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Income Taxes
9 Months Ended
Jul. 31, 2012
Income Tax Disclosure [Abstract]  
Income Taxes
Income Taxes
We compute on a quarterly basis an estimated annual effective tax rate considering ordinary income and related income tax expense. Certain foreign results in 2012 and 2011 are excluded from ordinary income due to ordinary losses for which no benefit can be recognized. Ordinary income refers to income (loss) before income tax expense excluding significant unusual or infrequently occurring items. Our effective tax rate in the first nine months of 2012 was higher than the U.S. statutory rate due to the impact of changes in valuation allowances related to our Canadian deferred tax assets, the geographical mix of the jurisdictions recognizing earnings or losses, and the favorable results from uncertain tax positions. Our effective tax rate for the third quarter of 2012 was higher than the U.S. statutory rate due to $173 million of income tax benefit resulting from a third quarter change in the estimated 2012 annual effective tax rate, resulting from a significant change in the 2012 forecasted results, which was caused by a change in the geographical mix of the jurisdictions in which we recognize earnings or losses, and the favorable results from uncertain tax positions. The tax effect of a significant unusual or infrequently occurring item is recorded in the interim period in which it occurs. Items included in income tax expense in the periods in which they occur include the tax effects of material restructurings and impairments, cumulative effect of changes in tax laws or rates, foreign exchange gains and losses, adjustments to uncertain tax positions, and adjustments to our valuation allowance due to changes in judgment regarding the ability to realize deferred tax assets in future years.
We have evaluated the need to maintain a valuation allowance for deferred tax assets based on our assessment of whether it is more likely than not that deferred tax benefits will be realized through the generation of future taxable income. Appropriate consideration is given to all available evidence, both positive and negative, in assessing the need for a valuation allowance. This evaluation resulted in the determination that we would be unable to realize a portion of our U.S. research and development credits and a valuation allowance of $14 million was, therefore, established as of July 31, 2012. We continue to maintain a valuation allowance on certain federal, state, and foreign deferred tax assets that we believe on a more-likely-than-not basis will not be realized based on current forecasted results. Based on our current domestic performance, as well as the risks associated with our strategy for meeting 2010 EPA emission standards, we also believe that it is reasonably possible that a significant additional U.S. deferred tax assets valuation allowance could be required in the next twelve months. Future events that may contribute to the need to establish an additional U.S. deferred tax asset valuation allowance include, but are not limited to: (i) continued deterioration of our domestic performance, (ii) significant warranty charges, and (iii) adverse developments with respect to our strategy for meeting 2010 EPA emission standards. For additional discussion on risks associated with our strategy for meeting 2010 EPA emission standards see section Meeting U.S. Federal and State 2010 Emission Standards Requirements of Note 12, Commitments and Contingencies.
During the second quarter 2012, our evaluation resulted in the determination that a significant portion of our valuation allowance on our Canadian deferred tax assets could be released. As a result of our analysis, we recognized an income tax benefit of $181 million from the release of valuation allowances in the nine months ended July 31, 2012.
Similarly, during the third quarter of 2011, we conducted an evaluation and determined that a significant portion of our valuation allowance on our U.S. deferred tax assets could be released as of July 31, 2011. As a result, we recognized an income tax benefit of $1.5 billion and an adjustment to Additional paid in capital of $45 million for the release of the valuation allowances on our U.S. deferred tax assets during the three months ended July 31, 2011.
We recognize the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the financial statements from such a position are measured based on the largest benefit that has a greater than fifty percent likelihood of being realized upon ultimate settlement. As of July 31, 2012, the amount of liability for uncertain tax positions was $14 million. If the unrecognized tax benefits are recognized, $6 million would impact our effective tax rate.
We recognize interest and penalties related to uncertain tax positions as part of Income tax benefit. For the three and nine months ended July 31, 2012, the tax benefit includes interest and penalties related to our uncertain tax positions of an expense of $2 million and a benefit of $9 million, respectively, reflecting the ongoing resolution of audits in various jurisdictions. We have open tax years back to 2005 with various significant taxing jurisdictions including the U.S., Canada, Mexico, and Brazil. In connection with the examination of tax returns, contingencies may arise that generally result from differing interpretations of applicable tax laws and regulations as they relate to the amount, timing, or inclusion of revenues or expenses in taxable income, or the sustainability of tax credits to reduce income taxes payable. We believe we have sufficient accruals for our contingent tax liabilities. Interim tax provisions include amounts considered sufficient to pay assessments that may result from examinations of prior year tax returns, although actual results may differ. The liability for unrecognized tax benefits may increase or decrease during the next twelve months. The impact of any such change on our financial condition and results of operation could be in the range of $0 to $25 million. We do not expect any such change to have a material effect on our cash flows.