Income Taxes

12 Months Ended

Dec. 31, 2011

Income Taxes [Abstract]

Income Taxes

13. Income Taxes

Our income tax expense is a function of the mix between our domestic and international pre-tax earnings or losses, as well as the mix of international tax jurisdictions in which we operate. Certain of our international rigs are owned and operated, directly or indirectly, by Diamond Offshore International Limited, or DOIL, a Cayman Islands subsidiary which we wholly own. It is our intention to indefinitely reinvest future earnings of DOIL and its foreign subsidiaries to finance foreign activities. Accordingly, we have not made a provision for U.S. income taxes on approximately $1.7 billion of undistributed foreign earnings and profits. Although we do not intend to repatriate the earnings of DOIL, and have not provided U.S. income taxes for such earnings, except to the extent that such earnings were immediately subject to U.S. income taxes, these earnings could become subject to U.S. income tax if remitted, or if deemed remitted as a dividend; however, it is not practical to estimate this potential liability.

In 2010 we had provided $15.0 million for U.S. taxes attributable to undistributed earnings of Diamond East Asia Limited, or DEAL, a wholly owned subsidiary of DOIL, as it had been our intention to repatriate its earnings to the U.S. However, a tax law provision that expired at the end of 2009, but was subsequently signed back into law on December 17, 2010, in conjunction with our decisions to build three new drillships overseas, caused us to reassess our intent to repatriate the earnings of DEAL to the U.S. We now plan to reinvest the earnings of DEAL internationally through another of our foreign subsidiaries, and consequently, we are no longer providing U.S. income taxes on its earnings. During the year ended December 31, 2011, we reversed the $15.0 million of U.S. income taxes that had been provided in 2010 for the earnings of DEAL.

The components of income tax expense (benefit) are as follows:

	Year Ended December 31,
	2011			2010			2009
	(In thousands)
Federal – current	$	109,684		$	183,825		$	255,753
State – current		264			191			131
Foreign – current		104,640			203,459			150,804
Total current		214,588			387,475			406,688
Federal – deferred		(1,023	)		8,287			80,258
Foreign – deferred		3,164			(15,203	)		5,266
Total deferred		2,141			(6,916	)		85,524
Total	$	216,729		$	380,559		$	492,212

The difference between actual income tax expense and the tax provision computed by applying the statutory federal income tax rate to income before taxes is attributable to the following:

	Year Ended December 31,
	2011			2010			2009
	(In thousands)
Income before income tax expense:
U.S.	$	486,393		$	755,982		$	1,250,094
Foreign		692,878			580,034			618,337
Worldwide	$	1,179,271		$	1,336,016		$	1,868,431
Expected income tax expense at federal statutory rate	$	412,745		$	467,606		$	653,951
Foreign earnings of foreign subsidiaries (not taxed at the statutory federal income tax rate) net of related foreign taxes		(192,975	)		(191,789	)		(184,783)
Foreign earnings of foreign subsidiaries for which U.S. federal income taxes have been provided		(14,681	)		29,736			62,025
Foreign taxes of domestic and foreign subsidiaries for which U.S. federal income taxes have also been provided		65,521			119,009			111,381
Foreign tax credits		(67,232	)		(89,809	)		(167,756)
Reduction of deferred tax liability related to a goodwill deduction resulting from a prior period stock acquisition		(2,950	)		(8,850	)		(8,850)
Domestic production activities deduction		—			—			(6,271)
Uncertain tax positions		(7,733	)		30,950			8,003
Amortization of deferred charges associated with intercompany rig sales to other tax jurisdictions		29,556			30,442			14,167
Long-term capital gain on dividend distribution		—			—			2,450
Net expense (benefit) in connection with resolutions of tax issues and adjustments relating to prior years		(6,085	)		(7,346	)		6,916
Other		563			610			979
Income tax expense	$	216,729		$	380,559		$	492,212

Significant components of our deferred income tax assets and liabilities are as follows:

	December 31,
	2011			2010
	(In thousands)
Deferred tax assets:
Net operating loss carryforwards, or NOLs	$	27,212		$	34,824
Goodwill		—			1,049
Worker’s compensation and other current accruals (1)		15,487			17,178
Disputed receivables reserved		6			2,521
Deferred compensation		4,504			7,478
Foreign contribution taxes		5,615			3,100
Foreign tax credits		—			186
Nonqualified stock options and SARs		7,538			6,048
Other		2,212			3,133
Total deferred tax assets		62,574			75,517
Valuation allowance for foreign tax credits		—			(186)
Valuation allowance for NOLs		(26,353	)		(31,916)
Net deferred tax assets		36,221			43,415
Deferred tax liabilities:
Depreciation		(558,915	)		(558,346)
Unbilled revenue		(3,216	)		(347)
Mobilization		(3,939	)		(2,181)
Undistributed earnings of foreign subsidiaries		(24	)		(15,023)
Other		(141	)		(219)
Total deferred tax liabilities		(566,235	)		(576,116)
Net deferred tax liability	$	(530,014	)	$	(532,701)

(1) $6.8 million and $9.6 million reflected in “Prepaid expenses and other current assets” in our Consolidated Balance Sheets at December 31, 2011 and 2010, respectively. See Note 2.

We record a valuation allowance to derecognize a portion of our deferred tax assets, which we do not expect to be ultimately realized. A summary of changes in the valuation allowance is as follows:

	For the Year Ended December 31,
	2011			2010			2009
	(In thousands)
Valuation allowance as of January 1	$	32,102		$	30,975		$	29,087
Establishment of valuation allowances:
Foreign tax credits		(186	)		79			107
Net operating losses		1,844			13,381			2,025
Releases of valuation allowances in various jurisdictions		(7,407	)		(12,333	)		(244)
Valuation allowance as of December 31	$	26,353		$	32,102		$	30,975

Our income tax returns are subject to review and examination in the various jurisdictions in which we operate and we are currently contesting various tax assessments. We accrue for income tax contingencies, or uncertain tax positions, that we believe are more likely than not exposures. A reconciliation of the beginning and ending amount of unrecognized tax benefits, excluding interest and penalties, is as follows:

	Long term Tax Receivable			Long term Tax Payable		Net Liability for Uncertain Tax Positions
	(In thousands)
Balance at January 1, 2009	$	5,534		$	(29,231)	$	(23,697)
Reduction based on tax positions related to a prior year		—			(4,557)		(4,557)
Additions based on tax positions related to the current year		2,441			(6,781)		(4,340)
Reductions as a result of a lapse of the applicable statute of limitations		(1,504	)		7,090		5,586
Balance at December 31, 2009	$	6,471		$	(33,479)	$	(27,008)
Additions based on tax positions related to a prior year		—			(15,764)		(15,764)
Additions based on tax positions related to the current year		565			(3,729)		(3,164)
Balance at December 31, 2010	$	7,036		$	(52,972)	$	(45,936)
Reduction based on tax positions related to a prior year		—			1,851		1,851
Additions based on tax positions related to the current year		145			(1,045)		(900)
Reductions as a result of a lapse of the applicable statute of limitations		—			3,744		3,744
Balance at December 31, 2011	$	7,181		$	(48,422)	$	(41,241)

At December 31, 2011, all $41.2 million of the net unrecognized tax benefits would affect the effective tax rate if recognized.

We record interest related to accrued unrecognized tax positions in interest expense and recognize penalties associated with uncertain tax positions in our tax expense. During the years ended December 31, 2011 and 2010, we recognized $0.2 million and $4.8 million of interest expense related to uncertain tax positions, respectively. During the year ended December 31, 2009, we recorded a net reduction to interest expense of $3.4 million. During the year ended December 31 2011, we recorded a net reduction to penalty related tax expense for uncertain tax positions of $3.0 million. Penalty related tax expense for uncertain tax positions during the years ended December 31, 2010 and 2009 was $12.0 million and $4.7 million, respectively. Accruals for the payment of interest and penalties in our Consolidated Balance Sheets at December 31, 2011 and 2010 were $31.4 million and $34.2 million, respectively.

In several of the international locations in which we operate, certain of our wholly-owned subsidiaries enter into agreements with other of our wholly-owned subsidiaries to provide specialized services and equipment in support of our foreign operations. We apply a transfer pricing methodology to determine the amount to be charged for providing the services and equipment. In most cases, there are alternative transfer pricing methodologies that could be applied to these transactions and, if applied, could result in different chargeable amounts. Taxing authorities in the various foreign locations in which we operate could apply one of the alternative transfer pricing methodologies which could result in an increase to our income tax liabilities with respect to tax returns that remain subject to examination.

We file income tax returns in the U.S. federal jurisdiction, various state jurisdictions and various foreign jurisdictions. Tax years that remain subject to examination by these jurisdictions include years 2003 to 2010. We are currently under audit in several of these jurisdictions. We do not anticipate that any adjustments resulting from the tax audits will have a material impact on our consolidated results of operations, financial position and cash flows. During 2011, an audit by the U.S. Internal Revenue Service for the year 2008 was completed without any adjustment proposed by the auditors.

The Brazilian tax authorities have audited our income tax returns for the years 2000, 2004 and 2005 and are currently auditing our income tax return for the year 2007. The tax auditors have issued an assessment for tax year 2000 of approximately $1.5 million, including interest and penalty. We have appealed the tax assessment and are awaiting the outcome of the appeal. In December 2009, we received an assessment of approximately $26.0 million for the years 2004 and 2005, including interest and penalty. We contested the tax assessment in January 2010 and are awaiting the outcome of the appeal. As required by GAAP, only the portion of the tax benefit that has a greater than 50% likelihood of being realized upon settlement is to be recognized. Consequently, we have accrued approximately $13.8 million of expense attributable to the portion of the tax assessment we determined to be an uncertain tax position, of which approximately $3.6 million is interest related and approximately $3.5 million is penalty related. We do not anticipate that any adjustments resulting from the tax audit of any of these years will have a material impact on our consolidated results of operations, financial position and cash flows. During 2011, unrecognized tax benefits were reduced by approximately $6.8 million due to the lapse in the applicable statute of limitations for the 2006 tax year, of which $1.1 million was interest and $2.0 million was penalty.

The Mexican tax authorities have audited our income tax returns for the years 2004 and 2006. The tax auditors have issued assessments for tax year 2004 of approximately $22.9 million, including interest and penalties. We have appealed the tax assessments and are awaiting the outcome of the appeals. In January 2012, we received tax assessments for the tax year 2006 of approximately $24.4 million including interest and penalties. We do not anticipate that any adjustments resulting from the tax audits of any of these years will have a material impact on our consolidated results of operations, financial position and cash flows.

As of December 31, 2011, we had recorded a deferred tax asset of $27.2 million for the benefit of NOL carryforwards related to our international operations. Approximately $8.2 million of this deferred tax asset relates to NOL carryforwards that have an indefinite life. The remaining $19.0 million relates to NOL carryforwards of our Mexican entities. Unless utilized, the tax benefits of these Mexican NOL carryforwards will expire between 2014 and 2021 as follows:

Year Expiring	Tax Benefit of     NOL     Carryforwards     (In millions)
2014	$	1.2
2015		4.5
2016		7.2
2017		5.8
2018		—
2019		—
2020		0.2
2021		0.1
Total	$	19.0

As of December 31, 2011, a valuation allowance of $26.4 million has been recorded for our NOLs as only $0.8 million of the deferred tax asset is more likely than not to be realized.