The reconciliation between the statutory federal income tax rate and our effective income tax rate is shown below:

In 2011, our effective tax rate was lower than the 35% statutory federal income tax rate due primarily to our corporate structure in which our foreign taxes are at a net effective tax rate lower than the U.S. rate and a $2.3 million tax benefit related to research and development (R&D) triggered by a retroactive extension of the R&D tax credit enacted in the first quarter of 2011. Our 2011 tax provision reflects a $7.5 million provision related to a research and development cost sharing prepayment by a foreign subsidiary to the U.S. A similar prepayment was made in 2010 resulting in a $6.0 million provision in that year. As a result, the net increase to the 2011 provision was $1.5 million. This impact is included in foreign rate differences in our effective tax rate reconciliation above. Also included in foreign rate differences is the effect of permanent items in foreign jurisdictions and the current year deferred charge associated with intercompany transactions.

In 2011, we continued our business reorganization of our legal entity structure which began in 2010 to support our tax and cash planning. The 2011 reorganization resulted in a $46.4 million taxable gain in the U.S. The tax on this gain was offset in part by the reversal of a deferred tax liability for unremitted earnings of a foreign subsidiary of $6.5 million (established in 2010 in contemplation of this transaction), the recognition of foreign tax credits previously not benefitted, and foreign tax credits generated as a result of this transaction.

During the fourth quarter of 2010, we completed a reorganization of our legal entity structure to support our tax and cash planning. The objective of this reorganization was to enable significant re-deployment and repatriation of cash between our international and domestic operations. This reorganization resulted in $446 million of foreign source taxable gain in the U.S., which was offset by foreign tax credits, primarily generated as a result of this transaction, and carry forward credits available. A significant amount of these carry forward credits were previously unrecognized due to the uncertainty of generating foreign source income in the U.S. The net tax effect of this reorganization was a $43.4 million tax provision in the U.S. While this reorganization drove a one-time increase in our 2010 effective income tax rate of 53%, it had no material effect on cash taxes paid. Our 2010 tax provision reflected a $6.0 million provision related to a research and development (R&D) cost sharing prepayment by a foreign subsidiary to the U.S. This prepayment had no impact on our 2010 tax rate as the same prepayment was made in 2009 (as described below). Additionally, we established a full valuation allowance on foreign tax credits not expected to be realized.

Significant items impacting the tax provision in 2009 include a $7.6 million one-time tax benefit in connection with litigation in a foreign jurisdiction, a $2.2 million tax benefit related to settlement of a foreign tax audit, a $6.0 million tax provision (included in foreign rate differential) from a research and development (R&D) cost sharing prepayment by a foreign subsidiary and a $1.2 million tax benefit related to R&D tax credits triggered by a retroactive extension of the tax credit enacted during the first quarter of 2009.

In the first quarter of 2009, we completed a realignment of our European business which, in part, resulted in a one-time taxable gain in the U.S. This taxable gain enabled us to recognize current year and previously unrecognized tax credits. The resulting tax impact of this one-time gain was deferred over the useful life of the property being transferred and as of September 30, 2011 and 2010, the accompanying consolidated balance sheet included deferred charges of $11.4 million ($3.6 million in other current assets and $7.8 million in other assets) and $15.0 million ($3.6 million in other current assets and $11.4 million in other assets), respectively. In the fourth quarter of 2011, there was an additional realignment of our European business where the tax impact was also deferred.

At September 30, 2011 and 2010, income taxes payable and income tax accruals recorded in accrued income taxes, other current liabilities, and other liabilities on the accompanying consolidated balance sheets were $27.5 million ($11.9 million in accrued income taxes, $5.4 million in other current liabilities and $10.2 million in other liabilities) and $12.5 million ($0.5 million in accrued income taxes, $4.0 million in other current liabilities and $8.0 million in other liabilities), respectively. At September 30, 2011 and 2010, prepaid taxes recorded in prepaid expenses on the accompanying consolidated balance sheets were $1.9 million and $6.9 million, respectively. We made net income tax payments of $28.1 million, $34.3 million and $55.6 million in 2011, 2010 and 2009, respectively.

The significant temporary differences that created deferred tax assets and liabilities are shown below:

The change in the net deferred tax asset to $121.9 million in 2011 from $103.5 million in 2010 includes an increase in deferred tax liabilities as a result of the MKS and 4CS acquisitions as described in Note E, the use of foreign tax credits and a corresponding release of the valuation allowance on foreign tax credits as a result of the reorganization of our legal entity structure described above, capitalized research and development expense and a change in accounting method for short term deferred maintenance revenue in the U.S.

For U.S. tax return purposes, net operating loss carryforwards (NOL) and tax credits are generally available to be carried forward to future years, subject to certain limitations. At September 30, 2011, we had U.S. federal NOL carryforwards of $14.5 million from acquisitions, consisting of $11.2 million from MKS which expire beginning in 2020 through 2030, $1.2 million from CoCreate which expire beginning in 2019 through 2027, $0.6 million from Computervision, which expire in 2017 and $1.5 million from 4CS which expire in 2030. The utilization of these NOL carryforwards is limited as a result of the change in ownership rules under Internal Revenue Code Section 382. In conjunction with filing our U.S. federal income tax return for fiscal 2008, and certain elections made on that return which were made in support of the European realignment but were previously not considered, we utilized net operating loss carryforwards that included windfall tax deductions for stock-based compensation expense. The windfall tax benefit realized for these deductions totaling $13.9 million was credited to additional paid-in capital in 2009.

As of September 30, 2011, we also had U.S. federal research and development credit carryforwards of $3.4 million, which expire beginning in 2030 and ending in 2031 and Massachusetts research and development credit carryforwards of $10.3 million, which expire beginning in 2016 and ending in 2026. A full valuation allowance is recorded against the Massachusetts research and development credit carryforwards.

We also have loss carryforwards in non-U.S. jurisdictions totaling $112.1 million, the majority of which do not expire. There are limitations imposed on the utilization of such NOLs that could further restrict the recognition of any tax benefits.

As of September 30, 2011, we have a valuation allowance of $13.8 million against net deferred tax assets in the U.S. and a remaining valuation allowance of $24.8 million against net deferred tax assets in certain foreign jurisdictions. The valuation allowance recorded against net deferred tax assets in the U.S. consists of $3.5 million for foreign tax credits and $10.3 million for Massachusetts research and development credits. The valuation allowance on foreign tax credits reflects the fact that deductions, not credits, are expected to be claimed in the U.S. in future periods. The valuation allowance recorded against net deferred tax assets of certain foreign jurisdictions is established primarily for our net operating loss carryforwards, the majority of which do not expire. There are limitations imposed on the utilization of such net operating losses that could further restrict the recognition of any tax benefits.

Significant management judgment is required to determine whether the future realization of our net deferred tax assets with a valuation allowance of $38.6 million as of September 30, 2011 is considered more likely than not. If and when we conclude that realization is more likely than not, we will record a reduction to our valuation allowance that will result in an increase to net income and additional paid-in capital in the period such determination is made.

As of September 30, 2011, our net deferred tax asset balance of $121.9 million primarily relates to our U.S. operations. We have concluded, based on the weight of available evidence, that most of our net deferred tax assets are more likely than not to be realized in the future. In arriving at this conclusion, we evaluated all available evidence, including our cumulative profitability on a pre-tax basis for the last three years (adjusted for permanent differences), which includes the results of having taken certain tax planning actions. We have taken and will continue to take measures to improve core earnings in the U.S. and we expect U.S. earnings to continue to improve in the near term. If the U.S. results do not improve as anticipated, however, a valuation allowance against the deferred tax assets may be required. We will continue to reassess our valuation allowance requirements each financial reporting period.


	Year ended September 30,
	2011			2010			2009
	(in millions)
Valuation allowance beginning of year	$	40.5		$	46.3		$	66.0
Net release of valuation allowance (1)		(2.4	)		(16.8	)		(12.1	)
Establish valuation allowance in the U.S. on foreign tax credits		—			4.8			—
Net increase in deferred tax assets for foreign jurisdictions with a full valuation allowance		—			2.8			—
Net decrease in deferred tax assets for foreign jurisdictions with a full valuation allowance		(0.8	)		(0.3	)		(0.5	)
Release of valuation allowance on windfall tax deductions		—			—			(6.6	)
Adjust deferred tax asset and valuation allowance in the U.S. primarily for tax credits		1.3			3.7			—
Other		—			—			(0.5	)

Valuation allowance end of year	$	38.6		$	40.5		$	46.3

(1)

In 2011, 2010 and 2009, this net reduction is primarily attributed to the release of the valuation allowance on foreign tax credits in the U.S. In both 2011 and 2010, this was the result of the subsidiary reorganizations described previously. As such, the current year change is included in subsidiary reorganization in the reconciliation between our statutory income tax rate and our effective income tax rate. In 2009, this was the result of the realignment of our European business. The benefit of this release is deferred over the useful life of the property being transferred. The 2009 valuation allowance release amount is included in foreign rate differences in the reconciliation between our statutory income tax rate and our effective income tax rate.

Our policy is to record estimated interest and penalties related to the underpayment of income taxes as a component of our income tax provision. In 2011, 2010 and 2009, we included in our income tax provision $0.3 million, $0.5 million and $0.8 million, respectively, of net interest expense and penalty expense of $0.1 million in 2010. In 2011 and 2009, we had no tax penalty expense in our income tax provision. As of September 30, 2011 and 2010, we had accrued $2.0 million and $1.0 million, respectively, of net estimated interest expense related to income tax accruals. We had no accrued tax penalties as of September 30, 2011, 2010 or 2009.

As of September 30, 2011, we had an unrecognized tax benefit of $16.2 million ($15.9 million net of tax benefits from other jurisdictions). As of September 30, 2010, we had an unrecognized tax benefit of $15.9 million ($15.6 million net of tax benefits from other jurisdictions). If all of our unrecognized tax benefits as of September 30, 2011 were to become recognizable in the future, we would record a $15.6 million benefit to the income tax provision. Changes in the unrecognized tax benefit were due to:

In 2009, we closed the IRS examination of PTC's U.S. federal tax years 2005 through 2007. The completion of the examination resulted in a decrease of unrecognized tax benefits of $9.4 million and a net benefit of $0.3 million to the tax provision. Although we believe our tax estimates are appropriate, the final determination of tax audits and any related litigation could result in favorable or unfavorable changes in our estimates. We anticipate the settlement of tax audits may be finalized within the next twelve months and could result in a decrease in our unrecognized tax benefits of up to $4 million.

In the normal course of business, PTC and its subsidiaries are examined by various taxing authorities, including the IRS in the United States. As of September 30, 2011, we remained subject to examination in the following major tax jurisdictions for the tax years indicated:

We incurred expenses related to stock-based compensation in 2011, 2010 and 2009 of $45.4 million, $48.9 million and $43.3 million, respectively. Accounting for the tax effects of stock-based awards requires that we establish a deferred tax asset as the compensation is recognized for financial reporting prior to recognizing the tax deductions. The tax benefit recognized in the consolidated statement of operations related to stock-based compensation totaled $13.6 million, $14.8 million and $13.9 million in 2011, 2010 and 2009, respectively. Upon the settlement of the stock-based awards (i.e., exercise, vesting, forfeiture or cancellation), the actual tax deduction is compared with the cumulative financial reporting compensation cost and any excess tax deduction is considered a windfall tax benefit, and is tracked in a "windfall tax benefit pool" to offset any future tax deduction shortfalls and will be recorded as increases to additional paid-in capital in the period when the tax deduction reduces income taxes payable. In 2011, we recorded a net windfall of $9.4 million. In 2010, we recorded a net shortfall of $1.1 million. We follow the with-and-without approach for the direct effects of windfall tax deductions to determine the timing of the recognition of benefits for windfall tax deductions. As of September 30, 2011, the tax effect of windfall tax deductions which had not yet reduced taxes payable was $9.4 million.

In the fourth quarter of 2010, in conjunction with the subsidiary reorganization completed in 2010 and a subsequent transfer executed in 2011, we changed our assertion on the undistributed earnings of certain foreign subsidiaries resulting in a tax charge of $43.4 million in 2010 and a benefit of $0.7 million was recorded to foreign currency translation adjustment in accumulated other comprehensive income. With the exception of this continued reorganization, we have not provided for U.S. income taxes or foreign withholding taxes on foreign unrepatriated earnings as it is our current intention to permanently reinvest these earnings outside the U.S. If we decide to change this assertion in the future to repatriate any additional non-U.S. earnings, we may be required to establish a deferred tax liability on such earnings through a charge to our income tax provision. The cumulative amount of undistributed earnings of our subsidiaries for which U.S. income taxes have not been provided totaled approximately $99 million and $27 million as of September 30, 2011 and 2010, respectively. The amount of unrecognized deferred tax liability on the undistributed earnings cannot be practicably determined at this time. However, we do currently have an outstanding loan receivable in the amount of $334.5 million owed to the U.S. from our top tier foreign subsidiary that can be repaid to repatriate foreign generated cash to the U.S. without tax cost.