(20) DISCONTINUED OPERATIONS

PHI’s (loss) income from discontinued operations, net of income taxes, is comprised of the following:


	For the Year Ended December 31,
	2014		2013			2012
	*(millions of dollars)*
Cross-border energy lease investments	$	—	$	(327	)	$	41
Pepco Energy Services’ retail electric and natural gas supply businesses		—		5			26

(Loss) income from discontinued operations, net of income taxes	$	—	$	(322	)	$	67

Cross-Border Energy Lease Investments

Between 1994 and 2002, PCI entered into cross-border energy lease investments consisting of hydroelectric generation facilities, coal-fired electric generation facilities and natural gas distribution networks located outside of the United States. Each of these lease investments was structured as a sale and leaseback transaction commonly referred to as a sale-in, lease-out, or SILO, transaction. During the second and third quarters of 2013, PHI terminated early all of its interests in the remaining lease investments. PHI received aggregate net cash proceeds from these early terminations of $873 million (net of aggregate termination payments of $2.0 billion used to retire the non-recourse debt associated with the terminated leases) and recorded an aggregate pre-tax loss, including transaction costs, of approximately $3 million ($2 million after-tax), representing the excess of the carrying value of the terminated leases over the net cash proceeds received. As a result, PHI has reported the results of operations of the cross-border energy lease investments as discontinued operations in all periods presented in the accompanying consolidated statements of income (loss).

Operating Results

The operating results for the cross-border energy lease investments are as follows:


	For the Year Ended December 31,
	2014		2013			2012
	*(millions of dollars)*
Operating revenue from PHI’s cross-border energy lease investments	$	—	$	7		$	50
Non-cash charge to reduce carrying value of PHI’s cross-border energy lease investments		—		(373	)		—

Total operating revenue	$	—	$	(366	)	$	50


(Loss) income from operations of discontinued operations, net of income taxes (a)	$	—	$	(325	)	$	32
Net (losses) gains associated with the early termination of the cross-border energy lease investments, net of income taxes (b)		—		(2	)		9

(Loss) income from discontinued operations, net of income taxes	$	—	$	(327	)	$	41

(a)	Includes income tax (benefit) expense of approximately zero, $(44) million and $5 million for the years ended December 31, 2014, 2013 and 2012, respectively.

(b)	Includes income tax (benefit) expense of approximately zero, $(1) million and $30 million for the years ended December 31, 2014, 2013 and 2012, respectively.

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 PHI 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 its tax position with respect to the benefits associated with its cross-border energy leases no longer met the more-likely-than-not standard of recognition for accounting purposes, and PCI recorded after-tax non-cash charges of $323 million in the first quarter of 2013 and $6 million in the second quarter of 2013, consisting of the following components:

•

A non-cash pre-tax charge of $373 million ($313 million after-tax) to reduce the carrying value of these cross-border energy lease investments under FASB guidance on leases (ASC 840). This pre-tax charge was originally recorded in the consolidated statements of income (loss) as a reduction in operating revenue and is now reflected in income (loss) from discontinued operations, net of income taxes.

•

A non-cash charge of $16 million after-tax to reflect the anticipated additional net interest expense under FASB guidance for income taxes (ASC 740) related to estimated federal and state income tax obligations for the period over which the tax benefits may be disallowed. This after-tax charge was originally recorded in the consolidated statements of income (loss) as an increase in income tax expense and is now reflected in income (loss) from discontinued operations, net of income taxes. The after-tax interest charge for PHI on a consolidated basis was $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 the recognition of a $12 million interest benefit for the Power Delivery segment, and interest expense of $16 million for PCI and $66 million for Corporate and Other, respectively.

PHI had also previously made certain business assumptions regarding foreign investment opportunities available at the end of the full lease terms. In view of the change in PHI’s tax position with respect to the tax benefits associated with the cross-border energy lease investments and PHI’s resulting decision to pursue the early termination of these investments, management concluded in the first quarter of 2013 that these business assumptions were no longer supportable and the tax effects of this conclusion were reflected in the after-tax charge of $313 million described above.

PHI accrued no penalties associated with its re-assessment of the likely outcome of tax positions associated with the cross-border energy lease investments. While the IRS could require PHI to pay a penalty of up to 20% of the amount of additional taxes due, PHI believes that it is more likely than not that no such penalty will be incurred, and therefore no amount for any potential penalty was included in the charge.

For additional information concerning these cross-border energy lease investments, see Note (16), “Commitments and Contingencies – PHI’s Cross-Border Energy Lease Investments.”

Retail Electric and Natural Gas Supply Businesses of Pepco Energy Services

On March 21, 2013, Pepco Energy Services entered into an agreement whereby a third party assumed all the rights and obligations of the remaining natural gas supply customer contracts, and the associated supply obligations, inventory and derivative contracts. The transaction was completed on April 1, 2013. In addition, in the second quarter of 2013, Pepco Energy Services completed the wind-down of its retail electric supply business by terminating its remaining customer supply and wholesale purchase obligations beyond June 30, 2013. As a result, PHI has reported the results of operations of Pepco Energy Services’ retail electric and natural gas supply businesses as discontinued operations in all periods presented in the accompanying consolidated statements of income (loss).

Operating Results

The operating results for the retail electric and natural gas supply businesses of Pepco Energy Services are as follows:


	For the Year Ended December 31,
	2014		2013		2012
	*(millions of dollars)*
Operating revenue	$	—	$	84	$	415


Income from operations of discontinued operations, net of income taxes	$	—	$	4	$	26
Net gains associated with accelerated disposition of retail electric and natural gas contracts, net of income taxes				1		—

Income from discontinued operations, net of income taxes (a)	$	—	$	5	$	26

(a)	Includes income tax expense of approximately zero, $3 million and $18 million for the years ended December 31, 2014, 2013 and 2012, respectively.

Derivative Instruments and Hedging Activities

Derivatives were used by the retail electric and natural gas supply businesses of Pepco Energy Services to hedge commodity price risk. There were no outstanding forward contracts or derivative positions for Pepco Energy Services as of December 31, 2014 and December 31, 2013.

Derivatives Designated as Hedging Instruments

At December 31, 2012, the cumulative net pre-tax loss related to effective cash flow hedges of the retail electric and natural gas supply businesses of Pepco Energy Services included in AOCL was $10 million ($6 million after-tax). With the assumption by a third party, on April 1, 2013, of all the rights and obligations of the derivative contracts associated with the retail natural gas supply business, PHI determined that the hedged forecasted purchases of supply for retail natural gas customers were probable not to occur. Accordingly, during the first quarter of 2013, PHI recognized $4 million of pre-tax unrealized derivative losses ($2 million after-tax) that were previously included in AOCL as cash flow hedges. The remaining pre-tax loss of $6 million included in AOCL was reclassified into income on completion of the wind-down of the retail electric business in the second quarter of 2013.

Other Derivative Activity

The retail electric and natural gas supply businesses of Pepco Energy Services held certain derivatives that were not in hedge accounting relationships and were not designated as normal purchases or normal sales. These derivatives were recorded at fair value on the balance sheet with the gain or loss for changes in fair value recorded through Income (loss) from discontinued operations, net of income taxes.

For the years ended December 31, 2014, 2013, and 2012, the amount of the derivative gain (loss) for the retail electric and natural gas supply businesses of Pepco Energy Services recognized in Income (loss) from discontinued operations, net of income taxes is provided in the table below:


	For the Year Ended December 31,
	2014		2013		2012
	*(millions of dollars)*
Reclassification of mark-to-market to realized on settlement of contracts	$	—	$	10	$	27
Unrealized mark-to-market loss		—		—		(3	)

Total net gain	$	—	$	10	$	24

As of December 31, 2014 and 2013, the retail electric and natural gas supply businesses of Pepco Energy Services had no outstanding commodity forward contracts or derivative positions.

As of December 31, 2014, Pepco Energy Services had posted net cash collateral of $2 million and letters of credit of zero. As of December 31, 2013, Pepco Energy Services had posted net cash collateral of $3 million and letters of credit of less than $1 million.