7. Income Taxes

We are incorporated under the laws of Bermuda and, under current Bermuda law, are not obligated to pay any taxes in Bermuda based upon income or capital gains. We have received an undertaking from the Supervisor of Insurance in Bermuda pursuant to the provisions of the Exempted Undertakings Tax Protection Act, 2011, which exempts us from any Bermuda taxes computed on profits, income or any capital asset, gain or appreciation, or any tax in the nature of estate duty or inheritance tax, at least until the year 2035.

We do not consider ourselves to be engaged in a trade or business in the United States or the United Kingdom and, accordingly, do not expect to be subject to direct United States or United Kingdom income taxation.

We have subsidiaries based in the United Kingdom that are subject to the tax laws of that country. Under current law, these subsidiaries are taxed at the applicable corporate tax rates. Six of the United Kingdom subsidiaries are deemed to be engaged in business in the United States and are therefore subject to United States corporate tax in respect of a proportion of their United States underwriting business only. Relief is available against the United Kingdom tax liabilities in respect of overseas taxes paid that arise from the underwriting business. Corporate income tax losses incurred in the United Kingdom can be carried forward, for application against future income, indefinitely. Our United Kingdom subsidiaries file separate United Kingdom income tax returns.

We have subsidiaries based in the United States that are subject to the tax laws of that country. Under current law, these subsidiaries are taxed at the applicable corporate tax rates. Our United States subsidiaries file a consolidated United States federal income tax return.

We also have operations in Belgium, Switzerland, Brazil, France, Malta, Spain and Ireland, which are subject to income taxes imposed by the jurisdiction in which they operate. We have operations in the United Arab Emirates, which are not subject to income tax under the laws of that country.

Our income tax provision includes the following components:


	For the Three Months Ended September 30,						For the Nine Months Ended September 30,
(in millions)	2012			2011			2012		2011
Current tax provision	$	5.7		$	2.6		$	11.2	$	3.0
Deferred tax (benefit) provision related to:
Future tax deductions		(2.1	)		4.4			0.8		11.0
Valuation allowance change		0.7			(0.2	)		1.8		(0.7	)

Income tax provision	$	4.3		$	6.8		$	13.8	$	13.3

Our expected income tax provision computed on pre-tax income (loss) at the weighted average tax rate has been calculated as the sum of the pre-tax income (loss) in each jurisdiction multiplied by that jurisdiction’s applicable statutory tax rate. For the three and nine months ended September 30, 2012 and 2011, pre-tax income (loss) attributable to our operations and the operations’ effective tax rates were as follows:


	For the Three Months Ended September 30,
(in millions)	2012						2011
	Pre-tax income (loss)			Effective Tax Rate			Pre-tax income (loss)			Effective Tax Rate
Bermuda	$	8.0			0.0	%	$	(24.4	)		0.0	%
United States		12.1			21.0	%		17.1			36.4	%
United Kingdom		0.1			1217.4	%		4.4			11.6	%
Belgium		0.1			20.0	%		0.1			25.5	%
Brazil		(1.9	)		0.0	%		(1.2	)		0.0	%
Dubai		0.0	⁽¹⁾		0.0	%		0.0	⁽¹⁾		0.0	%
Ireland		0.0			0.0	%		0.0			0.0	%
Malta		(0.7	)		0.0	%		n/a			n/a
Switzerland		0.0	⁽¹⁾		25.0	%		0.0	⁽¹⁾		0.0	%

Pre-tax income (loss)	$	17.7					$	(4.0	)

⁽¹⁾	Pre-tax income for the respective period was less than $0.1 million.


	For the Nine Months Ended September 30,
(in millions)	2012						2011
	Pre-tax income (loss)			Effective Tax Rate			Pre-tax income (loss)			Effective Tax Rate
Bermuda	$	18.2			0.0	%	$	(110.3	)		0.0	%
United States		45.8			22.8	%		67.4			27.9	%
United Kingdom		13.8			24.0	%		(25.2	)		22.1	%
Belgium		0.2			33.6	%		0.3			15.4	%
Brazil		(5.4	)		0.0	%		(2.2	)		0.0	%
Dubai		0.1			0.0	%		0.0	⁽¹⁾		0.0	%
Ireland		(0.1	)		0.0	%		0.0			0.0	%
Malta		(1.8	)		0.0	%		n/a			n/a
Switzerland		0.0	⁽¹⁾		24.0	%		0.0	⁽¹⁾		23.1	%

Pre-tax income (loss)	$	70.8					$	(70.0	)

⁽¹⁾	Pre-tax income for the respective period was less than $0.1 million.

A reconciliation of the difference between the provision for income taxes and the expected tax provision at the weighted average tax rate for the three and nine months ended September 30, 2012 and 2011 is as follows:


	For the Three Months Ended September 30,						For the Nine Months Ended September 30,
(in millions)	2012			2011			2012			2011
Income tax provision at expected rate	$	3.3		$	7.5		$	17.0		$	17.1
Tax effect of:
Tax-exempt interest		(1.2	)		(1.4	)		(4.2	)		(4.3	)
Dividends received deduction		(0.4	)		(0.1	)		(1.3	)		(1.2	)
Valuation allowance change		0.7			(0.2	)		1.8			(0.7	)
Other permanent adjustments, net		0.1			0.9			0.8			1.8
Adjustment for annualized rate		0.0			0.9			0.0			(0.1	)
United States state tax expense (benefit)		0.0			0.1			(0.2	)		(0.3	)
Other foreign adjustments		0.0			(0.1	)		0.1			0.0
Prior year foreign taxes recovered		0.0			(0.3	)		0.0			(0.3	)
Deferred tax rate reduction		(0.6	)		(0.1	)		(0.6	)		(0.1	)
Foreign exchange adjustments		2.4			(0.4	)		0.4			1.4

Income tax provision	$	4.3		$	6.8		$	13.8		$	13.3

Income tax provision (benefit) - Foreign	$	1.8		$	0.5		$	3.4		$	(5.5	)
Income tax provision - United States Federal		2.3			6.0			10.6			19.2
Income tax provision (benefit) - United States State		0.2			0.3			(0.2	)		(0.4	)

Income tax provision	$	4.3		$	6.8		$	13.8		$	13.3

Our net deferred tax assets (liabilities) are supported by taxes paid in previous periods, the reversal of the taxable temporary differences and the recognition of future income. Management regularly evaluates the recoverability of the deferred tax assets and makes any necessary adjustments to them based upon any changes in management’s expectations of future taxable income. Realization of deferred tax assets is dependent upon our generation of sufficient taxable income in the future to recover tax benefits that cannot be recovered from taxes paid in the carryback period, which is generally two years for net operating losses and three years for capital losses for our operations in the United States. At September 30, 2012, we had a total net deferred tax asset of $2.5 million prior to any valuation allowance. Management has concluded that a valuation allowance is required for a portion of the tax effected net capital loss carryforward of $31.0 million generated from the sale of PXRE Reinsurance Company, and a full valuation allowance is required for the tax effected net operating loss carryforward of $18.7 million from PXRE Corporation and for the tax effected net operating loss carryforward of $1.0 million from ARIS Title Insurance Corporation (“ARIS”). The capital loss carryforward generated from the sale of PXRE Reinsurance Company will expire if not utilized by December 31, 2013. Of the PXRE Corporation loss carryforwards, $17.2 million will expire if not utilized by December 31, 2025 and $1.5 million will expire if not utilized by December 31, 2027. Of the ARIS loss carryforward, $0.2 million will expire if not utilized by December 31, 2027, $0.4 million will expire if not utilized by December 31, 2028 and $0.4 million will expire if not utilized by December 31, 2029. The valuation allowances have been established as Internal Revenue Code Section 382 limits the utilization of net operating loss and net capital loss carryforwards following an ownership change. Accordingly, a valuation allowance of $52.2 million is required as of September 30, 2012. The loss carryforwards available to utilize per year are $2.8 million as required by Internal Revenue Code Section 382. For the nine months ended September 30, 2012, the valuation allowance was reduced by $0.7 million pertaining to the utilization of the PXRE and ARIS loss carryforwards, was increased by $0.7 million pertaining to the Malta operations and was increased by $1.8 million pertaining to the Brazil operations.

We have no material unrecognized tax benefits as of September 30, 2012. Our United States subsidiaries are no longer subject to U.S. federal and state income tax examinations by tax authorities for years before 2008. Our United Kingdom subsidiaries are no longer subject to United Kingdom income tax examinations by Her Majesty’s Revenue and Customs for years before 2008.