provision for income taxes	$(3,523)		$4,028)		$4,374)

U.S. and international components of income before income taxes are as follows:

(In millions)
Year Ended June 30	2003		2004		2005
U.S.	$07,674		$08,088		$09,806
International	3,380		4,108		6,822
Income before income taxes	$11,054		$12,196		$16,628

The items accounting for the difference between income taxes computed at the federal statutory rate and the provision for income taxes are as follows:

Year Ended June 30	2003%)		2004)%		2005)%
Federal statutory rate	35.0%)		35.0%)		35.0%)
Effect of:
IRS examination settlement	–)%		–)%		(4.7)%
Foreign earnings taxed at lower rates	(1.3)%		(1.7)%		(3.1)%
Extraterritorial income exclusion	(1.6)%		(0.9)%		(1.3)%
Other reconciling items	–%)		0.6)%		0.4)%
Effective rate	32.1%)		33.0%)		26.3%)

The 2005 other reconciling items include a $179 million repatriation tax benefit. The 2004 other reconciling items include the $208 million benefit from the resolution of the issue remanded by the Ninth Circuit Court of Appeals and the impact of the $605 million non-deductible European Commission fine.

The components of the deferred tax assets and liabilities are as follows:

(In millions)
June 30	2004)		2005
Deferred income tax assets:
Unearned revenue	$(1,746)		$(0,915)
Impaired investments	1,246)		861)
Stock-based compensation expense	3,749)		3,994)
Other revenue items	286)		213)
Other expense items	1,308)		1,751)
Other	–)		173)
Deferred income tax assets	$(8,335)		$(7,907)
Deferred income tax liabilities:
Unrealized gain on investments	$(1,087)		$(1,169)
International earnings	(1,327)		(1,393)
Other	(16)		(23)
Deferred income tax liabilities	(2,430)		(2,585)
Net deferred income tax assets	$(5,905)		$(5,322)
Reported as:
Current deferred tax assets	$(2,097)		$(1,701)
Long-term deferred tax assets	3,808)		3,621)
Net deferred income tax assets	$(5,905)		$(5,322)

Deferred income tax balances reflect the effects of temporary differences between the carrying amounts of assets and liabilities and their tax bases and are stated at enacted tax rates expected to be in effect when taxes are actually paid or recovered.

We have not provided for U.S. deferred income taxes or foreign withholding taxes on $4.1 billion of our undistributed earnings for certain non-U.S. subsidiaries, all of which relate to fiscal 2002 through 2005 earnings, because these earnings are intended to be permanently reinvested in operations outside the United States.

The American Jobs Creation Act of 2004 (the “Act”) was enacted in October 2004. The Act creates a temporary incentive for U.S. corporations to repatriate foreign subsidiary earnings by providing an elective 85% dividends received deduction for certain dividends from controlled foreign corporations. The deduction is subject to a number of limitations and requirements, including adoption of a specific domestic reinvestment plan for the repatriated funds. Based on our current understanding of the Act and subsequent guidance published by the U.S. Treasury, we have determined that we are eligible and intend to repatriate approximately $780 million in dividends subject to the elective 85% dividends received deduction. Accordingly, we recorded a corresponding tax provision benefit of $179 million from the reversal of previously provided U.S. deferred tax liabilities on these unremitted foreign subsidiary earnings. We intend to pay this dividend in fiscal year 2006.

Income taxes paid were $2.8 billion in fiscal year 2003, $2.5 billion in fiscal year 2004, and $4.3 billion in fiscal year 2005.

Tax Contingencies. We are subject to income taxes in the United States and numerous foreign jurisdictions. Significant judgment is required in determining our worldwide provision for income taxes and recording the related assets and liabilities. In the ordinary course of our business, there are many transactions and calculations where the ultimate tax determination is uncertain. We are regularly under audit by tax authorities. Accruals for tax contingencies are provided for in accordance with the requirements of SFAS No. 5, Accounting for Contingencies.

The Internal Revenue Service (IRS) has completed and closed its audits of our consolidated federal income tax returns through 1996. We recently entered into a closing agreement with the IRS for tax years 1997 through 1999 resulting in certain adjustments to our federal income tax liability for those years. Accordingly, our fiscal year 2005 tax provision has been reduced by $776 million as a result of reversing previously established reserves in excess of the additional tax liability assessed by the IRS for the 1997-1999 tax years. The IRS is currently conducting an audit of our consolidated federal income tax return for tax years 2000 through 2003.

Although we believe we have appropriate support for the positions taken on our tax returns, we have recorded a liability for our best estimate of the probable loss on certain of these positions, the non-current portion of which is included in other long-term liabilities. We believe that our accruals for tax liabilities are adequate for all open years, based on our assessment of many factors including past experience and interpretations of tax law applied to the facts of each matter, which matters result primarily from intercompany transfer pricing, tax benefits from the Foreign Sales Corporation and Extra Territorial Income tax rules and the amount of research and experimentation tax credits claimed. Although we believe our recorded assets and liabilities are reasonable, tax regulations are subject to interpretation and tax litigation is inherently uncertain; therefore our assessments can involve both a series of complex judgments about future events and rely heavily on estimates and assumptions. Although we believe that the estimates and assumptions supporting our assessments are reasonable, the final determination of tax audits and any related litigation could be materially different than that which is reflected in historical income tax provisions and recorded assets and liabilities. Based on the results of an audit or litigation a material effect on our income tax provision, net income, or cash flows in the period or periods for which that determination is made could result. Due to the complexity involved we are not able to estimate the range of reasonably possible losses in excess of amounts recorded.