INCOME TAXES
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Domestic and Foreign Components of Income Before Income Taxes |
In millions | | 2013 (1) |
| | 2012 (2) |
| | 2011 |
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Domestic | | $ | 3,979 |
| | $ | (401 | ) | | $ | 386 |
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Foreign | | 2,825 |
| | 2,066 |
| | 3,215 |
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Total | | $ | 6,804 |
| | $ | 1,665 |
| | $ | 3,601 |
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(1) | In 2013, the domestic component of "Income Before Income Taxes" included a gain of $2.195 billion related to the K-Dow arbitration and a $451 million gain related to the sale of Dow's Polypropylene Licensing and Catalysts business. |
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(2) | In 2012, the domestic component of "Income Before Income Taxes" was significantly impacted by the Company's 1Q12 and 4Q12 restructuring charges. |
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Provision for Income Taxes |
| | 2013 | | 2012 | | 2011 |
In millions | | Current | | Deferred | | Total | | Current | | Deferred | | Total | | Current | | Deferred | | Total |
Federal | | $ | 805 |
| | $ | 278 |
| | $ | 1,083 |
| | $ | 241 |
| | $ | (312 | ) | | $ | (71 | ) | | $ | 36 |
| | $ | (244 | ) | | $ | (208 | ) |
State and local | | 42 |
| | (73 | ) | | (31 | ) | | 9 |
| | (10 | ) | | (1 | ) | | 12 |
| | (13 | ) | | (1 | ) |
Foreign | | 1,028 |
| | (92 | ) | | 936 |
| | 780 |
| | (143 | ) | | 637 |
| | 768 |
| | 258 |
| | 1,026 |
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Total | | $ | 1,875 |
| | $ | 113 |
| | $ | 1,988 |
| | $ | 1,030 |
| | $ | (465 | ) | | $ | 565 |
| | $ | 816 |
| | $ | 1 |
| | $ | 817 |
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Reconciliation to U.S. Statutory Rate | | | | |
In millions | | 2013 |
| | 2012 |
| | 2011 |
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Taxes at U.S. statutory rate | | $ | 2,381 |
| | $ | 583 |
| | $ | 1,260 |
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Equity earnings effect | | (276 | ) | | (115 | ) | | (459 | ) |
Foreign income taxed at rates other than 35% (1) | | (76 | ) | | (76 | ) | | (242 | ) |
U.S. tax effect of foreign earnings and dividends | | 102 |
| | 13 |
| | 218 |
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Goodwill impairment losses | | — |
| | 77 |
| | — |
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Discrete equity earnings (2) | | — |
| | 48 |
| | — |
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Change in permanent reinvestment assertions | | — |
| | (236 | ) | | — |
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Change in valuation allowances | | (197 | ) | | 135 |
| | 367 |
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Unrecognized tax benefits | | 243 |
| | 122 |
| | 35 |
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Federal tax accrual adjustments | | 29 |
| | 4 |
| | 8 |
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Sale of a contract manufacturing subsidiary (3) | | — |
| | — |
| | (231 | ) |
Joint venture reorganization | | — |
| | — |
| | (95 | ) |
Gain from K-Dow arbitration (4) | | (212 | ) | | — |
| | — |
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Other – net | | (6 | ) | | 10 |
| | (44 | ) |
Total tax provision | | $ | 1,988 |
| | $ | 565 |
| | $ | 817 |
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Effective tax rate | | 29.2 | % | | 33.9 | % | | 22.7 | % |
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(1) | Includes the tax provision for statutory taxable income in foreign jurisdictions for which there is no corresponding amount in “Income Before Income Taxes.” |
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(2) | Includes nonrecurring charges related to equity in earnings of nonconsolidated affiliates. |
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(3) | The Company recognized a tax benefit of $231 million related to the sale of a contract manufacturing subsidiary, which was reduced by a $95 million valuation allowance in 2011. |
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(4) | In 2013, the K-Dow arbitration award generated a tax rate benefit of $212 million due to the tax treatment of certain components of the award. See Note 14 for further information. |
The tax rate for 2013 was favorably impacted by increased equity earnings; the K-Dow arbitration award, due to favorable tax treatment of certain components of the award; and, changes in valuation allowances in the United States on state income tax attributes and capital loss carryforwards. The tax rate was unfavorably impacted by adjustments to uncertain tax positions related to court rulings on two separate tax matters as well as the establishment of valuation allowances outside the United States. Additionally, the tax rate was unfavorably impacted by an increase in statutory taxable income in Latin America, primarily due to local currency devaluation. These factors resulted in an effective tax rate of 29.2 percent for 2013.
The tax rate for 2012 was negatively impacted by a change in the geographic mix of earnings, notably a decrease in earnings in Europe and an increase in earnings in the United States, as well as reductions in equity earnings. Equity earnings were further impacted by asset impairment and restructuring charges at Dow Corning. Additionally, the Company's impairment of Dow Formulated Systems goodwill and the impairment of the long-lived assets of Dow Kokam LLC received minimal tax relief. The tax rate was favorably impacted by a change in the permanent reinvestment assertions of certain affiliates in Europe and Asia Pacific; however, this was primarily offset by unfavorable adjustments to uncertain tax positions and valuation allowances. These factors resulted in an effective tax rate of 33.9 percent for 2012.
The tax rate for 2011 was positively impacted by a high level of equity earnings as a percentage of total earnings, earnings in foreign locations taxed at rates less than the U.S. statutory rate, the sale of a contract manufacturing subsidiary and the reorganization of a joint venture and was negatively impacted by a $264 million valuation allowance recorded in the fourth quarter of 2011. The valuation allowance was recorded against the deferred tax assets of two Dow entities in Brazil. As a result of the global recession in 2008-2009, coupled with rapidly deteriorating isocyanate industry conditions and increasing local costs, these two entities were in a three-year cumulative pretax operating loss position at December 31, 2011. While the Company expects to realize the tax loss carryforwards generated by these operating losses based on several factors - including forecasted margin expansion resulting from improving economic conditions, higher industry growth rates in Brazil, improving Dow operating rates, and a restructuring of legal entities to maximize the use of existing tax loss carryforwards - Dow was unable to overcome the negative evidence of recent cumulative operating losses; and at December 31, 2011, the Company could not assert it was more likely than not that it will realize its deferred tax assets in the two Brazilian entities. Accordingly, the Company established the valuation allowance against the deferred tax assets of these companies in the fourth quarter of 2011. If in the future, as a result of the Company's plans and expectations, one or both of these entities generates sufficient profitability such that the evaluation of the recoverability of the deferred tax assets changes, the valuation allowance could be reversed in whole or in part in a future period. These factors resulted in an effective tax rate of 22.7 percent for 2011.
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Deferred Tax Balances at December 31 | | 2013 | | 2012 |
In millions | | Deferred Tax Assets (1) |
| | Deferred Tax Liabilities |
| | Deferred Tax Assets (1) |
| | Deferred Tax Liabilities |
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Property | | $ | 62 |
| | $ | 2,165 |
| | $ | 58 |
| | $ | 2,128 |
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Tax loss and credit carryforwards | | 2,012 |
| | — |
| | 1,954 |
| | — |
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Postretirement benefit obligations | | 3,619 |
| | 1,150 |
| | 4,900 |
| | 1,291 |
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Other accruals and reserves | | 1,901 |
| | 392 |
| | 2,167 |
| | 329 |
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Intangibles | | 113 |
| | 827 |
| | 218 |
| | 994 |
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Inventory | | 217 |
| | 197 |
| | 240 |
| | 179 |
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Long-term debt | | — |
| | 600 |
| | — |
| | 599 |
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Investments | | 137 |
| | 111 |
| | 317 |
| | 183 |
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Other – net | | 1,143 |
| | 794 |
| | 1,168 |
| | 642 |
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Subtotal | | $ | 9,204 |
| | $ | 6,236 |
| | $ | 11,022 |
| | $ | 6,345 |
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Valuation allowances | | (1,112 | ) | | — |
| | (1,399 | ) | | — |
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Total | | $ | 8,092 |
| | $ | 6,236 |
| | $ | 9,623 |
| | $ | 6,345 |
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(1) | Included in current deferred tax assets are prepaid tax assets totaling $205 million in 2013 and $218 million in 2012. |
Gross operating loss carryforwards amounted to $11,435 million at December 31, 2013 and $10,436 million at December 31, 2012. At December 31, 2013, $1,452 million of the operating loss carryforwards were subject to expiration in 2014 through 2018. The remaining operating loss carryforwards expire in years beyond 2018 or have an indefinite carryforward period. Tax credit carryforwards at December 31, 2013 amounted to $124 million ($226 million at December 31, 2012), net of uncertain tax positions, of which $4 million is subject to expiration in 2014 through 2018. The remaining tax credit carryforwards expire in years beyond 2018 or have an indefinite carryforward period.
The Company had valuation allowances that primarily related to the realization of recorded tax benefits on tax loss carryforwards from operations in the United States, Brazil and Asia Pacific of $1,112 million at December 31, 2013 and $1,399 million at December 31, 2012.
Undistributed earnings of foreign subsidiaries and related companies that are deemed to be permanently invested amounted to $16,139 million at December 31, 2013, $14,504 million at December 31, 2012 and $12,741 million at December 31, 2011. It is not practicable to calculate the unrecognized deferred tax liability on undistributed earnings.
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Total Gross Unrecognized Tax Benefits | | | | |
In millions | | 2013 |
| | 2012 |
| | 2011 |
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Balance at January 1 | | $ | 409 |
| | $ | 339 |
| | $ | 319 |
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Increases related to positions taken on items from prior years | | 385 |
| | 66 |
| | 5 |
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Decreases related to positions taken on items from prior years | | (137 | ) | | (32 | ) | | (11 | ) |
Increases related to positions taken in the current year | | 10 |
| | 53 |
| | 70 |
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Settlement of uncertain tax positions with tax authorities | | (393 | ) | | (9 | ) | | (21 | ) |
Decreases due to expiration of statutes of limitations | | (8 | ) | | (8 | ) | | (23 | ) |
Balance at December 31 | | $ | 266 |
| | $ | 409 |
| | $ | 339 |
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At December 31, 2013, the total amount of unrecognized tax benefits was $266 million ($409 million at December 31, 2012), of which $257 million would impact the effective tax rate, if recognized ($392 million at December 31, 2012).
Interest and penalties associated with uncertain tax positions, including the matters that resulted in the adjustment of uncertain tax positions, are recognized as components of the “Provision for income taxes,” and totaled a benefit of $71 million in 2013, a charge of $92 million in 2012 and a charge of $21 million in 2011. The Company’s accrual for interest and penalties was $81 million at December 31, 2013 and $131 million at December 31, 2012.
During 2013, court rulings on two separate tax matters resulted in the adjustment of uncertain tax positions. In February 2013, the U.S. District Court for the Middle District of Louisiana issued a ruling that disallowed, for tax purposes, transactions and partnerships associated with Chemtech, a wholly owned subsidiary. In March 2013, the U.S. Supreme Court denied certiorari in Union Carbide's research tax credit case. Through denial of certiorari, the decision issued by the U.S. Court of Appeals denying Union Carbide's tax credit claim for supplies used in process-related research and development at its manufacturing facilities became final. As a result of these rulings, the Company adjusted uncertain tax positions related to these matters, resulting in a tax charge of $276 million in 2013.
Tax years that remain subject to examination for the Company’s major tax jurisdictions are shown below:
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Tax Years Subject to Examination by Major Tax Jurisdiction at December 31 |
| | Earliest Open Year |
Jurisdiction | | 2013 | | 2012 |
Argentina | | 2007 | | 2006 |
Brazil | | 2009 | | 2008 |
Canada | | 2009 | | 2008 |
France | | 2011 | | 2010 |
Germany | | 2006 | | 2006 |
Italy | | 2008 | | 2003 |
The Netherlands | | 2012 | | 2012 |
Spain | | 2008 | | 2008 |
Switzerland | | 2009 | | 2009 |
United Kingdom | | 2011 | | 2008 |
United States: | | | | |
Federal income tax | | 2004 | | 2004 |
State and local income tax | | 2004 | | 2004 |
The Company is currently under examination in a number of tax jurisdictions. It is reasonably possible that some of these examinations may be resolved within twelve months. As a result, it is reasonably possible that the total gross unrecognized tax benefits of the Company at December 31, 2013 may increase or decrease in the next twelve months by approximately $80 million as a result of these resolved examinations. The impact on the Company’s results of operations is not expected to be material.
The reserve for non-income tax contingencies related to issues in the United States and foreign locations was $105 million at December 31, 2013 and $151 million at December 31, 2012. This is management’s best estimate of the potential liability for non-income tax contingencies. Inherent uncertainties exist in estimates of tax contingencies due to changes in tax law, both legislated and concluded through the various jurisdictions’ tax court systems. It is the opinion of the Company’s management that the possibility is remote that costs in excess of those accrued will have a material impact on the Company’s consolidated financial statements.
