ADOBE INC. - 10-K filing on 2022-01-21

Income Taxes

12 Months Ended

Dec. 03, 2021

Income before income taxes for fiscal 2021, 2020 and 2019 consisted of the following:


(in millions)	2021		2020		2019
Domestic	$	1,736	$	1,090	$	438
Foreign	3,969		3,086		2,767
Income before income taxes	$	5,705	$	4,176	$	3,205

The provision for (benefit from) income taxes for fiscal 2021, 2020 and 2019 consisted of the following:


(in millions)	2021		2020		2019
Current:
United States federal	$	391	$	119	$	7
Foreign	197		222		211
State and local	103		79		31
Total current	691		420		249
Deferred:
United States federal	(148)		(123)		23
Foreign	359		(1,313)		(12)
State and local	(19)		(68)		(6)
Total deferred	192		(1,504)		5
Provision for (benefit from) income taxes	$	883	$	(1,084)	$	254

Intra-Entity Transfers of Certain Intellectual Property Rights (“IP rights”)

During fiscal 2020, we completed intra-entity transfers of certain IP rights to our Irish subsidiary in order to better align the ownership of these rights with how our business operates. The transfers did not result in taxable gains; however, our Irish subsidiary recognized deferred tax assets for the book and tax basis difference of the transferred IP rights. As a result of these transactions, we recorded deferred tax assets, net of valuation allowance, and related tax benefits totaling $1.35 billion, based on the fair value of the IP rights transferred. The determination of the fair value involves significant judgment on future revenue growth, operating margins and discount rates. The tax-deductible amortization related to the transferred IP rights is recognized over the period of economic benefit.

Reconciliation of Provision for (Benefit from) Income Taxes

Total income tax expense differed from the expected tax expense, computed by multiplying the U.S. federal statutory rate of 21% in fiscal 2021, 2020 and 2019 by income before income taxes, as a result of the following:


(in millions)	2021		2020		2019
Computed “expected” tax expense	$	1,198	$	877	$	673
Impacts of intra-entity IP transfers	—		(1,360)		—
Effects of non-U.S. operations	(23)		(337)		(224)
Stock-based compensation	(157)		(154)		(86)
Tax credits	(149)		(101)		(100)
Resolution of income tax examinations	(58)		(23)		(39)
State tax expense, net of federal benefit	66		10		24
Other	6		4		6
Provision for (benefit from) income taxes	$	883	$	(1,084)	$	254

Deferred Tax Assets and Liabilities

The tax effects of the temporary differences that gave rise to significant portions of the deferred tax assets and liabilities as of December 3, 2021 and November 27, 2020 were as follows:


(in millions)	2021		2020
Deferred tax assets:
Intangible assets	$	997	$	1,368
Capitalized expenses	355		292
Credit carryforwards	287		218
Operating lease liabilities	122		131
Net operating loss carryforwards of acquired companies	131		54
Stock-based compensation	91		92
Reserves and accruals	89		71
Benefits relating to tax positions	39		44
Other	46		37
Total gross deferred tax assets	2,157		2,307
Valuation allowance	(335)		(276)
Total deferred tax assets	1,822		2,031
Deferred tax liabilities:
Acquired intangible assets	447		330
Operating lease right-of-use assets	111		131
Prepaid expenses	123		107
Depreciation and amortization	49		52
Undistributed earnings of foreign subsidiaries	12		51
Total deferred tax liabilities	742		671
Net deferred tax assets	$	1,080	$	1,360

Deferred tax assets and liabilities are recognized for the expected future tax consequences of temporary differences between the financial reporting and tax bases of assets and liabilities, and for operating losses and tax credit carryforwards. In assessing the realizability of deferred tax assets, management determined that it is not more likely than not that we will have sufficient taxable income in certain states and foreign jurisdictions to fully utilize available tax credits and other attributes. The

deferred tax assets are offset by a valuation allowance to the extent it is more likely than not that they are not expected to be realized.

We provide U.S. income taxes on the earnings of foreign subsidiaries unless the subsidiaries’ earnings are considered permanently reinvested outside the United States or are exempted from further taxation. As of December 3, 2021, the cumulative amount of foreign earnings upon which U.S. income taxes have not been provided, and the corresponding unrecognized deferred tax liability, was not material.

As of December 3, 2021, we had federal, state and foreign net operating loss carryforwards of approximately $395 million, $467 million and $61 million, respectively. We also had federal, state and foreign tax credit carryforwards of approximately $35 million, $307 million and $9 million, respectively. The majority of the federal net operating loss and state tax credit carryforwards can be carried forward indefinitely, and the remaining will expire in various years from fiscal 2022 through 2040. Certain net operating loss carryforward assets and tax credits are reduced by a valuation allowance and/or are subject to an annual limitation under Internal Revenue Code Section 382. The carrying amount of such assets and credits is expected to be fully realized.

As of December 3, 2021, a valuation allowance of $335 million was established for deferred tax assets related to certain state and foreign assets. For fiscal 2021, the increase in the valuation allowance was $59 million.

Accounting for Uncertainty in Income Taxes

During fiscal 2021 and 2020, the aggregate changes in our total gross amount of unrecognized tax benefits were as follows:


(in millions)	2021		2020
Beginning balance	$	201	$	173
Gross increases in unrecognized tax benefits – prior year tax positions	30		14
Gross increases in unrecognized tax benefits – current year tax positions	86		44
Lapse of statute of limitations	(21)		(23)
Settlements with taxing authorities	(4)		(11)
Foreign exchange gains and losses	(3)		4
Ending balance	$	289	$	201

The combined amount of accrued interest and penalties related to tax positions taken on our tax returns were approximately $22 million and $26 million for fiscal 2021 and 2020, respectively. These amounts were included in long-term income taxes payable in their respective years.

While we file federal, state and local income tax returns globally, our major tax jurisdictions are Ireland, California and the United States. We are subject to the examination of our income tax returns by the U.S. Internal Revenue Service and other domestic and foreign tax authorities. These tax examinations are expected to focus on our research and development tax credits, intercompany transfer pricing practices and other matters. For Ireland, California and the United States, the earliest fiscal years open for examination are 2008, 2017 and 2018, respectively. We regularly assess the likelihood of outcomes resulting from these examinations to determine the adequacy of our provision for income taxes and have reserved for potential adjustments that may result from these examinations. We believe such estimates to be reasonable; however, we cannot provide assurance that the final determination of any of these examinations will not have an adverse effect on our operating results and financial position.

The timing of the resolution of income tax examinations is highly uncertain as are the amounts and timing of tax payments that are part of any audit settlement process. These events could cause large fluctuations in the balance sheet classification of our tax assets and liabilities. We believe that within the next 12 months, it is reasonably possible that either certain audits will conclude or statutes of limitations on certain income tax examination periods will expire, or both. Given the uncertainties described above, we can only determine a range of estimated potential decreases in underlying unrecognized tax benefits ranging from $0 to approximately $5 million over the next 12 months.