Income Taxes

6 Months Ended

Jun. 30, 2013

Income Taxes

(11) INCOME TAXES

A reconciliation of PHI’s consolidated effective income tax rate from continuing operations is as follows:

	Three Months Ended June 30,										Six Months Ended June 30,
	2013					2012					2013					2012
	(millions of dollars)
Income tax at Federal statutory rate	$	25		35.0	%	$	29		35.0	%	$	(79	)	35.0	%	$	53		35.0	%
Increases (decreases) resulting from:
State income taxes, net of Federal effect		6		8.6	%		5		6.1	%		10		(4.4	)%		10		6.6	%
Asset removal costs		(3	)	(4.3	)%		(4	)	(4.9	)%		(6	)	2.7	%		(7	)	(4.6	)%
Change in estimates and interest related to uncertain and effectively settled tax positions		3		4.3	%		3		3.7	%		70		(31.1	)%		(10	)	(6.6	)%
Cross-border energy lease investments		6		8.6	%		(1	)	(1.2	)%		70		(31.1	)%		(2	)	(1.3	)%
Establishment of valuation allowances related to deferred tax assets		—		—			—		—			101		(44.9	)%		—		—
Other, net		(5	)	(6.5	)%		(3	)	(3.3	)%		1		(0.4	)%		(6	)	(3.9	)%
Consolidated income tax expense related to continuing operations	$	32		45.7	%	$	29		35.4	%	$	167		(74.2	)%	$	38		25.2	%

Three Months Ended June 30, 2013 and 2012

PHI’s consolidated effective tax rates for the three months ended June 30, 2013 and 2012 were 45.7% and 35.4%, respectively. The increase in the effective tax rate primarily resulted from a charge of $6 million in the second quarter of 2013 to reflect a change in estimate associated with state income taxes related to the reduction of the carrying value of PCI’s cross-border energy lease investments recorded in the first quarter of 2013.

Six Months Ended June 30, 2013 and 2012

PHI’s consolidated effective tax rates for the six months ended June 30, 2013 and 2012 were (74.2)% and 25.2%, respectively.

The negative effective tax rate for the six months ended June 30, 2013 occurred as a result of recording $70 million of changes in estimates and interest related to uncertain and effectively settled tax positions, primarily associated with the cross-border energy lease investments (as further discussed in Note (8), “Leasing Activities”) and the recognition of a $64 million charge primarily for the tax consequences associated with PHI’s change in intent regarding foreign investment opportunities available at the end of the full lease terms of the cross-border energy lease investments.

The negative effective tax rate further resulted from the establishment of valuation allowances of $101 million in the first quarter of 2013 against certain deferred tax assets in PHI’s Other Non-Regulated segment. Between 1990 and 1999, PCI, through various subsidiaries, entered into certain transactions involving investments in aircraft and aircraft equipment, railcars and other assets. In connection with these transactions, PCI recorded deferred tax assets in prior years of $101 million in the aggregate. Following events that took place during the first quarter of 2013, which included (i) court decisions in favor of the IRS with respect to both Consolidated Edison’s cross-border lease transaction (as discussed in Note (8), “Leasing Activities”) and another taxpayer’s structured transactions, (ii) the change in PHI’s tax position with respect to the tax benefits associated with its cross-border energy leases and (iii) PHI’s decision in March 2013 to begin to pursue the early termination of its remaining cross-border energy lease investments (which represents a substantial portion of the remaining assets within PCI) without the intent to reinvest these proceeds in income-producing assets, management evaluated the likelihood that PCI will be able to realize the $101 million of deferred tax assets in the future. Based on this evaluation, PCI established valuation allowances against these deferred tax assets totaling $101 million in the first quarter of 2013.

In 2012, PHI’s effective tax rate was impacted by the effective settlement with the IRS in the first quarter of 2012 with respect to the methodology used historically to calculate deductible mixed service costs and the expiration of the statute of limitations associated with an uncertain tax position in Pepco.

Potomac Electric Power Co [Member]

Income Taxes

(9) INCOME TAXES

A reconciliation of Pepco’s effective income tax rate is as follows:

	Three Months Ended June 30,										Six Months Ended June  30,
	2013					2012					2013					2012
	(millions of dollars)
Income tax at Federal statutory rate	$	20		35.0	%	$	12		35.0	%	$	29		35.0	%	$	19		35.0	%
Increases (decreases) resulting from:
State income taxes, net of Federal effect		3		5.3	%		2		5.6	%		5		6.1	%		3		5.7	%
Asset removal costs		(3	)	(5.3	)%		(4	)	(11.5	)%		(6	)	(7.3	)%		(7	)	(12.8	)%
Change in estimates and interest related to uncertain and effectively settled tax positions		1		1.8	%		(1	)	(3.5	)%		(4	)	(4.9	)%		(11	)	(20.2	)%
Other, net		(1	)	(1.7	)%		(1	)	(2.7	)%		(2	)	(2.1	)%		(1	)	(2.1	)%
Income tax expense	$	20		35.1	%	$	8		22.9	%	$	22		26.8	%	$	3		5.6	%

Three Months Ended June 30, 2013 and 2012

Pepco’s effective tax rates for the three months ended June 30, 2013 and 2012 and were 35.1% and 22.9%, respectively. The increase in the effective tax rate primarily resulted from changes in estimates and interest related to uncertain and effectively settled tax positions.

Six Months Ended June 30, 2013 and 2012

Pepco’s effective tax rates for the six months ended June 30, 2013 and 2012 were 26.8% and 5.6%, respectively. The increase in the effective tax rate primarily resulted from changes in estimates and interest related to uncertain and effectively settled tax positions.

On January 9, 2013, the U.S. Court of Appeals for the Federal Circuit issued an opinion in Consolidated Edison Company of New York, Inc. & Subsidiaries v. United States (to which Pepco is not a party) that disallowed tax benefits associated with Consolidated Edison’s cross-border lease transaction. As a result of the court’s ruling in this case, PHI has determined that it can no longer support its current assessment with respect to the likely outcome of tax positions associated with its cross-border energy lease investments held by its wholly-owned subsidiary Potomac Capital Investment Corporation, and PHI recorded a charge of $377 million (after-tax) in the first quarter of 2013. Included in the $377 million charge was an after-tax interest charge of $70 million and this amount was allocated to each member of PHI’s consolidated group as if each member was a separate taxpayer, resulting in Pepco recording a $5 million interest benefit in the first quarter of 2013.

In the first quarter of 2012, Pepco recorded benefits for changes in estimates and interest related to uncertain and effectively settled tax positions primarily due to the effective settlement with the Internal Revenue Service (IRS) with respect to the methodology used historically to calculate deductible mixed service costs and the expiration of the statute of limitations associated with an uncertain tax position.

Delmarva Power & Light Co/De [Member]

Income Taxes

(10) INCOME TAXES

A reconciliation of DPL’s effective income tax rate is as follows:

	Three Months Ended June 30,								Six Months Ended June 30,
	2013				2012				2013					2012
	(millions of dollars)
Income tax at federal statutory rate	$	7	35.0	%	$	8	35.0	%	$	22		35.0	%	$	20	35.0	%
Increases (decreases) resulting from:
State income taxes, net of federal effect		1	4.8	%		1	5.1	%		3		4.8	%		3	5.4	%
Change in estimates and interest related to uncertain and effectively settled tax positions		—	—			—	—			(1	)	(1.6	)%		—	(0.2	)%
Other, net		1	3.1	%		—	0.8	%		1		1.5	%		—	0.2	%
Income tax expense	$	9	42.9	%	$	9	40.9	%	$	25		39.7	%	$	23	40.4	%

Three Months Ended June 30, 2013 and 2012

DPL’s effective tax rates for the three months ended June 30, 2013 and 2012 were 42.9% and 40.9%, respectively.

Six Months Ended June 30, 2013 and 2012

DPL’s effective tax rates for the six months ended June 30, 2013 and 2012 were 39.7% and 40.4%, respectively. The decrease in the effective tax rate primarily resulted from changes in estimates and interest related to uncertain and effectively settled tax positions. On January 9, 2013, the U.S. Court of Appeals for the Federal Circuit issued an opinion in Consolidated Edison Company of New York, Inc. & Subsidiaries v. United States (to which DPL is not a party) that disallowed tax benefits associated with Consolidated Edison’s cross-border lease transaction. As a result of the court’s ruling in this case, PHI has determined that it can no longer support its current assessment with respect to the likely outcome of tax positions associated with its cross-border energy lease investments held by its wholly-owned subsidiary Potomac Capital Investment Corporation, and PHI recorded a charge of $377 million (after-tax) in the first quarter of 2013. Included in the $377 million charge was an after-tax interest charge of $70 million and this amount was allocated to each member of PHI’s consolidated group as if each member was a separate taxpayer, resulting in DPL recording a $1 million interest benefit in the first quarter of 2013.

Atlantic City Electric Co [Member]

Income Taxes

(9) INCOME TAXES

A reconciliation of ACE’s consolidated effective income tax rate is as follows:

	Three Months Ended June 30,									Six Months Ended June 30,
	2013					2012				2013					2012
	(millions of dollars)
Income tax at Federal statutory rate	$	4		35.0	%	$	8	35.0	%	$	6		35.0	%	$	8		35.0	%
Increases (decreases) resulting from:
State income taxes, net of Federal effect		1		9.1	%		1	4.2	%		1		5.9	%		1		4.0	%
Change in estimates and interest related to uncertain and effectively settled tax positions		1		9.1	%		—	0.8	%		(9	)	(52.9	)%		(1	)	(4.0	)%
Other, net		(2	)	(16.8	)%		—	(0.9	)%		3		17.9	%		—		(1.7	)%
Consolidated income tax expense	$	4		36.4	%	$	9	39.1	%	$	1		5.9	%	$	8		33.3	%

Three Months ended June 30, 2013 and 2012

ACE’s consolidated effective tax rates for the three months ended June 30, 2013 and 2012 were 36.4% and 39.1%, respectively.

Six Months ended June 30, 2013 and 2012

ACE’s consolidated effective tax rates for the six months ended June 30, 2013 and 2012 were 5.9% and 33.3%, respectively. The change in the effective tax rate primarily resulted from changes in estimates and interest related to uncertain and effectively settled tax positions. In the first quarter of 2013, ACE recorded an interest benefit of $6 million as discussed further below. In the first quarter of 2012, ACE recorded an interest benefit as a result of the effective settlement with the Internal Revenue Service with respect to the methodology used historically to calculate deductible mixed service costs.

On January 9, 2013, the U.S. Court of Appeals for the Federal Circuit issued an opinion in Consolidated Edison Company of New York, Inc. & Subsidiaries v. United States (to which ACE is not a party) that disallowed tax benefits associated with Consolidated Edison’s cross-border lease transaction. As a result of the court’s ruling in this case, PHI has determined that it can no longer support its current assessment with respect to the likely outcome of tax positions associated with its cross-border energy lease investments held by its wholly-owned subsidiary Potomac Capital Investment Corporation, and PHI recorded a charge of $377 million (after-tax) in the first quarter of 2013. Included in the $377 million charge was an after-tax interest charge of $70 million and this amount was allocated to each member of PHI’s consolidated group as if each member was a separate taxpayer, resulting in ACE recording a $6 million interest benefit in the first quarter of 2013.