3 Income taxes

Income before income tax is analyzed as follows:

The provision for income taxes consisted of:

Included in the income tax payable is a current tax benefit of £2,546,000 (2006: £3,682,000; 2005: £370,000) and a deferred tax credit of £nil (2006: £nil; 2005: £6,072,000) in relation to employee stock options. Such benefits are reflected as additional paid-in capital.

Also included in the provision for income taxes is utilization of the deferred tax liability in relation to acquired intangibles of £7,231,000 (2006: 6,264,000; 2005: £6,921,000).

Total income tax expense differs from the amounts computed by applying the UK statutory income tax rate of 30% for 2007, 2006 and 2005 to income before income tax as a result of the following:

* The 2005 and 2006 comparatives have been reclassified for comparability with 2007.
** Permanent differences comprise permanent adjustments and benefits resulting from re-structuring following the acquisition of Artisan.
*** Other, net comprises prior year adjustments and deferred tax adjustments.

Significant components of the deferred tax assets/(liabilities) are as follows:

Disclosed on the balance sheet within:

Included in the amount of £12,691,000 (2006: £20,074,000) relating to intangible assets on acquisition is £6,735,000 (2006: £13,178,000) relating to liabilities that are expected to accrue after more than one year.

The valuation allowance for deferred tax assets increased by £3,525,000 in 2007 primarily due to non-deductible interest carryforwards of certain foreign subsidiaries, where management believes it is more likely than not that such amounts will not be realised. If or when recognised, the benefits relating to any reversal of the valuation allowance on deferred tax assets at 31 December 2007 will be accounted for as follows: £8,034,000 as a reduction of income tax expense and £1,540,000 as a reduction of goodwill.

The Company has net operating loss carryforwards for tax purposes and other deferred tax benefits that are available to offset against future taxable income. At 31 December 2007 the Company has US federal, US state, United Kingdom, Norwegian, French and Belgian net operating loss carryforwards of approximately £13.7 million, £14.2 million, £10.2 million, £1.9 million, £6.4 million and £1.3 million respectively. If unutilized, the US federal net operating loss will begin to expire in 2019 and the US state net operating loss will begin to expire in 2013.

In addition to the net operating losses the Company also had unutilized federal R&D tax credits of £5,737,000 which will begin to expire in 2012 and unutilized state R&D tax credits of £3,191,000 which have no expiration date.

The future use of the net operating losses carried forward in ARM Inc. may be restricted in the event of a purchase by a third party, whereby the level of losses to be utilized on an annual basis would be limited to 4% of the market value of ARM Inc. at the date of the transaction.

As a result of FAS 123R, the Company’s deferred tax assets at 31 December 2007 do not include £2,713,000 of excess tax benefits from employee share option exercises in 2007 and £1,909,000 due to exercises in 2006 that are a component of the Company’s research and development and net operating loss carryovers. Equity will be increased by £4,622,000 if and when such excess tax benefits are ultimately realized.

Undistributed earnings of the Company’s foreign subsidiaries amounted to approximately £31,655,000 (2006: £31,809,000) at 31 December 2007. Those earnings are considered to be indefinitely reinvested and accordingly no UK income taxes have been provided thereon. If these earnings were to be remitted without offsetting tax credits in the UK, taxes would be approximately £7,981,000 (2006: £10,758,000).

On 1 January 2007, the Company adopted the provisions of FIN 48 “Accounting for Uncertainty in Income Taxes”. As a result of applying the provisions of FIN 48, the Company recognised a decrease of £838,000 in the liability for unrecognised tax benefits, which was accounted for as an increase to the opening retained earnings. The Company’s unrecognised tax benefits at 31 December 2007 relate to the UK and various foreign jurisdictions. The following table summarises the movements in unrecognised tax benefits:

Included in the balance at 31 December 2007 are £3,175,000 of tax benefits that, if recognised, would reduce our annual effective tax rate. The Company recognised accrued interest of £131,000 related to these unrecognised tax benefits during 2007 in income tax expense. The Company does not expect its unrecognised tax benefits to change significantly over the next 12 months.

The tax years 2004 through to 2007 generally remain subject to examination by the UK tax authorities. In the US, the tax years 2001 through to 2007 generally remain subject to examination by federal and most state tax authorities.