10. Income taxes

During the year ended December 31, 2011, Nortel recorded a tax expense of $9 on earnings from continuing operations before income taxes and equity in net loss of associated companies and EMEA Subsidiaries of $3,701. The tax expense of $9 is comprised of $3 resulting from taxes on earnings in Asia, $8 relating to the accrual of the deferred tax liability associated with the investments in CALA and Asia, $4 of other taxes including withholding taxes, offset by decreases in uncertain tax positions and other taxes of $4 and the reversal of previously accrued income taxes and interest of $2.

The ultimate determination of the final allocation of proceeds among the various Nortel legal entities has not yet occurred and may be materially different from the classification and related amounts shown in these consolidated financial statements. Nortel expects that the final allocation of proceeds will mainly result in adjustments to existing loss carry-forward balances or other tax attributes, which will be offset with valuation allowance and have a nil impact to taxes payable.

During the year ended December 31, 2010, Nortel recorded a tax recovery of $40 on loss from continuing operations before income taxes and equity in net loss of associated companies and EMEA Subsidiaries of $4,199. The tax recovery of $40 is comprised of $11 of income taxes on current year profits during the applicable period in various jurisdictions offset by decreases in uncertain tax positions and other taxes of $10 and the adjustments to previously accrued income taxes and interest of $41.

Income tax expense or benefit from continuing operations is generally determined without regard to other categories of earnings, such as discontinued operations and other comprehensive income. An exception is provided when there is aggregate income from categories other than continuing operations and a loss from continuing operations in the current year. In this case, the tax expense or benefit allocated to continuing operations is the amount by which the loss from continuing operations reduces the tax expenses recorded with respect to the other categories of earnings, even when a valuation allowance has been established against the deferred tax assets. In instances where a valuation allowance is established against current year losses, income from other sources, including discontinued operations, is considered when determining whether sufficient future taxable income exists to realize the deferred tax assets. During the years ended December 31, 2011 and 2010, the amount of tax recovery allocated to continuing operations and tax expense allocated to discontinued operations as a result of income from discontinued operations being offset by losses from continued operations was nil and $7 respectively.

As of December 31, 2011, Nortel's net deferred tax liabilities were $7, representing the accrual of deferred tax liabilities associated with the expected withholding taxes relating to investments in CALA and Asia. During the third quarter of 2011, Nortel concluded the successful auction of Nortel's remaining patent and patent applications portfolio and closed this transaction on July 29, 2011, which generated a gain of $4,475 in the third quarter of 2011. The estimated tax impact in Canada resulted in a reduction of the gross deferred tax asset offset with a reduction in valuation allowance resulting in a net nil tax impact. There is significant uncertainty concerning the forecasted income or loss for 2012 and beyond and the uncertainty concerning the estimated final proceeds allocation by jurisdiction, and thus this significant negative evidence outweighs any positive evidence that may exist. Therefore, Nortel has concluded that a full valuation allowance continues to be necessary against Nortel's deferred tax assets in all jurisdictions as of December 31, 2011.

The following is a tabular reconciliation of Nortel's change in unrecognized tax benefits under ASC 740 from the beginning to the end of the year:


	2011			2010

Balance as of January 1	$	1,531		$	1,871
Reduction of uncertain tax positions resulting from the loss of control and sale of subsidiaries		-			(43	)
Increases related to current year tax positions		-			3
Decreases related to current year tax positions		-			(1	)
Increases related to prior year tax positions		-			590
Decreases related to prior year tax positions		(4	)		(24	)
Expiration of statute of limitations for assessment of taxes		-			(1	)
Settlement of tax positions		-			(918	)
Foreign exchange		(38	)		54
Tax rate change		(2	)		-

Balance as of December 31	$	1,487		$	1,531

Nortel had approximately $1,487 and $1,531 of total gross unrecognized tax benefits as of December 31, 2011 and December 31, 2010, respectively. Of the total gross unrecognized tax benefits of $1,487, $11 represented the amount of unrecognized tax benefits, net of valuation allowance that would favorably affect the effective income tax rate in future periods, if recognized. The net decrease of $44 since December 31, 2010 resulted from $38 due to changes to foreign exchange rates, a decrease in a prior year uncertain position of $4, and a decrease of $2 due to a change in tax rates.

Nortel recognized interest and penalties accrued related to unrecognized tax benefits in income tax expense. During the year ended December 31, 2011, Nortel recovered $2 related to interest, penalties and foreign exchange losses. Nortel has accrued approximately $7 and $9 for the payment of interest and penalties as of December 31, 2011 and 2010, respectively.

Nortel believes it is reasonably possible that $1,383 of its gross unrecognized tax benefit will decrease during the year ending December 31, 2012, of which $640 relates to the deductibility of legal settlement expenses and $743 relates to investment tax credits with the resulting impact being the expiry of unutilized non capital losses from prior years.

Nortel is subject to tax examinations in all major taxing jurisdictions in which it continues to operate and Nortel regularly assesses the status and the potential for adverse outcomes to determine the adequacy of the provision for income and other taxes. Nortel's 2000 through 2009 tax years remain open in most of these jurisdictions and are subject to ongoing audit activity. Specifically, the tax authorities in Canada are close to completing an audit and issuing a reassessment in respect of non-refundable investment tax credits claimed by NNL in its 2002 tax year. Nortel increased the unrecognized tax benefits relating to investment tax credits claimed in the 2002 to 2009 taxation years by $171 to reflect the amount that is more likely than not to be sustained. Nortel believes that it has adequately provided for other tax adjustments that are more likely than not to be realized as a result of these ongoing examinations.

The following is a reconciliation of income taxes, calculated at the Canadian combined federal and provincial income tax rate, to the income tax benefit (expense) included in the consolidated statements of operations for each of the years ended December 31:


	2011			2010
Income (taxes)/recovery at Canadian rates (2011 - 28%, 2010 - 31.0%)	$	(1,037	)	$	1,302
Difference between Canadian rates and rates applicable to subsidiaries in the U.S. and other jurisdictions		97			(184	)
Valuation allowances on tax benefits		252			(5,051	)
Tax effect of tax rate changes		(66	)		(4	)
Adjustments to provisions and reserves		8			(521	)
Foreign withholding and other taxes		(11	)		17
Gain on sale of patents attributable to non Canadian Debtors for tax purposes ^(a)		512			-
Deferred tax adjustments relating to prior years		46			(102	)
Non taxable gains and losses		194			(201	)
Previously unrecognized outside basis in deconsolidated subsidiaries		-			5,118
Impact of non-taxable/(non-deductible) items and other differences		(4	)		(334	)

Income tax benefit (expense)	$	(9	)	$	40

Details of Nortel's income (loss):
Earnings (loss) from continuing operations before income taxes and equity in net loss of associated companies: Canadian, excluding gain (loss) on sales of businesses and assets	$	3,711		$	(3,878	)
U.S. and other, excluding gain (loss) on sale of businesses and assets		(10	)		(321	)

	$	3,701		$	(4,199	)

Income tax benefit (expense):
Canadian, excluding loss on sales of businesses and assets	$	(10	)	$	33
U.S. and other, excluding loss on sales of businesses and assets		1			7

	$	(9	)	$	40

Income tax benefit (expense):
Current	$	(1	)	$	40
Deferred		(8	)		-

Income tax benefit (expense)	$	(9	)	$	40

Details of movement in valuation allowance
Balance as of January 1:		(8,587	)		(4,908	)
Reduction in valuation allowance due to the deconsolidation of subsidiaries		-			1,684
Amounts charged to income tax benefit (expense)		252			(5,050	)
Amounts charged to other comprehensive loss		18			(47	)
Other (additions)/ deductions		184			(266	)

Balance as of December 31:		(8,133	)		(8,587	)

(a)	Amount related to income recognized pertaining to the sale of patents and patent applications that is not expected to be taxable to the Canadian Debtors.

The following table shows the significant components included in deferred income taxes as of December 31:


	2011			2010
Assets:
Unrealized capital losses on cost investments	$	5,393		$	5,577
Tax benefit of loss carryforwards		991			1,177
Investment tax credits, net of deferred tax liabilities		904			923
Other tax credits		145			138
Provisions and reserves		160			149
Post-retirement benefits other than pensions		143			156
Plant and equipment		9			84
Pension plan liabilities		387			404
Deferred compensation		1			-
Unrealized foreign exchange		(23	)		(51	)
Other		23			30

		8,133			8,587
Valuation allowance		(8,133	)		(8,587	)

		-			-


Liabilities:
Withholding tax on investments		7			-

Net deferred income tax liabilities	$	7		$	-

Prior to 2010, deferred tax assets relating to the outside basis differences of the subsidiaries that were controlled were not recorded as it was not apparent that the differences would reverse in the foreseeable future. As described in note 1, certain Nortel subsidiaries are now accounted for under the cost method of accounting. As a result of this change the deferred tax asset relating to the unrealized capital losses on cost investments of $5,393 (2010 - $5,577) was recognized in 2011 with a full valuation allowance against it. In addition a deferred tax liability on withholding taxes on undistributed earnings of $7 was also recognized. In Canada, realized capital losses can not be utilized against ordinary income. However, capital losses can be applied against capital gains or can be utilized against future debt forgiveness in Canada.

As of December 31 2011, Nortel has $141 capital loss carry-forwards, which do not expire, and had the following net operating losses and investment tax credits which are scheduled to expire in the following years:


	Net Operating Losses		Investment Tax Credits ^(a)
2011 - 2012	$	31	$	-
2013 - 2015		336		-
2016 - 2021		25		641
2022 - 2031		1,284		263
Indefinitely		3,638		-

	$	5,314	$	904