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 2016; the United Kingdom, 2015 and 2016; Ireland, 2012 to 2016; Switzerland, 2013 to 2016; Hong Kong, 2010 to 2016; and Singapore, 2012 to 2016. The U.S. Internal Revenue Service (the “IRS”) is currently conducting an audit of the 2014 tax return of the U.S. services company. The audit is ongoing and the Company is not aware of any findings from the audit thus far. During the year ended December 31, 2016, the IRS completed its audit of the 2012 consolidated tax return of the Company's U.S. subsidiaries. There were no findings as a result of the audit. To the best of the Company’s knowledge, there are no other income tax 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, 2016.

The components of income tax expense are as follows:



	Year Ended December 31,
	2016			2015			2014
Current income tax expense	$	5.1		$	9.8		$	26.8
Deferred income tax (benefit) expense	(14.2		)	(4.0		)	3.7
Income tax (benefit) expense	$	(9.1	)	$	5.8		$	30.5

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



	Year Ended December 31,
	2016			2015			2014
Switzerland	$	(25.5	)	$	(15.7	)	$	(19.0	)
Bermuda	336.6			162.1			460.2
United States	(27.5		)	12.8			72.9
All other jurisdictions	(37.4		)	(69.5		)	6.7
Income before income taxes	$	246.2		$	89.7		$	520.8

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,
	2016			2015
Deferred tax assets:
Reserve for losses and loss expenses	$	17.7		$	22.2
Equity compensation	16.0			14.2
Unearned premium	17.1			18.1
Deferred acquisition costs	11.9			10.5
Mark-to-market losses	8.6			—
Net loss carryforward	21.0			27.3
Total deferred tax assets	92.3			92.3
Deferred tax liabilities:
Intangible assets	(21.9		)	(23.3		)
Mark-to-market gains	—			(3.0		)
Depreciation	(4.4		)	(6.4		)
Market discount on bonds	(2.0		)	(1.2		)
Other	(1.2		)	(5.2		)
Total deferred tax liabilities	(29.5		)	(39.1		)
Net deferred taxes before valuation allowance	62.8			53.2
Valuation allowance	(24.1		)	(28.8		)
Net deferred tax assets	$	38.7		$	24.4

The valuation allowance reported in the current period relates to net operating 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 valuation allowance decreased by $4.7 million during the year ended December 31, 2016 compared to the year ended December 31, 2015. The decrease in the valuation allowance was due to the decrease in the net loss carryforwards. The net loss carryforwards from the United Kingdom and Asia Pacific operations do not expire. The net loss carryforward in our Swiss operations expire in seven years.

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,
	2016		2015
Current tax receivable	$	5.5	$	5.5
Current tax payable	$	0.7	$	2.5

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 statutory tax rates for our Swiss, Bermuda, U.S., Canada, Hong Kong, Ireland, Singapore and the United Kingdom operations are 7.8%, 0%, 35%, 15%, 16.5%, 12.5%, 17% and 20%, respectively. 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,
	2016		2015		2014
Expected tax rate	7.8	%	7.8	%	7.8	%
Income not subject to income tax	(10.7	)%	(14.2	)%	(7.1	)%
Valuation allowance	4.4	%	14.5	%	2.3	%
Foreign taxes at local expected tax rates	(4.6	)%	(1.7	)%	4.4	%
Disallowed expenses and capital allowances	0.4	%	3.2	%	0.2	%
Prior year refunds and adjustments	(0.3	)%	—	%	1.2	%
Other	(0.7	)%	(3.2	)%	(2.9	)%
Effective tax rate	(3.7	)%	6.4	%	5.9	%

The Company recorded a negative effective tax rate for the year ended December 31, 2016, due to recording an income tax benefit in most of our jurisdictions, due to pre-tax losses, while most of our pre-tax income was generated in Bermuda, which is not subject to income tax. During the year ended December 31, 2016, the income from the Company’s Bermuda operations represented 137% of the Company’s consolidated ‘income before income taxes’.

The ‘Income not subject to income tax’ noted in the table above related to the income from the Company’s Bermuda operations, which are not subject to income tax. The change in this line item noted in the effective tax rate reconciliation for the year ended December 31, 2015 compared to the year ended December 31, 2014 was due to the income from the Company’s Bermuda operations representing a higher percentage of the Company’s consolidated ‘Income before income taxes’ during the year ended December 31, 2015 compared to the year ended December 31, 2014. During the years ended December 31, 2015 and 2014, the income from the Company’s Bermuda operations represented 181% and 88%, respectively, of the Company’s consolidated ‘income before income taxes’.