(10) INCOME TAXES

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


	Three Months Ended September 30,										Nine Months Ended September 30,
	2013					2012					2013					2012
	*(millions of dollars)*
Income tax at Federal statutory rate	$	61		35.0	%	$	51		35.0	%	$	116		35.0	%	$	97		35.0	%
Increases (decreases) resulting from:
State income taxes, net of Federal effect		11		6.3	%		9		6.3	%		21		6.3	%		19		6.9	%
Asset removal costs		(5	)	(2.9	)%		(1	)	(0.7	)%		(11	)	(3.3	)%		(8	)	(2.9	)%
Change in estimates and interest related to uncertain and effectively settled tax positions		1		0.6	%		—		—			55		16.6	%		(10	)	(3.6	)%
Establishment of valuation allowances related to deferred tax assets		—		—			—		—			101		30.4	%		—		—
Other, net		(3	)	(1.9	)%		(2	)	(1.0	)%		(2	)	(0.7	)%		(6	)	(2.1	)%

Consolidated income tax expense related to continuing operations	$	65		37.1	%	$	57		39.6	%	$	280		84.3	%	$	92		33.3	%

Three Months Ended September 30, 2013 and 2012

PHI’s consolidated effective tax rates for the three months ended September 30, 2013 and 2012 were 37.1% and 39.6%, respectively. The decrease in the effective tax rate primarily resulted from an increase in asset removal costs.

Nine Months Ended September 30, 2013 and 2012

PHI’s consolidated effective tax rates for the nine months ended September 30, 2013 and 2012 were 84.3% and 33.3%, respectively.

The increase in the effective tax rate for the nine months ended September 30, 2013 occurred as a result of recording $55 million of changes in estimates and interest related to uncertain and effectively settled tax positions in the first quarter of 2013.

In addition, the increase in the effective tax rate resulted from the establishment of valuation allowances of $101 million in the first quarter of 2013 against certain deferred tax assets in Corporate and Other. 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 Internal Revenue Service (IRS) with respect to both Consolidated Edison’s cross-border lease transaction (as discussed in Note (16), “Discontinued Operations – Cross-Border Energy Lease Investments”) 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 represented 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.

Final IRS Regulations on Repair of Tangible Property

In September 2013, the IRS issued final regulations on expense versus capitalization of repairs with respect to tangible personal property. The regulations are effective for tax years beginning on or after January 1, 2014, and provide an option to early adopt the final regulations for tax years beginning on or after January 1, 2012. It is expected that the IRS will issue revenue procedures that will describe how taxpayers may implement the final regulations. The final repair regulations retain the operative rule that the Unit of Property for network assets is determined by the taxpayer’s particular facts and circumstances except as provided in published guidance. In 2012, with the filing of its 2011 tax return, PHI filed a request for an automatic change in accounting method related to repairs of its network assets in accordance with IRS Revenue Procedure 2011-43. PHI does not expect the effects of the final regulations to be significant and will continue to evaluate the impact of the new guidance on its consolidated financial statements.

Income Taxes

(9) INCOME TAXES

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


	Three Months Ended September 30,										Nine Months Ended September 30,
	2013					2012					2013					2012
	*(millions of dollars)*
Income tax at Federal statutory rate	$	37		35.0	%	$	30		35.0	%	$	66		35.0	%	$	49		35.0	%
Increases (decreases) resulting from:
State income taxes, net of Federal effect		6		5.7	%		5		5.9	%		11		5.9	%		8		5.8	%
Asset removal costs		(5	)	(4.7	)%		(1	)	(1.2	)%		(11	)	(5.9	)%		(8	)	(5.8	)%
Change in estimates and interest related to uncertain and effectively settled tax positions		—		—			—		—			(4	)	(2.1	)%		(11	)	(7.9	)%
Permanent differences related to deferred compensation funding		—		—			—		—			—		—			(1	)	(0.7	)%
Tax credits		—		—			—		—			—		—			(1	)	(0.7	)%
Other, net		2		1.7	%		1		1.5	%		—		0.1	%		2		1.6	%

Income tax expense	$	40		37.7	%	$	35		41.2	%	$	62		33.0	%	$	38		27.3	%

Three Months Ended September 30, 2013 and 2012

Pepco’s effective tax rates for the three months ended September 30, 2013 and 2012 and were 37.7% and 41.2%, respectively. The decrease in the effective tax rate primarily resulted from an increase in asset removal costs.

Nine Months Ended September 30, 2013 and 2012

Pepco’s effective tax rates for the nine months ended September 30, 2013 and 2012 were 33.0% and 27.3%, 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 determined in the first quarter of 2013 that it could 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 $54 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 of $11 million 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.

Final IRS Regulations on Repair of Tangible Property

In September 2013, the IRS issued final regulations on expense versus capitalization of repairs with respect to tangible personal property. The regulations are effective for tax years beginning on or after January 1, 2014, and provide an option to early adopt the final regulations for tax years beginning on or after January 1, 2012. It is expected that the IRS will issue revenue procedures that will describe how taxpayers may implement the final regulations. The final repair regulations retain the operative rule that the Unit of Property for network assets is determined by the taxpayer’s particular facts and circumstances except as provided in published guidance. In 2012, with the filing of its 2011 tax return, PHI filed a request for an automatic change in accounting method related to repairs of its network assets in accordance with IRS Revenue Procedure 2011-43. Pepco does not expect the effects of the final regulations to be significant and will continue to evaluate the impact of the new guidance on its financial statements.

Income Taxes

(10) INCOME TAXES

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


	Three Months Ended September 30,										Nine Months Ended September 30,
	2013					2012					2013					2012
	*(millions of dollars)*
Income tax at Federal statutory rate	$	13		35.0	%	$	12		35.0	%	$	35		35.0	%	$	32		35.0	%
Increases (decreases) resulting from:
State income taxes, net of Federal effect		2		5.4	%		2		6.1	%		5		5.0	%		5		5.6	%
Adjustments to prior year taxes		—		—			(2	)	(6.1	)%		—		—			(2	)	(2.2	)%
Change in estimates and interest related to uncertain and effectively settled tax positions		—		—			—		—			(1	)	(1.0	)%		—		—
Depreciation		—		—			(1	)	(3.0	)%		—		—			(1	)	(1.1	)%
Other, net		(1	)	(2.6	)%		—		1.3	%		—		—			—		0.5	%

Income tax expense	$	14		37.8	%	$	11		33.3	%	$	39		39.0	%	$	34		37.8	%

Three Months Ended September 30, 2013 and 2012

DPL’s effective tax rates for the three months ended September 30, 2013 and 2012 were 37.8% and 33.3%, respectively. The increase in the effective tax rate primarily resulted from adjustments to prior year taxes and tax benefits related to depreciation that were recorded during the three months ended September 30, 2012.

Nine Months Ended September 30, 2013 and 2012

DPL’s effective tax rates for the nine months ended September 30, 2013 and 2012 were 39.0% and 37.8%, respectively. The increase in the effective tax rate primarily resulted from adjustments to prior year taxes recorded during the nine months ended September 30, 2012.

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 determined in the first quarter of 2013 that it could 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 $54 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.

Final IRS Regulations on Repair of Tangible Property

In September 2013, the IRS issued final regulations on expense versus capitalization of repairs with respect to tangible personal property. The regulations are effective for tax years beginning on or after January 1, 2014, and provide an option to early adopt the final regulations for tax years beginning on or after January 1, 2012. It is expected that the IRS will issue revenue procedures that will describe how taxpayers may implement the final regulations. The final repair regulations retain the operative rule that the Unit of Property for network assets is determined by the taxpayer’s particular facts and circumstances except as provided in published guidance. In 2012, with the filing of its 2011 tax return, PHI filed a request for an automatic change in accounting method related to repairs of its network assets in accordance with IRS Revenue Procedure 2011-43. DPL does not expect the effects of the final regulations to be significant and will continue to evaluate the impact of the new guidance on its financial statements.

Income Taxes

(9) INCOME TAXES

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


	Three Months Ended September 30,									Nine Months Ended September 30,
	2013					2012				2013					2012
	*(millions of dollars)*
Income tax at Federal statutory rate	$	13		35.0	%	$	11	35.0	%	$	19		35.0	%	$	20		35.0	%
Increases (decreases) resulting from:
State income taxes, net of Federal effect		2		5.3	%		2	6.1	%		4		7.3	%		3		5.3	%
Change in estimates and interest related to uncertain and effectively settled tax positions		—		—			—	—			(9	)	(16.4	)%		—		—
Other, net		(2	)	(6.1	)%		—	(1.7	)%		—		(0.4	)%		(2	)	(3.5	)%

Consolidated income tax expense	$	13		34.2	%	$	13	39.4	%	$	14		25.5	%	$	21		36.8	%

Three Months Ended September 30, 2013 and 2012

ACE’s consolidated effective tax rates for the three months ended September 30, 2013 and 2012 were 34.2% and 39.4%, respectively. The decrease in the effective tax rate primarily resulted from reductions in property-related temporary differences that are flowed through to income tax expense as part of the regulatory process.

Nine Months Ended September 30, 2013 and 2012

ACE’s consolidated effective tax rates for the nine months ended September 30, 2013 and 2012 were 25.5% and 36.8%, 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 determined in the first quarter of 2013 that it could 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 $54 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.

Final IRS Regulations on Repair of Tangible Property

In September 2013, the IRS issued final regulations on expense versus capitalization of repairs with respect to tangible personal property. The regulations are effective for tax years beginning on or after January 1, 2014, and provide an option to early adopt the final regulations for tax years beginning on or after January 1, 2012. It is expected that the IRS will issue revenue procedures that will describe how taxpayers may implement the final regulations. The final repair regulations retain the operative rule that the Unit of Property for network assets is determined by the taxpayer’s particular facts and circumstances except as provided in published guidance. In 2012, with the filing of its 2011 tax return, PHI filed a request for an automatic change in accounting method related to repairs of its network assets in accordance with IRS Revenue Procedure 2011-43. ACE does not expect the effects of the final regulations to be significant and will continue to evaluate the impact of the new guidance on its consolidated financial statements.