Taxes on Income
A reconciliation between the effective tax rate and the U.S. statutory rate is as follows:
|
| | | | | | | | | | | | | | | | | | | | |
| 2013 | | 2012 | | 2011 |
| Amount | | Tax Rate | | Amount | | Tax Rate | | Amount | | Tax Rate |
U.S. statutory rate applied to income before taxes | $ | 1,941 |
| | 35.0 | % | | $ | 3,059 |
| | 35.0 | % | | $ | 2,567 |
| | 35.0 | % |
Differential arising from: | | | | | | | | | | | |
Foreign earnings | (1,316 | ) | | (23.7 | ) | | (1,955 | ) | | (22.4 | ) | | (2,220 | ) | | (30.3 | ) |
Tax settlements | (497 | ) | | (9.0 | ) | | (113 | ) | | (1.3 | ) | | (721 | ) | | (9.8 | ) |
The American Taxpayer Relief Act of 2012 | (269 | ) | | (4.8 | ) | | — |
| | — |
| | — |
| | — |
|
Unremitted foreign earnings | (81 | ) | | (1.5 | ) | | (11 | ) | | (0.1 | ) | | (86 | ) | | (1.2 | ) |
Tax rate changes | (10 | ) | | (0.2 | ) | | 57 |
| | 0.6 |
| | (295 | ) | | (4.0 | ) |
Amortization of purchase accounting adjustments | 934 |
| | 16.8 |
| | 905 |
| | 10.3 |
| | 875 |
| | 11.9 |
|
Restructuring | 224 |
| | 4.0 |
| | 62 |
| | 0.7 |
| | 163 |
| | 2.2 |
|
U.S. health care reform legislation | 65 |
| | 1.2 |
| | 60 |
| | 0.7 |
| | 50 |
| | 0.7 |
|
Intangible asset impairment charges | 56 |
| | 1.0 |
| | 40 |
| | 0.5 |
| | (5 | ) | | (0.1 | ) |
Vioxx and ENHANCE litigation settlements | — |
| | — |
| | 98 |
| | 1.2 |
| | — |
| | — |
|
Arbitration settlement charge | — |
| | — |
| | — |
| | — |
| | 177 |
| | 2.4 |
|
State taxes | 44 |
| | 0.8 |
| | 31 |
| | 0.3 |
| | 72 |
| | 1.0 |
|
Other (1) | (63 | ) | | (1.1 | ) | | 207 |
| | 2.4 |
| | 365 |
| | 5.0 |
|
| $ | 1,028 |
| | 18.5 | % | | $ | 2,440 |
| | 27.9 | % | | $ | 942 |
| | 12.8 | % |
| |
(1) | Other includes the tax effect of contingency reserves, research credits and miscellaneous items. |
The foreign earnings tax rate differentials in the tax rate reconciliation above primarily reflect the impacts of operations in jurisdictions with different tax rates than the United States, particularly Singapore, Ireland, Switzerland and Puerto Rico (which operates under a tax incentive grant), where the earnings have been indefinitely reinvested, thereby yielding a favorable impact on the effective tax rate as compared with the 35.0% U.S. statutory rate. The foreign earnings tax rate differentials do not include the impact of intangible asset impairment charges, amortization of purchase accounting adjustments, restructuring costs and the arbitration settlement charge. These items are presented separately as they each represent a significant, separately disclosed pretax cost or charge, and a substantial portion of each of these items relates to jurisdictions with lower tax rates than the United States. Therefore, the impact of recording these expense items in lower tax rate jurisdictions is an unfavorable impact on the effective tax rate as compared to the 35.0% U.S. statutory rate.
The American Taxpayer Relief Act of 2012 was signed into law on January 2, 2013, extending the research credit and the controlled foreign corporation look-through provisions for two years retroactively from January 1, 2012 through December 31, 2013. The Company has recorded the entire 2012 benefit of this legislation in 2013, the financial statements period that includes the date of enactment, and that impact is reflected in the reconciliation above.
Income before taxes consisted of:
|
| | | | | | | | | | | |
Years Ended December 31 | 2013 | | 2012 | | 2011 |
Domestic | $ | 3,513 |
| | $ | 4,500 |
| | $ | 2,626 |
|
Foreign | 2,032 |
| | 4,239 |
| | 4,708 |
|
| $ | 5,545 |
| | $ | 8,739 |
| | $ | 7,334 |
|
Taxes on income consisted of:
|
| | | | | | | | | | | |
Years Ended December 31 | 2013 | | 2012 | | 2011 |
Current provision | | | | | |
Federal | $ | 568 |
| | $ | 1,346 |
| | $ | 859 |
|
Foreign | 923 |
| | 651 |
| | 1,568 |
|
State | (133 | ) | | (226 | ) | | 52 |
|
| 1,358 |
| | 1,771 |
| | 2,479 |
|
Deferred provision | | | | | |
Federal | 30 |
| | 749 |
| | (584 | ) |
Foreign | (398 | ) | | (323 | ) | | (683 | ) |
State | 38 |
| | 243 |
| | (270 | ) |
| (330 | ) | | 669 |
| | (1,537 | ) |
| $ | 1,028 |
| | $ | 2,440 |
| | $ | 942 |
|
Deferred income taxes at December 31 consisted of:
|
| | | | | | | | | | | | | | | |
| 2013 | | 2012 |
| Assets | | Liabilities | | Assets | | Liabilities |
Intangibles | $ | — |
| | $ | 3,772 |
| | $ | — |
| | $ | 4,584 |
|
Inventory related | 49 |
| | 604 |
| | 79 |
| | 488 |
|
Accelerated depreciation | 125 |
| | 1,215 |
| | 129 |
| | 1,348 |
|
Unremitted foreign earnings | — |
| | 2,361 |
| | — |
| | 2,435 |
|
Equity investments | — |
| | 539 |
| | — |
| | 451 |
|
Pensions and other postretirement benefits | 162 |
| | 543 |
| | 1,098 |
| | 109 |
|
Compensation related | 600 |
| | — |
| | 748 |
| | — |
|
Unrecognized tax benefits | 497 |
| | — |
| | 706 |
| | — |
|
Net operating losses and other tax credit carryforwards | 225 |
| | — |
| | 425 |
| | — |
|
Other | 1,605 |
| | 71 |
| | 1,798 |
| | 91 |
|
Subtotal | 3,263 |
| | 9,105 |
| | 4,983 |
| | 9,506 |
|
Valuation allowance | (205 | ) | | | | (107 | ) | | |
Total deferred taxes | $ | 3,058 |
| | $ | 9,105 |
| | $ | 4,876 |
| | $ | 9,506 |
|
Net deferred income taxes | | | $ | 6,047 |
| | | | $ | 4,630 |
|
Recognized as: | | | | | | | |
Deferred income taxes and other current assets | $ | 572 |
| | | | $ | 624 |
| | |
Other assets | 381 |
| | | | 527 |
| | |
Income taxes payable | | | $ | 224 |
| | | | $ | 41 |
|
Deferred income taxes | | | 6,776 |
| | | | 5,740 |
|
The Company has net operating loss (“NOL”) carryforwards in several jurisdictions. As of December 31, 2013, approximately $170 million of deferred taxes on NOL carryforwards relate to foreign jurisdictions, none of which are individually significant. Approximately $205 million of valuation allowances have been established on these foreign NOL carryforwards and other foreign deferred tax assets. In addition, the Company has approximately $55 million of deferred tax assets relating to various U.S. tax credit carryforwards and NOL carryforwards, all of which are expected to be fully utilized prior to expiry.
Income taxes paid in 2013, 2012 and 2011 were $2.3 billion, $2.5 billion and $2.7 billion, respectively. Tax benefits relating to stock option exercises reflected in paid-in capital were $61 million in 2013 and $94 million in 2012. These amounts were not material in 2011.
A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows:
|
| | | | | | | | | | | |
| 2013 | | 2012 | | 2011 |
Balance January 1 | $ | 4,425 |
| | $ | 4,277 |
| | $ | 4,919 |
|
Additions related to current year positions | 320 |
| | 496 |
| | 695 |
|
Additions related to prior year positions | 177 |
| | 58 |
| | 145 |
|
Reductions for tax positions of prior years (1) | (747 | ) | | (320 | ) | | (1,223 | ) |
Settlements | (603 | ) | | (67 | ) | | (259 | ) |
Lapse of statute of limitations | (69 | ) | | (19 | ) | | — |
|
Balance December 31 | $ | 3,503 |
| | $ | 4,425 |
| | $ | 4,277 |
|
| |
(1) | Amounts reflect the settlements with the IRS and CRA as discussed below. |
If the Company were to recognize the unrecognized tax benefits of $3.5 billion at December 31, 2013, the income tax provision would reflect a favorable net impact of $3.3 billion.
The Company is under examination by numerous tax authorities in various jurisdictions globally. The Company believes that it is reasonably possible that the total amount of unrecognized tax benefits as of December 31, 2013 could decrease by up to $128 million in the next 12 months as a result of various audit closures, settlements or the expiration of the statute of limitations. The ultimate finalization of the Company’s examinations with relevant taxing authorities can include formal administrative and legal proceedings, which could have a significant impact on the timing of the reversal of unrecognized tax benefits. The Company believes that its reserves for uncertain tax positions are adequate to cover existing risks or exposures.
Interest and penalties associated with uncertain tax positions amounted to a benefit of $319 million in 2013, $88 million in 2012 and $95 million in 2011. These amounts reflect the beneficial impacts of various tax settlements, including those discussed below. Liabilities for accrued interest and penalties were $665 million and $1.2 billion as of December 31, 2013 and 2012, respectively.
In 2013, the Internal Revenue Service (“IRS”) finalized its examination of Schering-Plough’s 2007-2009 tax years. The Company’s unrecognized tax benefits for the years under examination exceeded the adjustments related to this examination period and therefore the Company recorded a net $165 million tax provision benefit in 2013.
In 2010, the IRS finalized its examination of Schering-Plough’s 2003-2006 tax years. In this audit cycle, the Company reached an agreement with the IRS on an adjustment to income related to intercompany pricing matters. This income adjustment mostly reduced NOLs and other tax credit carryforwards. The Company’s reserves for uncertain tax positions were adequate to cover all adjustments related to this examination period. Additionally, as previously disclosed, the Company was seeking resolution of one issue raised during this examination through the IRS administrative appeals process. In 2013, the Company recorded an out-of-period net tax benefit of $160 million related to this issue, which was settled in the fourth quarter of 2012, with final resolution relating to interest owed being reached in the first quarter of 2013. The Company’s unrecognized tax benefits related to this issue exceeded the settlement amount. Management has concluded that the exclusion of this benefit is not material to current or prior year financial statements.
As previously disclosed, the Canada Revenue Agency (the “CRA”) had proposed adjustments for 1999 and 2000 relating to intercompany pricing matters and, in July 2011, the CRA issued assessments for other miscellaneous audit issues for tax years 2001-2004. In 2012, Merck and the CRA reached a settlement for these years that calls for Merck to pay additional Canadian tax of approximately $65 million. The Company’s unrecognized tax benefits related to these matters exceeded the settlement amount and therefore the Company recorded a net $112 million tax provision benefit in 2012. A portion of the taxes paid is expected to be creditable for U.S. tax purposes. The Company had previously established reserves for these matters. The resolution of these matters did not have a material effect on the Company’s results of operations, financial position or liquidity.
In 2011, the IRS concluded its examination of Merck’s 2002-2005 federal income tax returns and as a result the Company was required to make net payments of approximately $465 million. The Company’s unrecognized tax benefits for the years under examination exceeded the adjustments related to this examination period and therefore the Company recorded a net $700 million tax provision benefit in 2011. This net benefit reflects the decrease of unrecognized tax benefits for the years under examination partially offset by increases to unrecognized tax benefits for years subsequent to the examination period as a result of this settlement. The Company disagrees with the IRS treatment of one issue raised during this examination and is appealing the matter through the IRS administrative process.
In addition, various state and foreign tax examinations are in progress. For most of its other significant tax jurisdictions (both U.S. state and foreign), the Company’s income tax returns are open for examination for the period 2003 through 2013.
At December 31, 2013, foreign earnings of $57.1 billion have been retained indefinitely by subsidiary companies for reinvestment; therefore, no provision has been made for income taxes that would be payable upon the distribution of such earnings and it would not be practicable to determine the amount of the related unrecognized deferred income tax liability. In addition, the Company has subsidiaries operating in Puerto Rico and Singapore under tax incentive grants that began to expire in 2013.
