Arch Capital is incorporated under the laws of Bermuda and, under current Bermuda law, is not obligated to pay any taxes in Bermuda based upon income or capital gains. The Company has received a written undertaking from the Minister of Finance in Bermuda under the Exempted Undertakings Tax Protection Act 1966 that, in the event that any legislation is enacted in Bermuda imposing any tax computed on profits, income, gain or appreciation on any capital asset, or any tax in the nature of estate duty or inheritance tax, such tax will not be applicable to Arch Capital or any of its operations until March 31, 2035. This undertaking does not, however, prevent the imposition of taxes on any person ordinarily resident in Bermuda or any company in respect of its ownership of real property or leasehold interests in Bermuda.

source income that is subject to U.S. withholding tax or income that is effectively connected with the conduct of a trade or business within the U.S. and is not exempt from U.S. tax under an applicable income tax treaty with the U.S. Arch Capital and its non-U.S. subsidiaries will be subject to a withholding tax on dividends from U.S. investments and interest from certain U.S. payors (subject to reduction by any applicable income tax treaty). Arch Capital and its non-U.S. subsidiaries intend to conduct their operations in a manner that will not cause them to be treated as engaged in a trade or business in the United States and, therefore, will not be required to pay U.S. federal income taxes (other than U.S. excise taxes on insurance and reinsurance premium and withholding taxes on dividends and certain other U.S. source investment income). However, because there is uncertainty as to the activities which constitute being engaged in a trade or business within the United States, there can be no assurances that the U.S. Internal Revenue Service will not contend successfully that Arch Capital or its non-U.S. subsidiaries are engaged in a trade or business in the United States. If Arch Capital or any of its non-U.S. subsidiaries

were subject to U.S. income tax, Arch Capital’s shareholders’ equity and earnings could be materially adversely affected. Arch Capital has subsidiaries and branches that operate in various jurisdictions around the world that are subject to tax in the jurisdictions in which they operate. The significant jurisdictions in which Arch Capital’s subsidiaries and branches are subject to tax are the United States, United Kingdom, Ireland, Canada, Switzerland, Australia and Denmark.



	Year Ended December 31,
	2019			2018		2017
Current expense (benefit):
United States	$	139,407		$	73,078	$	(51,705	)
Non-U.S.	4,954			12,785		5,969
	144,361			85,863		(45,736		)
Deferred expense (benefit):
United States	11,849			19,544		169,093
Non-U.S.	(400		)	8,544		4,211
	11,449			28,088		173,304
Income tax expense	$	155,810		$	113,951	$	127,568

The expected tax provision computed on pre-tax income or loss at the weighted average tax rate has been calculated as the sum of the pre-tax income in each jurisdiction multiplied by that jurisdiction’s applicable statutory tax rate. The 2019 applicable statutory tax rates by jurisdiction were as follows: Bermuda (0.0%), United States (21.0%), United Kingdom (19.0%), Ireland (12.5%), Denmark (22.0%), Canada (26.5%), Gibraltar (10.0%), Australia (30.0%), Hong Kong (16.5%) and the Netherlands (19.0%). The United States rate was 35% in 2017.



	Year Ended December 31,
	2019			2018			2017
Expected income tax expense (benefit) computed on pre-tax income at weighted average income tax rate	$	149,799		$	91,529		$	126,262
Addition (reduction) in income tax expense (benefit) resulting from:
Tax-exempt investment income	(3,091		)	(4,790		)	(13,330		)
Meals and entertainment	1,134			1,060			1,063
State taxes, net of U.S. federal tax benefit	3,314			2,086			732
Foreign branch taxes	1,231			5,428			5,752
Prior year adjustment	632			(2,522		)	(559		)
Foreign exchange gains & losses	436			1,293			(572		)
Changes in applicable tax rate	—			(128		)	7,745
Dividend withholding taxes	6,510			6,594			232
Change in valuation allowance	1,628			18,396			14,798
Contingent consideration	190			740			3,785
Share based compensation	(6,592		)	(5,356		)	(18,733		)
Other	619			(379		)	393
Income tax expense (benefit)	$	155,810		$	113,951		$	127,568

On December 22, 2017, the Tax Cuts Act was signed into law which significantly changed the U.S. tax laws in many ways including a reduction of the U.S. federal income tax rate from 35% to 21% effective January 1, 2018. Also on December 22, 2017, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 118 (“SAB 118”) which provided guidance on accounting for tax effects of the Tax Cuts Act. SAB 118 provided a measurement period of up to one year from the enactment date to complete the accounting. During 2018, the Company finalized its accounting for the income tax impact of the Tax Cuts Act resulting in a tax expense of $1.2 million, primarily attributable to the write down of temporary differences identified following the filing of the Company’s 2017 corporate tax return offset by AMT credits that were currently recoverable.

Deferred income tax assets and liabilities reflect temporary differences based on enacted tax rates between the carrying amounts of assets and liabilities for financial reporting and income tax purposes. Significant components of the Company’s deferred income tax assets and liabilities were as follows:



	December 31,
	2019			2018
Deferred income tax assets:
Net operating loss	$	30,836		$	24,089
Uncrystallized losses	1,565			7,960
AMT credit carryforward	1,323			2,652
Discounting of net loss reserves	52,582			43,130
Net unearned premium reserve	64,269			68,305
Compensation liabilities	21,693			20,492
Foreign tax credit carryforward	9,521			9,116
Interest expense	—			1,387
Goodwill and intangible assets	11,644			17,127
Bad debt reserves	5,983			5,626
Lease liability	26,438			—
Net unrealized foreign exchange losses	598			949
Net unrealized decline of investments	—			13,453
Other, net	206			3,418
Deferred tax assets before valuation allowance	226,658			217,704
Valuation allowance	(48,219		)	(44,659		)
Deferred tax assets net of valuation allowance	178,439			173,045
Deferred income tax liabilities:
Depreciation and amortization	(1,215		)	(2,559		)
Deposit accounting liability	(2,169		)	(2,292		)
Contingency reserve	(132,831		)	(112,852		)
Deferred policy acquisition costs	(29,847		)	(32,105		)
Net unrealized appreciation of investments	(38,764		)	—
Right-of-use asset	(23,416		)	—
Other, net	(3,680		)	(735		)
Total deferred tax liabilities	(231,922		)	(150,543		)
Net deferred income tax assets (liabilities)	$	(53,483	)	$	22,502

The Company provides a valuation allowance to reduce certain deferred tax assets to an amount which management expects to more likely than not be realized. As of December 31, 2019, the Company’s valuation allowance was $48.2 million, compared to $44.7 million at December 31, 2018. The valuation allowance in both periods was primarily attributable to valuation allowance on the Company’s U.K. Canadian and Australian operations and certain other deferred tax assets relating to loss carryforwards that have a limited use.



	Year Ended December 31,
	2019		Expiration
Operating Loss Carryforwards
United Kingdom	$	89,000	No expiration
Ireland	10,200		No expiration
Australia	22,000		No expiration
Hong Kong	17,600		No expiration
Denmark	400		No expiration
United States (1) (2)	23,100		2029 - 2038

Tax Credits
U.K. foreign tax credits	9,521		No expiration
U.S. refundable AMT credits	1,323		No expiration

(2) On January 30, 2014, the Company’s U.S. mortgage operations underwent an ownership change for U.S. federal income tax purposes as a result of the Company’s acquisition of the CMG Entities. As a result of this ownership change, a limitation has been imposed upon the utilization of approximately $8.9 million of the Company’s existing U.S. net operating loss carryforwards. Utilization is limited to approximately $0.6 million per year in accordance with Section 382 of the Internal Revenue Code of 1986 as amended (“the Code”).

The Company’s U.S. mortgage operations are eligible for a tax deduction, subject to certain limitations, under Section 832(e) of the Code for amounts required by state law or regulation to be set aside in statutory contingency reserves. The deduction is allowed only to the extent that the Company purchases non-interest bearing U.S. Mortgage Guaranty Tax and Loss Bonds (“T&L Bonds”) issued by the U.S. Treasury Department in an amount equal to the tax benefit derived from deducting any portion of the statutory contingency reserves. T&L Bonds are reflected in ‘other assets’ on the Company’s balance sheet and totaled approximately $207.0 million at December 31, 2019, compared to $183.0 million at December 31, 2018.

Deferred income tax liabilities have not been accrued with respect to the undistributed earnings of the Company's U.S., U.K. and Ireland subsidiaries as it is the Company’s intention that all such earnings will be indefinitely reinvested. If the earnings were to be distributed, as dividends or otherwise, such amounts may be subject to withholding tax in the jurisdiction of the paying entity. The Company no longer intends to indefinitely reinvest earnings from the Company's Canada subsidiary, however, no income or withholding taxes have been accrued as the Canada subsidiary does not have positive cumulative earnings and profits and therefore a distribution from this particular subsidiary would not be subject to income taxes or withholding taxes. Potential tax implications of repatriation from the Company’s unremitted earnings that are indefinitely reinvested are driven by facts at the time of distribution. Therefore it is not practicable to estimate the income tax liabilities that might be incurred if such earnings were remitted. Distributions from the U.K. or Ireland would not

The Company recognizes interest and penalties relating to unrecognized tax benefits in the provision for income taxes. As of December 31, 2019, the Company’s total unrecognized tax benefits, including interest and penalties, were $2.0 million. If recognized, the full amount of the unrecognized tax benefit would impact the consolidated effective tax rate. A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows:



	December 31,
	2019		2018
Balance at beginning of year	$	2,008	$	2,008
Additions based on tax positions related to the current year	—		—
Additions for tax positions of prior years	—		—
Reductions for tax positions of prior years	—		—
Settlements	—		—
Balance at end of year	$	2,008	$	2,008

The Company or its subsidiaries or branches files income tax returns in the U.S. federal jurisdiction and various state, local and foreign jurisdictions.The following table details open tax years that are potentially subject to examination by local tax authorities, in the following major jurisdictions: