Dolby Laboratories (DLB)

Income Taxes

Our quarterly provision for income taxes includes U.S. federal, state and international income taxes and is based on our estimated annual effective tax rate. We estimate our annual effective tax rate based on projections of our income before taxes for the full fiscal year. However, events that occur in a quarter are reflected as discrete items, which could impact the tax rate. In the period that we file our annual tax returns, we true up our provision for income taxes to reflect any difference between our estimated provision and our filed tax return. A deferred tax liability is recognized for all future taxable temporary differences, and a deferred tax asset is recognized for all future deductible temporary differences. A valuation allowance is recognized if it is more likely than not that some portion of the deferred tax asset will not be realized.

Income Taxes

Our effective tax rate is based upon a projection of our annual fiscal year results. Our effective tax rate for the second quarter of fiscal 2008 was 34.3% compared to 35.5% for the second quarter of fiscal 2009. Our effective tax rate was 34.1% and 34.2% for the fiscal year-to-date periods ended March 28, 2008 and March 27, 2009, respectively. In the second quarter of fiscal 2009, a reduction in forecasted tax exempt interest income and Internal Revenue Code’s Section 199 manufacturer’s deduction resulted in a higher tax rate in comparison to the second quarter of fiscal 2008.

On February 19, 2009, the State of California enacted new legislation which will allow us to make an annual election to use a single sales factor based apportionment formula to allocate income beginning with our fiscal year ended 2012. We expect this change to impact our fiscal 2011 by reducing current deferred tax assets which are expected to reverse in periods in which the election is effective, likely resulting in an increase in our fiscal 2011 tax provision. Beginning in fiscal 2012 and thereafter, the likely impact of this change will also be a reduction to current California income tax expense. In addition, since certain of our existing long-term deferred tax assets are expected to reverse in fiscal 2012 and thereafter when the election is effective, we have recorded additional tax expense of $0.3 million in our second quarter of fiscal 2009 to reflect the estimated impact.

Income Taxes

Our quarterly provision for income taxes includes U.S. federal and state and international income taxes and is based on our estimated annual effective tax rate. We estimate our annual effective tax rate based on projections of our income before taxes for the full fiscal year. However, events that occur in a quarter are reflected as discrete items, which could impact the tax rate. In the period that we file our annual tax returns, we true up our provision for income taxes to reflect any difference between our estimated provision and our filed tax return. A deferred tax liability is recognized for all future taxable temporary differences, and a deferred tax asset is recognized for all future deductible temporary differences. A valuation allowance is recognized if it is more likely than not that some portion of the deferred tax asset will not be realized.

Income Taxes

Our effective tax rate is based upon a projection of our annual fiscal year results. Our effective tax rate for the first quarter of fiscal 2008 was 34% compared to 33% for the first quarter of fiscal 2009. In fiscal 2009, a change in tax law reinstated research and development tax credits for periods prior to fiscal 2009. As a result, we recognized an increase in research and development tax credits in the first quarter of fiscal 2009, thereby lowering our effective tax rate. We did not recognize a similar benefit in the first quarter of fiscal 2008.

Income Taxes

Our effective tax rate for fiscal 2007 was 31% compared to 38% for fiscal 2006. The decrease in
our effective tax rate was primarily due to an increase in certain manufacturing incentive tax deductions and an increase in our federal deduction for state taxes. In addition, our effective tax rate decreased from fiscal 2006 to fiscal 2007 due to
an increase in disqualifying dispositions of incentive stock options, an increase in tax free interest income generated from our investments and an increase in research and development tax credits in fiscal 2007 due to a change in the tax law.

In the fourth quarter of fiscal 2007, we increased our estimates for certain manufacturing incentives related to extraterritorial income
exclusions and federal domestic production deductions which decreased our tax rate for fiscal 2007 by approximately 3%.

Income Taxes

We account for income taxes in accordance with Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes (SFAS 109). SFAS 109 requires the use of the asset and liability method, under which deferred income tax assets and liabilities are determined based upon the difference between the financial statement carrying amounts and the tax bases of assets and liabilities and net operating loss carryforwards and are measured using the enacted tax rate expected to apply to taxable income in the years in which the differences are expected to be reversed. In assessing the realizability of deferred tax assets, we consider whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. We consider the scheduled reversal of deferred tax liabilities and projected future taxable income in making this assessment. We record a valuation allowance to reduce our deferred tax assets when uncertainty regarding their realizability exists. See Note 6 “Income Taxes” for further discussion.

The Company adopted the provisions of FASB Interpretation No. 48 (FIN 48), Accounting for Uncertainty in Income Taxes, effective September 29, 2007. The cumulative effect of adopting FIN 48 was a decrease in tax reserves of $0.3 million, resulting in a corresponding increase of $0.3 million to the September 29, 2007 retained earnings balance.

Our policy to include interest and penalties related to gross unrecognized tax benefits within our provision for income taxes did not change upon the adoption of FIN 48. To the extent accrued interest and penalties do not ultimately become payable, amounts accrued are reduced in the period that such determination is made, and reflected as a reduction of the overall income tax provision.

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Income Taxes

Our effective tax rate is based upon our projection of annual fiscal year results. Our effective tax rate in the third quarter of fiscal 2007 was 35%, compared to 34% in the third quarter of fiscal 2008. The change in our effective tax rate from the third quarter of fiscal 2007 to the third quarter of fiscal 2008 was due to additional tax benefits identified in the fiscal 2007 tax return, which were recorded in the third quarter of fiscal 2008 as a result of a change in our estimate and an increase in Section 199 domestic production deduction benefits. The decrease in our effective tax rate was partially offset by a decreased impact of tax exempt interest income. Our effective tax rate was 35% for the fiscal year-to-date period ended June 29, 2007, compared to 34% for the fiscal year-to-date period ended June 27, 2008. The change in our effective tax rate for the fiscal year-to-date period ended June 29, 2007 to the fiscal year-to-date period ended June 27, 2008, was primarily due to additional tax benefits identified in the fiscal 2007 tax return, which were recorded in the fiscal 2008 as a result of a change in our estimate and an increase in Section 199 domestic production deduction benefits for fiscal 2008.

For United States federal income tax purposes, a corporation is generally considered to be a “personal holding company” under the United States Internal Revenue Code if (i) at any time during the last half of its taxable year more than 50% of its stock by value is owned, directly or indirectly, by virtue of the application of certain stock ownership attribution rules set forth in the Internal Revenue Code for purposes of applying the personal holding company rules, by five or fewer individuals and (ii) at least 60% of its adjusted ordinary gross income, as defined for United States federal income tax purposes, is “personal holding company income.” A personal holding company is subject to an additional tax on its undistributed after-tax income, calculated at the statutory tax rate, which is currently 15%. Since the personal holding company tax is imposed only on undistributed income, a personal holding company can avoid or mitigate liability for the tax, but not interest or penalties, by paying a dividend to its stockholders. We meet the ownership test as a personal holding company. Personal holding company income is generally passive income, including royalty income, but does not include certain qualifying software royalties. In July 2008, we received a private ruling from the Internal Revenue Service that, subject to certain factual representations, the licensing fees received by us will be considered qualifying software royalties. Therefore, given our current sources of revenue, we believe that neither we nor any of our subsidiaries is currently liable for personal holding company tax.

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Income Taxes

Our effective tax rate is based upon a projection of annual fiscal year results. Our effective tax rate in the second quarter of fiscal 2007 was 37%, compared to 34% for the second quarter of fiscal 2008. Our effective tax rate was 35% for the fiscal year-to-date period ended March 30, 2007, compared to 34% for the fiscal year-to-date period ended March 28, 2008. The change in our effective tax rate from the second quarter of fiscal 2007 to the second quarter of fiscal 2008 was due primarily to an increase in domestic production deductions and deductions related to disqualifying dispositions in the second quarter of fiscal 2008. The change in our effective tax rate for the fiscal year-to-date period ended March 30, 2007 to the fiscal year-to-date period ended March 28, 2008, was primarily due to an increase in domestic production deductions.

Income Taxes

Our effective tax rate is based upon a projection of annual fiscal year results. Our effective tax rate in the first quarter of fiscal 2007 was 32%, compared to 34% for the first quarter of fiscal 2008. In fiscal 2007, a change in tax law reinstated research and development tax credits for periods prior to fiscal 2007. As a result, we recognized an increase in research and development tax credits in the first quarter of fiscal 2007 thereby lowering our effective tax rate. We did not recognize a similar benefit in the first quarter of fiscal 2008.

Income Taxes

We account for income taxes in accordance with Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes (SFAS 109). SFAS 109 requires the use of the asset and liability method, under which deferred income tax assets and liabilities are determined based upon the difference between the financial statement carrying amounts and the tax bases of assets and liabilities and net operating loss carryforwards and are measured using the enacted tax rate expected to apply to taxable income in the years in which the differences are

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expected to be reversed. In assessing the realizability of deferred tax assets, we consider whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. We consider the scheduled reversal of deferred tax liabilities and projected future taxable income in making this assessment. We record a valuation allowance to reduce our deferred tax assets when uncertainty regarding their realizability exists. See Note 6 “Income Taxes” for further discussion.

Income Taxes

Our effective tax rate is based upon a projection of annual fiscal year results. Our effective tax rate in the third quarter of fiscal 2006 was 38%, compared to 35% for the third quarter of fiscal 2007 and 38% for the fiscal year-to-date period ended June 30, 2006, compared to 35% for the fiscal year-to-date period ended June 29, 2007. The decrease in our effective tax rate from the third quarter of fiscal 2006 to the third quarter of fiscal 2007 was due primarily to the increase in projected tax-exempt interest income. In the third quarter of fiscal 2007, we determined that we had incorrectly estimated the amount of tax-free interest income that we expect for the full year of fiscal 2007. As a result, we adjusted our provision for income taxes in the third quarter of fiscal 2007 by $1.4 million related to the first two quarters of fiscal 2007. We concluded that the impact of this adjustment was not material to the third quarter of fiscal 2007 or any prior quarters.

The change in our effective tax rate for the fiscal year-to-date period ended June 29, 2006 to the fiscal year-to-date period ended June 29, 2007 was due primarily to a taxable gain on the transfer of intellectual property from a foreign subsidiary in the second quarter of fiscal 2006, an increase in tax deductions related to disqualifying dispositions of incentive stock options, an increase in the projected tax-exempt interest income and an increase in research and development tax credits resulting from a change in the tax law. This change in tax law reinstated the research and development tax credits for periods prior to fiscal 2007.

Income Taxes

Our effective tax rate is based upon a projection of annual fiscal year results. Our effective tax rate in the second quarter of fiscal 2006 was 38%, compared to 37% for the second quarter of fiscal 2007 and 38% for the fiscal year-to-date period ended March 31, 2006, compared to 35% for the fiscal year-to-date period ended March 30, 2007. The change in our effective tax rate from the second quarter of fiscal 2006 to the second quarter of fiscal 2007 was due primarily to a taxable gain on the transfer of intellectual property from a foreign subsidiary in the second quarter of fiscal 2006 and an increase in tax deductions in the second quarter of fiscal 2007 related to disqualifying dispositions of incentive stock options. The change in our effective tax rate for the fiscal year-to-date period ended March 30, 2006 to the fiscal year-to-date period ended March 30, 2007 was due primarily to increases in research and development tax credits resulting from a change in the tax law. This change reinstated the research and development tax credits for periods prior to fiscal 2007. In addition, in fiscal 2007, an increase in tax deductions related to disqualifying dispositions of incentive stock options, as well as the generation of tax-exempt interest income, further decreased our effective tax rate for the fiscal year-to-date period ended March 30, 2007. For the remaining quarters of fiscal 2007, we expect our effective tax rate to be approximately 38%. However, our tax rate could be affected by future events, including disqualifying dispositions of shares acquired under our equity compensation plans.

Income Taxes

Our effective tax rate is based upon projection of annual fiscal year results. Our effective tax rate in the first quarter of fiscal 2006 was 37%, compared to 32% for the first quarter of fiscal 2007. The change in our effective tax rate from the first quarter of fiscal 2006 to the first quarter of fiscal 2007 was due primarily to increases in research and development tax credits resulting from a change in the tax law. This change reinstated the research and development tax credits for periods prior to the first quarter of fiscal 2007. In addition, in the first quarter of fiscal 2007, an increase in tax deductions related to disqualifying dispositions of incentive stock options, as well as the generation of tax-exempt interest income, further decreased our effective tax rate. For the remaining quarters of fiscal 2007 we expect our effective tax rate to be approximately 38% excluding the impact of any further disqualifying dispositions of incentive stock options.

Income Taxes

We account for income taxes in accordance with Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes (SFAS 109). SFAS 109 requires the use of the asset and liability method, under which deferred income tax assets and liabilities are determined based upon the difference between the financial statement carrying amounts and the tax bases of assets and liabilities and are measured using the enacted tax rate expected to apply to taxable income in the years in which the differences are expected to be reversed. In assessing the realizability of deferred tax assets, we consider whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. We consider the scheduled reversal of deferred tax liabilities and projected future taxable income in making this assessment. We record a valuation allowance to reduce our deferred tax assets when uncertainty regarding their realizability exists. See Note 5 “Income Taxes” for further discussion.

Income Taxes

Our effective tax rate is based upon projection of annual fiscal year results. In the third quarter of fiscal 2005, our effective tax rate was 45%, while our effective tax rate for fiscal 2005 was 41%. Our effective tax rate for the third quarter of fiscal 2006 was 38%, lower than in the third quarter of fiscal 2005, primarily due to income from a foreign subsidiary which is not included in taxable income in the third quarter of fiscal 2006 compared to a loss from a foreign subsidiary in the third quarter of fiscal 2005, a decrease in non-deductible stock-based compensation expense related to the exercise of incentive stock options, as well as tax exempt interest income from investments.

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Income Taxes

Our effective tax rate is based upon projection of annual fiscal year results. In the second quarter of fiscal 2005, our effective tax rate was 43%, while our effective tax rate for fiscal 2005 was 41%. Our effective tax rate for the second quarter of fiscal 2006 was 38%, lower than in the second quarter of fiscal 2005, primarily due to income from a foreign subsidiary which is not included in taxable income in the second quarter of fiscal 2006 compared to a loss from a foreign subsidiary in the second quarter of fiscal 2005 as well as an update to our fiscal 2006 projections from which we determine our expected effective tax rate. We expect our effective tax rate for fiscal year 2006 to be approximately 40%.

Income Taxes

Our effective tax rate is based upon projection of annual fiscal year results. In the first quarter of fiscal 2005, our effective tax rate was 42%, while our effective tax rate for fiscal 2005 was 41%. Our effective tax rate for the first quarter of fiscal 2006 was 37%, lower than in the first quarter of fiscal 2005, primarily due to a smaller loss from a foreign subsidiary compared to the first quarter of fiscal 2005 and a change in the classification of certain stock-based awards. We expect our effective tax rate for fiscal year 2006 to be approximately 40% to 43%.

Income Taxes

We account for income taxes in accordance with Statement of Financial Accounting Standards No. 109, “Accounting for Income Taxes,” (SFAS 109). SFAS 109 requires the use of the asset and liability method, under which deferred income tax assets and liabilities are determined based upon the difference between the financial statement carrying amounts and the tax bases of assets and liabilities and are measured using the enacted tax rate expected to apply to taxable income in the years in which the differences are expected to be reversed. In assessing the realizability of deferred tax assets, we consider whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. We consider the scheduled reversal of deferred tax liabilities and projected future taxable income in making this assessment. We record a valuation allowance to reduce our deferred tax assets when uncertainty regarding their realizability exists.