INCOME TAXES

Under Swiss law, a resident company is subject to income tax at the federal, cantonal and communal levels that is levied on net income. Income attributable to permanent establishments or real estate located abroad is excluded from the Swiss tax base. Allied World Switzerland is a holding company and, therefore, is exempt from cantonal and communal income tax. As a result, Allied World Switzerland is subject to Swiss income tax only at the federal level. Allied World Switzerland is resident of the Canton of Zug and, as such, is subject to an annual cantonal and communal capital tax on the taxable equity of Allied World Switzerland in Switzerland. Allied World Switzerland has a Swiss operating company resident in the Canton of Zug. The operating company is subject to federal, cantonal and communal income tax and to annual cantonal and communal capital tax.

Under current Bermuda law, Allied World Bermuda and its Bermuda subsidiaries are not required to pay taxes in Bermuda on either income or capital gains. Allied World Bermuda and Allied World Assurance Company, Ltd have received an assurance from the Bermuda Minister of Finance under the Exempted Undertakings Tax Protection Act 1966 of Bermuda, that in the event of any such taxes being imposed, Allied World Bermuda and Allied World Assurance Company, Ltd will be exempted until March 2035.

Certain subsidiaries of Allied World Switzerland file U.S. federal income tax returns and various U.S. state income tax returns, as well as income tax returns in Canada, Hong Kong, Ireland, Singapore, Switzerland and the United Kingdom. The Company has open tax years that are potentially subject to examinations by local tax authorities, in the following major tax jurisdictions: the U.S., 2011 to 2014; the United Kingdom, 2013 and 2014; Ireland, 2010 to 2014; Switzerland, 2013 to 2014; Hong Kong, 2009 to 2014; and Singapore, 2010 to 2014. In December 2014, the Company received notice that the U.S. Internal Revenue Service will conduct an audit of the 2012 tax return of the Company's U.S. subsidiaries. To the best of the Company’s knowledge, there are no other examinations pending by any other tax authority.

Management has deemed all material tax positions to have a greater than 50% likelihood of being sustained based on technical merits if challenged. The Company does not expect any material unrecognized tax benefits within 12 months of December 31, 2014.

The components of income tax expense are as follows:



	Year Ended December 31,
	2014		2013			2012
Current income tax expense	$	26,768	$	21,669		$	18,239
Deferred income tax expense (benefit)	3,755		(11,889		)	201
Income tax expense	$	30,523	$	9,780		$	18,440

Our income is primarily sourced from our Bermuda, U.S., European and Asia Pacific operations. The income before income taxes for these operations are as follows:



	Year Ended December 31,
	2014		2013		2012
Non-U.S.	$	447,875	$	401,778	$	474,412
United States	72,907		25,882		37,035
Income before income taxes	$	520,782	$	427,660	$	511,447

Deferred income taxes reflect the tax impact of temporary differences between the carrying amounts of assets and liabilities for financial reporting and income tax purposes. The significant components of the net deferred tax assets are as follows:



	December 31,
	2014			2013
Deferred tax assets:
Reserve for losses and loss expenses	$	21,644		$	22,567
Equity compensation	15,316			15,828
Unearned premium	16,921			14,299
Deferred acquisition costs	11,184			10,604
Other-than-temporary impairments	—			407
Net loss carryforward	7,958			7,642
Total deferred tax assets	73,023			71,347
Deferred tax liabilities:
Intangible assets	(13,856		)	(14,743		)
Realized gains	(12,819		)	(6,980		)
Depreciation	(2,513		)	(2,942		)
Unrealized appreciation and timing differences on investments	(94		)	(56		)
Market discount on bonds	(740		)	(271		)
Other	(2,965		)	(1,244		)
Total deferred tax liabilities	(32,987		)	(26,236		)
Net deferred taxes before valuation allowance	40,036			45,111
Valuation allowance	(6,421		)	(7,642		)
Net deferred tax assets	$	33,615		$	37,469

The valuation allowance reported in the current period relates to net loss carryforwards for the European and Asia Pacific operations as it is unlikely those operations will have sufficient income to utilize the net loss carryforwards in the near term. The change in valuation allowance of $1,221 was included in income tax expense for the year ended December 31, 2014. The capital loss carryforwards from the United Kingdom and Asia Pacific operations do not expire as along as minimum capital requirements are maintained. The net loss carryforwards from the Switzerland operation expire between 2020 and 2021.

Current tax receivable and payable has been included in “other assets” and “accounts payable and accrued liabilities” on the consolidated balance sheets, respectively. Current taxes receivable or payable was as follows:



	December 31,
	2014		2013
Current tax receivable	$	8,640	$	11,684
Current tax payable	$	829	$	1,452

The expected tax provision has been calculated using the pre-tax accounting income in each jurisdiction multiplied by that jurisdiction’s applicable statutory tax rate. The reconciliation between the Company’s effective tax rate on pre-tax accounting income and the expected tax rate is as follows:



	Year Ended December 31,
	2014		2013		2012
Expected tax rate	7.8	%	7.8	%	7.8	%
Income not subject to income tax	(7.1	)%	(8.2	)%	(7.3	)%
Foreign taxes at local expected tax rates	4.4	%	1.4	%	2.1	%
Disallowed expenses and capital allowances	0.2	%	1.0	%	0.7	%
Prior year refunds and adjustments	1.2	%	0.8	%	0.4	%
Other	(0.6	)%	(0.5	)%	(0.1	)%
Effective tax rate	5.9	%	2.3	%	3.6	%