Income Taxes

12 Months Ended

Dec. 31, 2011

Income Taxes

Income Taxes

Note 6—Income Taxes

Tax rate—Transocean Ltd., a holding company and Swiss resident, is exempt from cantonal and communal income tax in Switzerland, but is subject to Swiss federal income tax.  At the federal level, qualifying net dividend income and net capital gains on the sale of qualifying investments in subsidiaries are exempt from Swiss federal income tax.  Consequently, Transocean Ltd. expects dividends from its subsidiaries and capital gains from sales of investments in its subsidiaries to be exempt from Swiss federal income tax.

Our provision for income taxes is based on the tax laws and rates applicable in the jurisdictions in which we operate and earn income.  The relationship between our provision for or benefit from income taxes and our income or loss before income taxes can vary significantly from period to period considering, among other factors, (a) the overall level of income before income taxes, (b) changes in the blend of income that is taxed based on gross revenues rather than income before taxes, (c) rig movements between taxing jurisdictions and (d) our rig operating structures.  Generally, our annual marginal tax rate is lower than our annual effective tax rate.

The components of our provision (benefit) for income taxes were as follows (in millions):

	Years ended December 31,
	2011			2010			2009
Current tax expense	$	426		$	450		$	738
Deferred tax expense (benefit)	(31		)	(114		)	(15		)
Income tax expense	$	395		$	336		$	723

The following is a reconciliation of the differences between the income tax expense for our continuing operations computed at the Swiss holding company federal statutory rate of 7.83 percent and our reported provision for income taxes (in millions):

	Years ended December 31,
	2011			2010			2009
Income tax expense at the Swiss federal statutory rate	$	(425	)	$	101		$	307
Taxes on earnings subject to rates greater than the Swiss federal statutory rate	285			107			288
Taxes on impairment loss subject to rates less than the Swiss federal statutory rate	409			79			—
Taxes on asset sales subject to rates less than the Swiss federal statutory rate	(16		)	—			—
Taxes on litigation matters subject to rates less than the Swiss federal statutory rate	78			—			—
Changes in unrecognized tax benefits, net	62			71			135
Change in valuation allowance	19			4			49
Benefit from foreign tax credits	(28		)	(23		)	(49		)
Taxes on asset acquisition costs at rates lower than the Swiss federal statutory rate	8			—			—
Other, net	3			(3		)	(7		)
Income tax expense	$	395		$	336		$	723

Deferred taxes—The significant components of our deferred tax assets and liabilities were as follows (in millions):

	December 31,
	2011			2010
Deferred tax assets
Drilling contract intangibles	$	2		$	6
Net operating loss carryforwards	341			184
Tax credit carryforwards	45			29
Accrued payroll expenses not currently deductible	77			72
Deferred income	67			84
Valuation allowance	(183		)	(164		)
Other	81			61
Total deferred tax assets	430			272
Deferred tax liabilities
Depreciation and amortization	(749		)	(680		)
Drilling management services intangibles	(25		)	(26		)
Other	(37		)	(26		)
Total deferred tax liabilities	(811		)	(732		)
Net deferred tax liabilities	$	(381	)	$	(460	)

Our deferred tax assets include U.S. foreign tax credit carryforwards of $45 million, which will expire between 2015 and 2021.  Deferred tax assets related to our NOLs were generated in various worldwide tax jurisdictions.  The tax effect of our Brazilian NOLs, which do not expire, was $57 million and $62 million at December 31, 2011 and 2010, respectively.  In connection with our acquisition of Aker Drilling, we acquired $141 million of Norwegian NOLs, which do not expire.

The valuation allowance for our non-current deferred tax assets was as follows (in millions):

	December 31,
	2011		2010
Valuation allowance for non-current deferred tax assets	$	183	$	164

Our deferred tax liabilities include taxes related to the earnings of certain subsidiaries that are not permanently reinvested or that will not be permanently reinvested in the future.  Should our expectations change regarding future tax consequences, we may be required to record additional deferred taxes that could have a material adverse effect on our consolidated statement of financial position, results of operations or cash flows.

We consider the earnings of certain of our subsidiaries to be indefinitely reinvested.  As such, we have not provided for taxes on these unremitted earnings.  Should we make a distribution from the unremitted earnings of these subsidiaries, we would be subject to taxes payable to various jurisdictions.  At December 31, 2011, the amount of indefinitely reinvested earnings was approximately $2.2 billion.  If all of these indefinitely reinvested earnings were distributed, we would be subject to estimated taxes of $150 million to $200 million.

Unrecognized tax benefits—The changes to our liabilities related to unrecognized tax benefits, excluding interest and penalties that we recognize as a component of income tax expense, were as follows (in millions):

	Years ended December 31,
	2011			2010			2009
Balance, beginning of period	$	485		$	460		$	372
Additions for current year tax positions	45			46			64
Additions for prior year tax positions	23			9			62
Reductions for prior year tax positions	—			(11		)	(22		)
Settlements	(42		)	(17		)	(3		)
Reductions related to statute of limitation expirations	(2		)	(2		)	(13		)
Balance, end of period	$	509		$	485		$	460

The liabilities related to our unrecognized tax benefits, including related interest and penalties that we recognize as a component of income tax expense, were as follows (in millions):

	December 31,
	2011		2010
Unrecognized tax benefits, excluding interest and penalties	$	509	$	485
Interest and penalties	272		235
Unrecognized tax benefits, including interest and penalties	$	781	$	720

For the years ended December 31, 2011, 2010 and 2009, we recognized interest and penalties related to our unrecognized tax benefits, recorded as a component of income tax expense, in the amount of $37 million, $35 million and $51 million, respectively.  If recognized, $781 million of our unrecognized tax benefits, including interest and penalties, as of December 31, 2011, would favorably impact our effective tax rate.

It is reasonably possible that our existing liabilities for unrecognized tax benefits may increase or decrease in the year ending December 31, 2012 primarily due to the progression of open audits or the expiration of statutes of limitation.  However, we cannot reasonably estimate a range of potential changes in our existing liabilities for unrecognized tax benefits due to various uncertainties, such as the unresolved nature of various audits.

Tax returns—We file federal and local tax returns in several jurisdictions throughout the world.  With few exceptions, we are no longer subject to examinations of our U.S. and non-U.S. tax matters for years prior to 2003.  For the years ended December 31, 2011, 2010 and 2009, the amount of current tax benefit recognized from the settlement of disputes with tax authorities and from the expiration of statutes of limitations was insignificant.

Our tax returns in the major jurisdictions in which we operate, other than the U.S., Norway and Brazil which are mentioned below, are generally subject to examination for periods ranging from three to six years.  We have agreed to extensions beyond the statute of limitations in two major jurisdictions for up to 17 years.  Tax authorities in certain jurisdictions are examining our tax returns and in some cases have issued assessments.  We are defending our tax positions in those jurisdictions.  While we cannot predict or provide assurance as to the final outcome of these proceedings, we do not expect the ultimate liability to have a material adverse effect on our consolidated statement of financial position or results of operations, although it may have a material adverse effect on our consolidated cash flows.

U.S. tax investigations—With respect to our 2004 U.S. federal income tax return, the U.S. tax authorities withdrew all of their previously proposed tax adjustments, including all claims related to transfer pricing.  Accordingly, the trial previously scheduled to be heard in U.S. Tax Court in February 2012 has been cancelled.  With respect to our 2005 U.S. federal income tax returns, the U.S. tax authorities have withdrawn all of their previously proposed tax adjustments, except a claim regarding transfer pricing for certain charters of drilling rigs between our subsidiaries, resulting in a total proposed adjustment of approximately $50 million, excluding interest.  We believe an unfavorable outcome on this assessment with respect to 2005 activities would not result in a material adverse effect on our consolidated statement of financial position, results of operations or cash flows.  Although we believe the transfer pricing for these charters is materially correct, we have been unable to reach a resolution with the tax authorities.

In May 2010, we received an assessment from the U.S. tax authorities related to our 2006 and 2007 U.S. federal income tax returns.  In July 2010, we filed a protest letter with the U.S. tax authorities responding to this assessment.  The significant issues raised in the assessment relate to transfer pricing for certain charters of drilling rigs between our subsidiaries and the creation of intangible assets resulting from the performance of engineering services between our subsidiaries.  These two items would result in net adjustments of approximately $278 million of additional taxes, excluding interest.  An unfavorable outcome on these adjustments could result in a material adverse effect on our consolidated statement of financial position, results of operations or cash flows.  We believe our returns are materially correct as filed, and we intend to continue to vigorously defend against all such claims.

In addition, the May 2010 assessment included adjustments related to a series of restructuring transactions that occurred between 2001 and 2004.  These restructuring transactions impacted our basis in our former subsidiary, TODCO, which we disposed of in 2004 and 2005.  The authorities are disputing the amount of capital losses that resulted from the disposition of TODCO.  We utilized a portion of the capital losses to offset capital gains on our U.S federal income tax returns for 2006 through 2009.  The majority of the capital losses were unutilized and expired on December 31, 2009.  The adjustments would also impact the amount of certain net operating losses and other carryovers in 2006 and later years.  The authorities are also contesting the characterization of certain amounts of income received in 2006 and 2007 as capital gain and thus the availability of the capital gain for offset by the capital loss.  These claims with respect to our U.S. federal income tax returns for 2006 through 2009 could result in net tax adjustments of approximately $295 million.  An unfavorable outcome on these potential adjustments could result in a material adverse effect on our consolidated statement of financial position, results of operations or cash flows.  We believe that our U.S federal income tax returns are materially correct as filed, and we intend to vigorously defend against any potential claims.

The May 2010 assessment also included certain claims with respect to withholding taxes and certain other items resulting in net tax adjustments of approximately $160 million, excluding interest.  In addition, the tax authorities assessed penalties associated with the various tax adjustments for the 2006 and 2007 audits in the aggregate amount of approximately $88 million, excluding interest.  We believe that our tax returns are materially correct as filed, and we intend to vigorously defend against potential claims.

See Note 28—Subsequent Events.

Norway tax investigations—Norwegian civil tax and criminal authorities are investigating various transactions undertaken by our subsidiaries in 2001 and 2002 as well as the actions of certain employees of our former external tax advisors on these transactions.  The authorities issued tax assessments of (a) approximately $262 million plus interest, related to certain restructuring transactions, (b) approximately $115 million plus interest, related to the migration of a subsidiary that was previously subject to tax in Norway, (c) approximately $69 million plus interest, related to a 2001 dividend payment and (d) approximately $7 million plus interest, related to certain foreign exchange deductions and dividend withholding tax.  We have filed or expect to file appeals to these tax assessments.  With respect to the tax assessment related to the migration of a subsidiary, we provided a guarantee in the amount of approximately $120 million, plus interest, while this dispute is addressed by the Norwegian courts.  Furthermore, we may be required to provide some form of additional financial security, in an amount up to $776 million, including interest and penalties, for these other assessed amounts while these disputes are appealed and addressed by the Norwegian courts.  The authorities have indicated that they plan to seek penalties of 60 percent on most but not all matters.  For these matters, we believe our returns are materially correct as filed, and we have and will continue to respond to all information requests from the Norwegian authorities.  In June 2011, the Norwegian authorities issued criminal indictments against two of our subsidiaries alleging misleading or incomplete disclosures in Norwegian tax returns for the years 1999 through 2001, as well as inaccuracies in Norwegian statutory financial statements for the years ended December 31, 1996 through 2001.  The criminal trial has been scheduled for December 2012.  Two employees of our former external tax advisors were also issued indictments with respect to the disclosures in our tax returns.  We believe these charges are without merit and plan to vigorously defend our subsidiaries to the fullest extent.  We intend to vigorously contest any assertions by the Norwegian civil and criminal authorities in connection with the various transactions being investigated.  In October 2011, the Norwegian authorities issued criminal indictments against a Norwegian tax attorney related to certain of our restructuring transactions and to a 2001 dividend payment.  An unfavorable outcome on these Norwegian civil and criminal tax matters could result in a material adverse effect on our consolidated statement of financial position, results of operations or cash flows.  However, while we cannot predict or provide assurance as to the final outcome of these proceedings, we do not expect the ultimate resolution of these matters to have a material adverse effect on our consolidated statement of financial position or results of operations, although it may have a material adverse effect on our consolidated cash flows.  See Note 28—Subsequent Events.

Brazil tax investigations—Certain of our Brazilian income tax returns for the years 2000 through 2004 are currently under examination.  The Brazilian tax authorities have issued tax assessments totaling $109 million, plus a 75 percent penalty in the amount of $82 million and interest through December 31, 2011 in the amount of $150 million.  An unfavorable outcome on these proposed assessments could result in a material adverse effect on our consolidated statement of financial position, results of operations or cash flows.  We believe our returns are materially correct as filed, and we are vigorously contesting these assessments.  On January 25, 2008, we filed a protest letter with the Brazilian tax authorities, and we are currently engaged in the appeals process.

Other tax matters—We conduct operations through our various subsidiaries in a number of countries throughout the world.  Each country has its own tax regimes with varying nominal rates, deductions and tax attributes.  From time to time, we may identify changes to previously evaluated tax positions that could result in adjustments to our recorded assets and liabilities.  Although we are unable to predict the outcome of these changes, we do not expect the effect, if any, resulting from these assessments to have a material adverse effect on our consolidated statement of financial position, results of operations or cash flows.