Microsoft 2012 Annual Report Download - page 29

recognized gains on investments increased, primarily due to higher gains on sales of equity securities, offset in part by
fewer gains on sales of fixed-income securities. Derivative losses decreased, primarily due to higher gains on commodity
derivatives offset in part by higher losses on currency contracts used to hedge foreign currency revenue.
Income Taxes
Fiscal year 2012 compared with fiscal year 2011
Our effective tax rates for fiscal years 2012 and 2011 were approximately 24% and 18%, respectively. Our effective tax
rates were lower than the U.S. federal statutory rate primarily due to earnings taxed at lower rates in foreign jurisdictions
resulting from producing and distributing our products and services through our foreign regional operations centers in
Ireland, Singapore, and Puerto Rico, which have lower income tax rates.
Our fiscal year 2012 effective rate increased by 6% from fiscal year 2011 mainly due to a nonrecurring $6.2 billion non-tax
deductible goodwill impairment charge that was recorded in the fourth quarter of 2012. The goodwill impairment charge
increased our effective tax rate by 10%. In addition, in fiscal years 2012 and 2011, we recognized a reduction of 21% and
16%, respectively, to the effective tax rate due to foreign earnings taxed at lower rates. In fiscal year 2011, we settled a
portion of an I.R.S. audit of tax years 2004 to 2006, which reduced our income tax expense for fiscal year 2011 by $461
million and reduced the effective tax rate by 2%.
Changes in the mix of income before income taxes between the U.S. and foreign countries also impacted our effective tax
rates and resulted primarily from changes in the geographic distribution of and changes in consumer demand for our
products and services. As discussed above, Windows Division operating income declined $751 million in fiscal year 2012,
while MBD and Server and Tools operating income increased $1.1 billion and $1.1 billion, respectively, during this same
period. We supply Windows, our primary Windows Division product, to customers through our U.S. regional operating
center, while we supply the Microsoft Office System, our primary MBD product, and our Server and Tools products to
customers through our foreign regional operations centers. In fiscal years 2012 and 2011, our U.S. income before income
taxes was $1.6 billion and $8.9 billion, respectively, and comprised 7% and 32%, respectively, of our income before
income taxes. In fiscal years 2012 and 2011, the foreign income before income taxes was $20.7 billion and $19.2 billion,
respectively, and comprised 93% and 68%, respectively, of our income before income taxes. The primary driver for the
decrease in the U.S. income before income tax in fiscal year 2012 was the goodwill impairment charge.
Tax contingencies and other tax liabilities were $7.6 billion and $7.4 billion as of June 30, 2012 and 2011, respectively,
and are included in other long-term liabilities. While we settled a portion of the I.R.S. audit for tax years 2004 to 2006
during the third quarter of fiscal year 2011, we remain under audit for these years. In February 2012, the I.R.S. withdrew
its 2011 Revenue Agents Report and reopened the audit phase of the examination. As of June 30, 2012, the primary
unresolved issue relates to transfer pricing which could have a significant impact on our financial statements if not
resolved favorably. We believe our allowances for tax contingencies are appropriate. We do not believe it is reasonably
possible that the total amount of unrecognized tax benefits will significantly increase or decrease within the next 12
months, as we do not believe the remaining open issues will be resolved within the next 12 months. We also continue to
be subject to examination by the I.R.S. for tax years 2007 to 2011.
Fiscal year 2011 compared with fiscal year 2010
Our effective tax rates for fiscal years 2011 and 2010 were approximately 18% and 25%, respectively. Our effective tax
rate was lower than the U.S. federal statutory rate and our prior year effective rate primarily due to a higher mix of
earnings taxed at lower rates in foreign jurisdictions resulting from producing and distributing our products and services
through our foreign regional operations centers in Ireland, Singapore, and Puerto Rico, which have lower income tax
rates. In fiscal years 2011 and 2010, our U.S. income before income taxes was $8.9 billion and $9.6 billion, respectively,
and comprised 32% and 38%, respectively, of our income before income taxes. In fiscal years 2011 and 2010, the foreign
income before income taxes was $19.2 billion and $15.4 billion, respectively, and comprised 68% and 62%, respectively,
of our income before income taxes. In fiscal years 2011 and 2010, the reduction of the U.S. federal statutory rate as a
result of foreign earnings taxed at lower rates was 16% and 12%, respectively.