Taxation

Under Swiss law, a resident company is subject to income tax at the federal, cantonal, and communal levels that is levied on net worldwide income. Income attributable to permanent establishments or real estate located abroad is excluded from the Swiss tax base. ACE Limited is a holding company and, therefore, is exempt from cantonal and communal income tax. As a result, ACE Limited is subject to Swiss income tax only at the federal level. Furthermore, participation relief (i.e., tax relief) is granted to ACE Limited at the federal level for qualifying dividend income and capital gains related to the sale of qualifying participations (i.e., subsidiaries). It is expected that the participation relief will result in a full exemption of participation income from federal income tax. ACE Limited is resident in the Canton and City of Zurich and, as such, is subject to an annual cantonal and communal capital tax on the taxable equity of ACE Limited in Switzerland.

ACE has two Swiss operating subsidiaries resident in the Canton and City of Zurich, an insurance company, ACE Insurance (Switzerland) Limited, which, in turn, owns a reinsurance company, ACE Reinsurance (Switzerland) Limited. Both are subject to federal, cantonal, and communal income tax and to annual cantonal and communal capital tax.

Under current Bermuda law, ACE Limited and its Bermuda subsidiaries are not required to pay any taxes on income or capital gains. If a Bermuda law were enacted that would impose taxes on income or capital gains, ACE Limited and the Bermuda subsidiaries have received an undertaking from the Minister of Finance in Bermuda that would exempt such companies from Bermudian taxation until March 2035.

Income from ACE's operations at Lloyd's is subject to United Kingdom corporation taxes. Lloyd's is required to pay U.S. income tax on U.S. connected income (U.S. income) written by Lloyd's syndicates. Lloyd's has a closing agreement with the Internal Revenue Service (IRS) whereby the amount of tax due on this business is calculated by Lloyd's and remitted directly to the IRS. These amounts are then charged to the accounts of the Names/Corporate Members in proportion to their participation in the relevant syndicates. ACE's Corporate Members are subject to this arrangement but, as U.K. domiciled companies, will receive U.K. corporation tax credits for any U.S. income tax incurred up to the value of the equivalent U.K. corporation income tax charge on the U.S. income.

ACE Group Holdings and its respective subsidiaries are subject to income taxes imposed by U.S. authorities and file a consolidated U.S. tax return. Combined Insurance and its subsidiaries will file a separate consolidated U.S. tax return for tax years prior to 2014. Should ACE Group Holdings pay a dividend to ACE, withholding taxes would apply. Currently, however, no withholding taxes are accrued with respect to such un-remitted earnings as management has no intention of remitting these earnings. Similarly, no taxes have been provided on the un-remitted earnings of certain foreign subsidiaries as management has no intention of remitting these earnings. The cumulative amount that would be subject to withholding tax, if distributed, as well as the determination of the associated tax liability are not practicable to compute; however, such amount would be material to ACE. Certain international operations of ACE are also subject to income taxes imposed by the jurisdictions in which they operate.

ACE is not subject to income taxation other than as stated above. There can be no assurance that there will not be changes in applicable laws, regulations, or treaties which might require ACE to change the way it operates or become subject to taxation.

ACE's domestic operations are in Switzerland, the jurisdiction where we are legally organized, incorporated, and registered. Domestic operations for the years ended December 31, 2012, 2011, and 2010 are not considered significant to the consolidated income before income taxes for the respective periods.

The following table presents the provision for income taxes:



	Years Ended December 31
(in millions of U.S. dollars)	2012			2011		2010
Current tax expense	$	305		$	485	$	443
Deferred tax expense (benefit)	(35		)	17		110
Provision for income taxes	$	270		$	502	$	553

The most significant jurisdictions contributing to the overall taxation of ACE are calculated using the following rates: Switzerland 7.83 percent, Bermuda 0.0 percent, U.S. 35.0 percent, and U.K. 24.5 percent. The following table presents a reconciliation of the difference between the provision for income taxes and the expected tax provision at the Swiss statutory income tax rate:



	Years Ended December 31
(in millions of U.S. dollars)	2012			2011			2010
Expected tax provision at Swiss statutory tax rate	$	233		$	160		$	285
Permanent differences:
Taxes on earnings subject to rate other than Swiss statutory rate	129			323			327
Tax-exempt interest and dividends received deduction, net of proration	(24		)	(21		)	(20		)
Net withholding taxes	23			19			15
Favorable resolution of prior years' tax matters and closing statutes of limitations	(124		)	—			(21		)
Change in valuation allowance	4			(2		)	(3		)
Non-taxable acquisition gain	—			—			(61		)
Other	29			23			31
Total provision for income taxes	$	270		$	502		$	553

The following table presents the components of the net deferred tax assets:



	December 31		December 31
(in millions of U.S. dollars)	2012		2011
Deferred tax assets:
Loss reserve discount	$	849	$	933
Unearned premiums reserve	98		85
Foreign tax credits	1,131		1,074
Investments	43		67
Provision for uncollectible balances	110		113
Loss carry-forwards	55		43
Other, net	110		31
Cumulative translation adjustment	—		5
Total deferred tax assets	2,396		2,351
Deferred tax liabilities:
Deferred policy acquisition costs	68		47
VOBA and other intangible assets	379		372
Un-remitted foreign earnings	795		810
Unrealized appreciation on investments	586		392
Cumulative translation adjustment	59		—
Total deferred tax liabilities	1,887		1,621
Valuation allowance	56		57
Net deferred tax assets	$	453	$	673

The valuation allowance of $56 million at December 31, 2012, and $57 million at December 31, 2011, reflects management's assessment, based on available information, that it is more likely than not that a portion of the deferred tax assets will not be realized due to the inability of certain foreign subsidiaries to generate sufficient taxable income and the inability of ACE Group Holdings and its subsidiaries to utilize foreign tax credits. Adjustments to the valuation allowance are made when there is a change in management's assessment of the amount of deferred tax assets that are realizable.

At December 31, 2012, ACE has net operating loss carry-forwards of $157 million which, if unutilized, will expire in the years 2013 through 2030, and a foreign tax credit carry-forward in the amount of $76 million which, if unutilized, will expire in the years 2015 through 2022.

The following table presents a reconciliation of the beginning and ending amount of unrecognized tax benefits:



	December 31			December 31
(in millions of U.S. dollars)	2012			2011
Balance, beginning of year	$	134		$	139
Additions based on tax provisions related to the current year	19			1
Reductions for tax positions of prior years	—			(6		)
Reductions for settlements with tax authorities	(16		)	—
Reductions for the lapse of the applicable statutes of limitations	(111		)	—
Balance, end of year	$	26		$	134

Not included in the balance above at December 31, 2012 and 2011, is $18 million and $1 million, respectively, of unrecognized tax benefits for which the ultimate deductibility is highly certain but for which there is uncertainty about the timing of such deductibility. Because of the impact of deferred tax accounting, other than interest and penalties, an unfavorable resolution of these temporary items would not affect the annual effective tax rate but would accelerate the payment of cash to the taxing authority to an earlier period. Consequently, the total amount of unrecognized tax benefits at December 31, 2012, that would affect the effective tax rate, if recognized, is $8 million.

ACE recognizes accruals for interest and penalties, if any, related to unrecognized tax benefits in income tax expense in the consolidated statements of operations. Tax-related interest expense (income) and penalties reported in the consolidated statements of operations for the years ended December 31, 2012, 2011, and 2010 were $(8) million, $3 million, and $(1) million, respectively. At December 31, 2012 and 2011, ACE recorded $12 million and $22 million, respectively, in liabilities for tax-related interest and penalties in our consolidated balance sheets.

In 2010, ACE reached final settlement with the IRS Appeals Division (Appeals) regarding its federal tax returns for 2002, 2003, and 2004. As a result of the settlement, the amount of unrecognized tax benefits including interest was reduced by approximately $21 million. In 2012, ACE reached final settlement with Appeals regarding several issues raised by the IRS Examination Division in its federal tax returns for 2005, 2006, and 2007. The settlement of these issues had no net impact on our results of operations. During 2012, the IRS completed its field examination of ACE’s federal tax returns for 2008 and 2009. No material adjustments resulted from this examination. During 2012, ACE recognized a $124 million benefit resulting from the favorable resolution of various prior years' tax matters and the closing of statutes of limitations. It is reasonably possible that over the next twelve months, the amount of unrecognized tax benefits may change resulting from the re-evaluation of unrecognized tax benefits arising from examinations of taxing authorities and the closing of tax statutes of limitations. With few exceptions, ACE is no longer subject to state and local or non-U.S. income tax examinations for years before 2005.