Taxation

XL-Bermuda conducts global operations through its subsidiaries in various jurisdictions around the world, including but not limited to Bermuda, the U.S., the U.K., Switzerland, Ireland, Germany, Italy, Spain, and France. The Company is subject to tax in accordance with the relevant tax laws and regulations governing taxation in the jurisdictions in which it operates.

XL-Bermuda, and its Bermuda subsidiaries, are not subject to any income or capital gains taxes under current Bermuda law. In the event that there is a change such that these taxes are imposed, the Bermuda subsidiaries would be exempted from any such tax until March 2035 pursuant to the Bermuda Exempted Undertakings Tax Protection Act 1966, and the Exempted Undertakings Tax Protection Amendment Act 2011.

The Company’s U.S. subsidiaries are subject to federal, state and local corporate income taxes, as well as premium, excise and other taxes applicable to U.S. corporations. The U.S. related provision for federal income taxes has been determined under the principles of the consolidated tax provisions of the IRS Code and Regulations thereunder.

With the exception of the U.S., deferred income taxes have not been accrued with respect to certain undistributed earnings of subsidiaries located outside of Bermuda. If the earnings were to be distributed, as dividends or otherwise, such amounts may be subject to withholding taxation in the jurisdiction of the paying entity. The Company does not assert that all earnings arising in the U.S. will be permanently reinvested in the U.S., and accordingly, the Company provides for withholding taxes arising in respect of current period U.S. earnings. No withholding taxes are accrued with respect to the earnings of the Company’s subsidiaries arising outside the U.S. However, if there is a change in tax law, interpretation of existing law, or change in way in which the Company conducts its business, then the company would accrue the required withholding tax.

The Company's current corporate structure is such that distribution of earnings from subsidiaries located outside of the United States would not be subject to significant incremental taxation. It is not practicable to estimate the amount of additional withholding taxes that might be payable on such earnings due to a variety of factors, including the timing, extent and nature of any repatriation.

The following table details the years that are the subject of open examinations, by major tax jurisdiction. While the Company cannot estimate with certainty the outcome of these examinations, the Company does not believe that adjustments from open tax years will result in a significant change to the Company's financial results.



Jurisdiction	Tax Years
U.S.	2013-2015
Ireland	2008 - 2009
U.K.	2014
France	2013 - 2014
Spain	2011 - 2012

The following table details open tax years that are open to assessment by local tax authorities, in the following major tax jurisdictions.



Jurisdiction	Tax Years
U.S.	2013 - 2016
Ireland	2008 - 2016
U.K.	2014 - 2016
Germany	2014 - 2016
Switzerland	2011 - 2016
France	2013 - 2016
Spain	2011 - 2016
Italy	2012 - 2016

The Company’s income (loss) before income tax and non-controlling interests, for the years ended December 31, 2016, 2015 and 2014, was distributed between U.S. and non-U.S. jurisdictions as follows:



Income (loss) before income tax: (U.S. dollars in thousands)	2016		2015			2014
U.S.	$	68,970	$	(5,931	)	$	228,708
Non U.S.	543,304		1,300,109			137,027
Total	$	612,274	$	1,294,178		$	365,735

The income tax provisions for the years ended December 31, 2016, 2015 and 2014 are as follows:



(U.S. dollars in thousands)	2016			2015			2014
Current expense (benefit):
U.S.	$	(12,201	)	$	(22,698	)	$	45,598
Non U.S.	59,031			67,784			81,371
Total current expense (benefit)	$	46,830		$	45,086		$	126,969
Deferred expense (benefit):
U.S.	$	8,502		$	(63,491	)	$	8,572
Non U.S.	(13,203		)	(756		)	(38,644		)
Total deferred expense (benefit)	$	(4,701	)	$	(64,247	)	$	(30,072	)
Total tax expense (benefit)	$	42,129		$	(19,161	)	$	96,897

The applicable statutory tax rates for the current year of the most significant jurisdictions contributing to the overall taxation of the Company are:



Jurisdiction	Applicable Statutory Corporate Income Tax Rates
Ireland (1)	12.50	%
Bermuda	—	%
U.S.	35.00	%
U.K.	20.00	%
Switzerland (2)	21.15	%
Germany (3)	15.00	%
France (4)	33.33	%

____________


(1)	The 12.5% statutory corporate income tax rate applies to active income from the conduct of a trade in Ireland. For passive income or income from other defined activities the rate increases to 25%.

(2) Represents the combined federal and cantonal rate primarily applicable to XL Catlin Swiss entities.


(3)	The statutory corporate income tax rate is 15% . However, including applicable surcharges and local trade tax, which can vary by location, would increase the combined statutory rate to approximately 33%.


(4)	The statutory corporate income tax rate is 33.33%. However, with the mandatory social surcharge, the combined statutory rate would increase to 34.43%.

The expected tax provision in the table below has been calculated using the pre-tax accounting income (loss) in each jurisdiction multiplied by that jurisdiction’s applicable statutory tax rate. A reconciliation of the difference between the provision for income taxes and the expected tax provision for the years ended December 31, 2016, 2015 and 2014 is provided below:



(U.S. dollars in thousands)	2016			2015			2014
Expected tax (benefit) provision	$	(31,080	)	$	(50,797	)	$	132,775
Permanent differences:
Non-taxable (income) loss	(19,937		)	(23,036		)	(19,870		)
Revision to prior year estimates	(24,121		)	7,402			2,016
State, local and foreign taxes	23,157			27,499			47,078
Valuation allowance	1,197			9,517			(181		)
Net allocated investment income	5,990			(405		)	3,399
Stock awards	543			(433		)	411
Non-deductible expenses	48,206			42,839			22,556
Other investment related adjustments	(905		)	2,075			(2,916		)
Adjustments related to GreyCastle Life Retro Arrangements	21,682			(35,045		)	(99,535		)
Change in tax rates	(6,233		)	(11,877		)	3,974
Uncertain tax positions	23,630			13,100			7,190
Total tax expense (benefit)	$	42,129		$	(19,161	)	$	96,897

Significant components of the Company’s deferred tax assets and liabilities at December 31, 2016 and 2015 were as follows:



(U.S. dollars in thousands)	2016		2015
Deferred tax asset:
Net unpaid loss reserve discount	$	96,357	$	111,584
Net unearned premiums	95,676		80,434
Compensation liabilities	96,280		94,013
Net operating losses	323,716		181,295
Investment adjustments	14,030		14,399
Pension	6,817		10,370
Bad debt reserve	12,418		7,425
Amortizable goodwill	967		5,396
Net unrealized depreciation on investments	5,915		5,051
Stock options	7,249		16,192
Depreciation	26,525		13,299
Net realized capital losses	89,568		98,756
Deferred intercompany capital losses	18,221		26,164
Untaxed Lloyd's result	—		3,769
Deferred acquisition costs	17,820		31,133
Currency translation adjustments	—		6,280
Tax Credits	71,651		5,047
Other	34,708		19,930
Deferred tax asset, gross of valuation allowance	$	917,918	$	730,537
Valuation allowance	367,366		276,301
Deferred tax asset, net of valuation allowance	$	550,552	$	454,236

Deferred tax liability:
Net unrealized appreciation on investments	$	21,500	$	51,010
Unremitted earnings	—		3,739
Deferred acquisition costs	10,858		8,308
Currency translation adjustments	12,813		1,210
Regulatory reserves	116,500		64,352
Net unearned premiums	4,380		—
Investment adjustments	5,269		6,373
Untaxed Lloyd’s result	11,940		—
Depreciation	15,601		11,500
Syndicate capacity	82,106		92,756
Intangible asset	32,508		40,126
Other	3,806		13,202
Deferred tax liability	$	317,281	$	292,576
Net Deferred Tax Asset	$	233,271	$	161,660

The deferred tax asset and deferred tax liability balances presented above represent the gross deferred tax asset and liability balances across each tax jurisdiction. As disclosed on the consolidated balance sheets, the deferred tax asset balances of $310.5 million and $282.3 million at December 31, 2016 and 2015, respectively, and deferred tax liability balances of $77.3 million and $120.7 million at December 31, 2016 and 2015, respectively, include netting of certain deferred tax assets and liabilities within a tax jurisdiction to the extent such netting is consistent with ASC 740 "Income Taxes".

During 2016, the Company recorded net deferred tax assets related to certain branch operations that were previously deemed worthless and not disclosed. Due to changes in the global operating environment, the company now believes that, while unlikely, these net deferred tax assets may have future value. As such, the company has updated its year end deferred tax balances to reflect these net deferred tax assets with an offsetting valuation allowance. There is no net impact to equity or reported tax expense resulting from this change in disclosure.

At December 31, 2016 and 2015, the valuation allowance of $367.4 million and $276.3 million, respectively, related primarily to net operating loss and realized capital loss carryforwards in the following major tax jurisdictions:



Jurisdiction (U.S. dollars in thousands)	2016		2015
Ireland	$	96,642	$	93,396
U.S.	92,999		106,624
U.K.	32,528		46,732
Switzerland	15,025		7,818
Other	130,172		21,731
Valuation Allowance Total	$	367,366	$	276,301

The increase in the valuation allowance in 2016 of $91.1 million was primarily driven by the valuation allowances recorded on branch operations, as noted above. This increase was partially offset by a decrease in the valuation allowance related to U.K. losses based on filing positions taken on the 2015 tax returns, and a reduction in the valuation allowance held against U.S. capital loss carry-forwards that expired in 2016.

Management believes it is more likely than not that the tax benefit associated with the group's deferred tax assets, not offset by a valuation allowance, will be realized.

At December 31, 2016, the Company had total net operating loss carryforwards of $1.6 billion, with an associated net deferred tax asset of $117.1 million ($323.7 million gross deferred tax asset with an offsetting valuation allowance of $206.6 million).

At December 31, 2016, the Company had U.S. net operating loss carryforwards of $108.0 million, with an associated net deferred tax asset of $37.0 million ($37.8 million gross deferred tax asset with an offsetting valuation allowance of $0.8 million), which were primarily generated during 2015. Of this amount, approximately $47.0 million are subject to restrictions on timing and utilization under §382 of the IRS Code. Management has reviewed historical taxable income and future taxable income projections for its U.S. group and has determined that in its judgment, all of the U.S. net operating losses will more likely than not be realized as reductions to future taxable income prior to expiration through 2036.

At December 31, 2016, the Company had net operating loss carryforwards in the U.K. of $203.3 million, with an associated net deferred tax asset of $12.8 million ($39.0 million gross deferred tax asset with an offsetting valuation allowance of $26.2 million). These operating loss carryforward have no expiration.

At December 31, 2016, the Company had net operating loss carryforwards in Switzerland of $200.1 million, with an associated net deferred tax asset of $8.8 million ($23.7 million gross deferred tax asset with an offsetting valuation allowance of $14.9 million). Losses of $5.3 million and $4.0 million will expire in 2017 and 2018, respectively, with the remaining $190.8 million expiring through 2023.

At December 31, 2016, the Company had net operating loss carryforwards in Ireland of $484.9 million, with no associated net deferred tax asset ($60.6 million gross deferred tax asset with an offsetting valuation allowance of $60.6 million). These net operating loss carryforwards primarily relate to XL-Ireland and XL-Cayman, formerly an Irish tax resident company. Although these losses may be carried forward indefinitely, the companies are in the process of filing final Irish tax returns and are not expected to generate further taxable profits in Ireland. Therefore, a valuation allowance is being held with respect to these losses. The Company expects to receive tax clearance from the Irish taxing authority in 2017 and at that point will write-off any remaining deferred tax asset and related valuation allowance.

At December 31, 2016, the Company had net operating loss carryforwards in other jurisdictions of $629.1 million, with an associated net deferred tax asset of $58.5 million ($162.6 million gross deferred tax asset with an offsetting valuation allowance of $104.1 million). Losses of $609.1 million have no expiration date and the remaining losses will expire through 2028.

At December 31, 2016, the Company had capital loss carryforwards of $293.5 million, with no associated net deferred tax asset ($89.6 million gross deferred tax asset with an offsetting valuation allowance of $89.6 million).

At December 31, 2016, the Company had U.S. realized capital loss carryforwards of $165.5 million, with no associated net deferred tax asset ($57.9 million gross deferred tax asset with an offsetting valuation allowance of $57.9 million). The five year carryforward limitation for the utilization of realized capital losses applies to this balance. Losses of $59.1 million will expire at the end of 2018 with another $106.3 million of realized capital losses expiring in future years through 2021.

At December 31, 2016, the Company had capital loss carryforwards in Ireland of $122.1 million, with no associated net deferred tax asset ($30.5 million gross deferred tax asset with an offsetting valuation allowance of $30.5 million) and in the U.K of $5.9 million, with no associated net deferred tax asset ($1.1 million gross deferred tax asset with an offsetting valuation allowance of $1.1 million). Although these capital losses may be carried forward indefinitely, due to the uncertainty surrounding any future capital gain income generation within these specific entities, a full valuation allowance is held in respect of these losses.

At December 31, 2016, the Company had total tax credits of $71.7 million comprised of $32.3 million of U.S. Alternative Minimum Tax Credits, that do not expire, $5.6 million of U.S. foreign tax credits that expire through 2025, $3.1 million of U.S. Research and Development tax credits which expire through 2034, and $30.7 million of U.K. foreign tax credits that do not expire.

Shareholders’ equity at December 31, 2016 and 2015 reflected cumulative tax benefits of $10.6 million and $9.2 million, respectively, related to the excess of tax deductions over book compensation expense for stock awards exercised/vested by the Company's U.S. subsidiaries.

For the years ended December 31, 2016, 2015 and 2014, the Company had unrecognized tax benefits of $97.8 million,$80.6 million and $37.2 million, respectively. If recognized, the full amount of these unrecognized tax benefits would decrease the annual effective tax rate. The Company does not currently anticipate any significant change in unrecognized tax benefits during 2017.

The following table presents a reconciliation of the Company’s unrecognized tax benefits:



(U.S. dollars in thousands)	2016			2015			2014
Unrecognized tax benefits, beginning of the year	$	80,590		$	37,190		$	30,000
Increases for tax positions taken during the year	25,250			20,370			12,182
Increases for tax positions taken in prior years	11,700			38,650			15,304
Decreases for tax positions taken in prior years	(6,440		)	(4,850		)	(20,296		)
Decreases for lapse of the applicable statute of limitations	(13,320		)	(10,770		)	—
Unrecognized tax benefits, end of year	$	97,780		$	80,590		$	37,190

The Company’s policy is to recognize any interest and penalties related to unrecognized tax benefits as a component of tax expense. For the years ended December 31, 2016, 2015 and 2014, the Company had accrued interest and penalties of $0.9 million, $0.4 million and $0.4 million, respectively.