INCOME TAXES

Earnings before income taxes for the years ended December 31 were taxed within the following jurisdictions:



In millions	2011			2010			2009
United States	$	(718.0	)	$	(38.7	)	$	(293.9	)
Non-U.S.	1,331.3			1,049.4			888.2
Total	$	613.3		$	1,010.7		$	594.3

The components of the Provision for income taxes for the years ended December 31 were as follows:



In millions	2011			2010			2009
Current tax expense (benefit):
United States	$	59.2		$	31.0		$	(22.7	)
Non-U.S.	202.6			114.5			141.1
Total:	261.8			145.5			118.4
Deferred tax expense (benefit):
United States	(120.0		)	84.9			10.8
Non-U.S.	45.4			(2.3		)	(47.7		)
Total:	(74.6		)	82.6			(36.9		)
Total tax expense (benefit):
United States	(60.8		)	115.9			(11.9		)
Non-U.S.	248.0			112.2			93.4
Total	$	187.2		$	228.1		$	81.5

The Provision for income taxes differs from the amount of income taxes determined by applying the applicable U.S. statutory income tax rate to pretax income, as a result of the following differences:



	Percent of pretax income
	2011		2010		2009
Statutory U.S. rate	35.0	%	35.0	%	35.0	%
Increase (decrease) in rates resulting from:
Subsidiaries results subject to non-U.S. tax rates⁽¹⁾	(32.7	)	(17.7	)	(30.2	)
U.S. tax on non-U.S. earnings⁽¹⁾	4.8		2.4		9.6
State and local income taxes⁽¹⁾	(4.7	)	—		9.2
Non-deductible goodwill write-off - Hussmann	23.2		—		—
Reserves for uncertain tax positions	5.8		0.1		(3.3	)
Impact of change in taxation of retiree drugs subsidy	—		4.0		—
Provision to return and other true-up adjustments	0.5		(0.2	)	(6.0	)
Other adjustments	(1.4	)	(1.0	)	(0.6	)
Effective tax rate	30.5	%	22.6	%	13.7	%


(1)	Net of changes in valuation allowances

Tax incentives, in the form of tax holidays, have been granted to the Company in certain jurisdictions to encourage industrial development. The expiration of these tax holidays varies by country. The tax holidays are conditional on the Company meeting certain employment and investment thresholds. The most significant tax holidays relate to the Company’s qualifying locations in Ireland, China and Puerto Rico. The benefit for the tax holidays for the years ended December 31, 2011 and 2010 was $15.2 million and $10.1 million, respectively.

At December 31, a summary of the deferred tax accounts were as follows:



In millions	2011			2010
Deferred tax assets:
Inventory and accounts receivable	$	26.8		$	34.9
Fixed assets and intangibles	4.0			2.6
Postemployment and other benefit liabilities	814.3			750.2
Product liability	258.7			282.7
Other reserves and accruals	213.8			210.9
Net operating losses and credit carryforwards	1,002.9			1,075.4
Other	148.7			169.7
Gross deferred tax assets	2,469.2			2,526.4
Less: deferred tax valuation allowances	(333.8		)	(378.7		)
Deferred tax assets net of valuation allowances	$	2,135.4		$	2,147.7
Deferred tax liabilities:
Inventory and accounts receivable	$	(44.9	)	$	(48.5	)
Fixed assets and intangibles	(2,149.3		)	(2,324.1		)
Postemployment and other benefit liabilities	(4.6		)	(2.9		)
Other reserves and accruals	(6.6		)	(12.5		)
Other	(74.3		)	(85.0		)
Gross deferred tax liabilities	(2,279.7		)	(2,473.0		)
Net deferred tax assets (liabilities)	$	(144.3	)	$	(325.3	)

At December 31, 2011, no deferred taxes have been provided for any portion of the $6.6 billion of undistributed earnings of the Company’s subsidiaries, since these earnings have been, and under current plans will continue to be, permanently reinvested in these subsidiaries. It is not practicable to estimate the amount of additional taxes which may be payable upon distribution.

At December 31, 2011, the Company had the following operating loss and tax credit carryforwards available to offset taxable income in prior and future years:



In millions	Amount		Expiration Period
U.S. Federal net operating loss carryforwards	$	1,613.1	2012-2031
U.S. Federal credit carryforwards	85.4		2014-2031
U.S. State net operating loss carryforwards	3,342.1		2012-2031
Non-U.S. net operating loss carryforwards	1,124.7		2012-Unlimited
Non-U.S. credit carryforwards	8.9		Unlimited

The amount of net operating loss carryforwards for which a benefit would be recorded in additional paid in capital when realized is $176.3 million.

The U.S. state net operating loss carryforwards were incurred in various jurisdictions. The non-U.S. net operating loss carryforwards were incurred in various jurisdictions, predominantly in Barbados, Belgium, Brazil, Germany, Spain, and the United Kingdom.

Activity associated with the Company’s valuation allowance is as follows:



In millions	2011			2010			2009
Beginning balance	$	378.7		$	352.6		$	247.8
Increase to valuation allowance	17.0			106.9			166.0
Decrease to valuation allowance	(52.2		)	(45.9		)	(17.8		)
Other deductions	(1.5		)	(1.5		)	(4.9		)
Write off against valuation allowance	—			—			(41.3		)
Acquisition and purchase accounting	—			—			(38.9		)
Accumulated other comprehensive income (loss)	(8.2		)	(33.4		)	41.7
Ending balance	$	333.8		$	378.7		$	352.6

The Company has total unrecognized tax benefits of $536.9 million and $534.1 million as of December 31, 2011, and December 31, 2010, respectively. The amount of unrecognized tax benefits that, if recognized, would affect the effective tax rate are $467.5 million as of December 31, 2011. A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows:



In millions	2011			2010			2009
Beginning balance	$	534.1		$	525.1		$	589.6
Additions based on tax positions related to the current year	16.7			14.1			25.2
Additions based on tax positions related to acquisitions	—			—			—
Additions based on tax positions related to prior years	64.9			116.3			80.5
Reductions based on tax positions related to prior years	(63.6		)	(101.4		)	(121.8		)
Reductions related to settlements with tax authorities	(3.7		)	(11.9		)	(33.4		)
Reductions related to lapses of statute of limitations	(10.4		)	(6.0		)	(18.9		)
Translation (gain)/loss	(1.1		)	(2.1		)	3.9
Ending balance	$	536.9		$	534.1		$	525.1

In connection with Trane’s spin-off of WABCO Holdings Inc. (WABCO), Trane and WABCO entered into a tax sharing agreement for the allocation of pre spin-off taxes. Of the total unrecognized tax benefit of $536.9 million at December 31, 2011, WABCO has agreed to indemnify Trane for $7.6 million, which is reflected in an other long-term receivable account.

The Company records interest and penalties associated with the uncertain tax positions within its Provision for income taxes. The Company had reserves associated with interest and penalties, net of tax, of $108.3 million and $100.4 million at December 31, 2011, and December 31, 2010, respectively. For the year ended December 31, 2011 and December 31, 2010, the Company recognized $12.3 million and $19.1 million, respectively, in interest and penalties net of tax related to these uncertain tax positions.

It is reasonably possible that the total amount of unrecognized tax benefits could change within 12 months as a result of settlements of ongoing tax examinations resulting in a decrease of approximately $21.4 million in the unrecognized tax benefits.

The provision for income taxes involves a significant amount of management judgment regarding interpretation of relevant facts and laws in the jurisdictions in which the Company operates. Future changes in applicable laws, projected levels of taxable income and tax planning could change the effective tax rate and tax balances recorded by the Company. In addition, tax authorities periodically review income tax returns filed by the Company and can raise issues regarding its filing positions, timing and amount of income or deductions, and the allocation of income among the jurisdictions in which the Company operates. A significant period of time may elapse between the filing of an income tax return and the ultimate resolution of an issue raised by a revenue authority with respect to that return. In the normal course of business the Company is subject to examination by taxing authorities throughout the world, including such major jurisdictions as Brazil, Canada, Germany, Ireland, Italy, the Netherlands and the United States. In general, the examination of the Company’s material tax returns is completed for the years prior to 2001, with certain matters being resolved through appeals and litigation.

On July 20, 2007, the Company received a notice from the IRS containing proposed adjustments to the Company’s tax filings in connection with an audit of the 2001 and 2002 tax years. The IRS did not contest the validity of the Company’s reincorporation in Bermuda. The most significant adjustments proposed by the IRS involve treating the entire intercompany debt incurred in connection with the Company’s reincorporation in Bermuda as equity. As a result of this recharacterization, the IRS disallowed the deduction of interest paid on the debt and imposed dividend withholding taxes on the payments denominated as interest. The IRS also asserted an alternative argument to be applied if the intercompany debt is respected as debt. In that circumstance the IRS proposed to ignore the entities that hold the debt and to which the interest was paid and impose 30% withholding tax on a portion of the interest payments as if they were made directly to a company that was not eligible for reduced U.S withholding tax under a U.S income tax treaty. The IRS asserted under this alternative theory that the Company owes additional taxes with respect to 2002 of approximately $84 million plus interest. The Company strongly disagreed with the view of the IRS and filed a protest with the IRS in the third quarter of 2007.

On January 12, 2010, the Company received an amended notice from the IRS eliminating its assertion that the intercompany debt incurred in connection with the Company’s reincorporation in Bermuda should be treated as equity. However, the IRS continues to assert the alternative position described above and proposes adjustments to the Company’s 2002 tax filings. If this alternative position is upheld, the Company would be required to record additional charges. In addition, the IRS provided notice on January 19, 2010, that it is assessing penalties of 30% on the asserted underpayment of tax described above.

The Company has and intends to continue to vigorously contest these proposed adjustments. The Company, in consultation with its outside advisors, carefully considered the form and substance of the Company’s intercompany financing arrangements including the actions necessary to qualify for the benefits of the applicable U.S. income tax treaties. The Company believes that these financing arrangements are in accordance with the laws of the relevant jurisdictions including the U.S., that the entities involved should be respected and that the interest payments qualify for the U.S income tax treaty benefits claimed.

Although the outcome of this matter cannot be predicted with certainty, based upon an analysis of the merits of the Company's position, the Company believes that it is adequately reserved for this matter and does not expect that the ultimate resolution will have a material adverse impact on its future results of operations, financial condition, or cash flows. As the Company moves forward to resolve this matter with the IRS, the reserves established may be adjusted. Although the Company continues to contest the IRS's position, there can be no assurance that it will be successful. If the IRS's position with respect to 2002 is ultimately sustained it will have a material adverse impact on the Company's future results of operations, financial condition and cash flows.

Although the Company expects them to do so, at this time the IRS has not yet proposed any similar adjustments for years subsequent to 2002 as the federal income tax audits for those years are still in process or have not yet begun. It is unclear how the IRS will apply their position to subsequent years or whether the IRS will take a similar position with respect to other intercompany debt instruments.

The Company believes that it has adequately provided for any reasonably foreseeable resolution of any tax disputes, but will adjust its reserves if events so dictate in accordance with GAAP. To the extent that the ultimate results differ from the original or adjusted estimates of the Company, the effect will be recorded in the Provision for income taxes.

As a result of the Healthcare Reform Legislation, defined in Note 10, effective 2013, the tax benefits available to the Company will be reduced to the extent its prescription drug expenses are reimbursed under the Medicare Part D retiree drug subsidy program. Although the provisions of the Healthcare Reform Legislation relating to the retiree drug subsidy program do not take effect until 2013, the Company is required to recognize the full accounting impact in its financial statements in the reporting period in which the Healthcare Reform Legislation is enacted. As retiree healthcare liabilities and related tax impacts are already reflected in the Company’s financial statements, the Healthcare Reform Legislation resulted in a non-cash charge to income tax expense in the first quarter of 2010 of $40.5 million.

The Healthcare Reform Legislation contains provisions which could impact our accounting for income taxes in future periods. We will continue to assess the accounting implications of the Healthcare Reform Legislation. In addition, we may consider plan amendments in future periods that may have accounting implications.

During 2011, the Company identified certain accounting errors associated with its previously reported income tax balances and tax positions. The Company corrected these errors in 2011 resulting in a tax charge of approximately $35 million, of which $30 million was recorded in the third quarter, primarily related to the accrual of a previously unrecorded future withholding tax liability. The Company does not believe that the accounting errors are material to 2011 or to any of its previously issued financial statements. As a result, the Company did not adjust any prior period amounts.

During 2011 and 2010, the Company recorded to continuing operations a tax benefit of approximately $27 million and $20 million, respectively as a result of reducing its deferred tax asset valuation allowance for state net operating losses.

During 2009, the Company identified certain accounting errors associated with its previously reported income tax balance sheet accounts. The Company corrected these errors in 2009, which resulted in a tax benefit for the year of $13 million recorded to continuing operations and a tax charge for the year of $29 million recorded to discontinued operations.

In addition, during 2009, the Company recorded a net tax charge to continuing operations of approximately $35 million. The net charge was primarily driven by an increase in its deferred tax asset valuation allowances for state net operating losses and a write-off of foreign tax credit carryforwards offset by a reduction in its liability for unrecognized tax benefits. During 2009, the Company also recorded within discontinued operations a tax benefit of $22 million primarily resulting from reducing its liability for unrecognized tax benefits.