Baker Hughes 2010 Annual Report Download - page 110

28 B a k e r H u g h e s I n c o r p o r a t e d
Income Taxes
The liability method is used for determining our income
taxes, under which current and deferred tax liabilities and
assets are recorded in accordance with enacted tax laws and
rates. Under this method, the amounts of deferred tax liabili-
ties and assets at the end of each period are determined using
the tax rate expected to be in effect when taxes are actually
paid or recovered. Valuation allowances are established to
reduce deferred tax assets when it is more likely than not that
some portion or all of the deferred tax assets will not be real-
ized. In determining the need for valuation allowances, we
have considered and made judgments and estimates regarding
estimated future taxable income and ongoing prudent and
feasible tax planning strategies. These estimates and judg-
ments include some degree of uncertainty and changes in
these estimates and assumptions could require us to adjust
the valuation allowances for our deferred tax assets. Histori-
cally, changes to valuation allowances have been caused by
major changes in the business cycle in certain countries and
changes in local country law. The ultimate realization of the
deferred tax assets depends on the generation of sufficient
taxable income in the applicable taxing jurisdictions.
We operate in more than 80 countries under many legal
forms. As a result, we are subject to the jurisdiction of numer-
ous domestic and foreign tax authorities, as well as to tax
agreements and treaties among these governments. Our
operations in these different jurisdictions are taxed on various
bases: actual income before taxes, deemed profits (which
are generally determined using a percentage of revenues
rather than profits) and withholding taxes based on revenue.
Determination of taxable income in any jurisdiction requires
the interpretation of the related tax laws and regulations and
the use of estimates and assumptions regarding significant
future events such as the amount, timing and character of
deductions, permissible revenue recognition methods under
the tax law and the sources and character of income and
tax credits. Changes in tax laws, regulations, agreements and
treaties, foreign currency exchange restrictions or our level of
operations or profitability in each taxing jurisdiction could have
an impact on the amount of income taxes that we provide
during any given year.
Our tax filings for various periods are subjected to audit
by the tax authorities in most jurisdictions where we conduct
business. These audits may result in assessments of additional
taxes that are resolved with the authorities or through the
courts. We believe these assessments may occasionally be
based on erroneous and even arbitrary interpretations of local
tax law. Resolution of these situations inevitably includes some
degree of uncertainty; accordingly, we provide taxes only for
the amounts we believe will ultimately result from these pro-
ceedings. The resulting change to our tax liability, if any, is
dependent on numerous factors that are difficult to estimate.
These include, among others, the amount and nature of addi-
tional taxes potentially asserted by local tax authorities; the
willingness of local tax authorities to negotiate a fair settle-
ment through an administrative process; the impartiality of the
local courts; the sheer number of countries in which we do
business; and the potential for changes in the tax paid to one
country to either produce, or fail to produce, an offsetting tax
change in other countries. Our experience has been that the
estimates and assumptions we have used to provide for future
tax assessments have proven to be appropriate. However, past
experience is only a guide, and the potential exists that the tax
resulting from the resolution of current and potential future tax
controversies may differ materially from the amount accrued.
In addition to the aforementioned assessments that have
been received from various tax authorities, we also provide for
taxes for uncertain tax positions where formal assessments have
not been received. The determination of these liabilities requires
the use of estimates and assumptions regarding future events.
Once established, we adjust these amounts only when more
information is available or when a future event occurs necessi-
tating a change to the reserves such as changes in the facts or
law, judicial decisions regarding the application of existing law
or a favorable audit outcome. We believe that the resolution of
tax matters will not have a material effect on the consolidated
financial condition of the Company, although a resolution
could have a material impact on our consolidated statement
of operations for a particular period and on our effective tax
rate for any period in which such resolution occurs.
Pensions and Postretirement Benefit Obligations
Pensions and postretirement benefit obligations and the
related expenses are calculated using actuarial models and
methods. This involves the use of two critical assumptions,
the discount rate and the expected rate of return on assets,
both of which are important elements in determining pension
expense and in measuring plan assets and liabilities. We evalu-
ate these critical assumptions at least annually. Although con-
sidered less critical, other assumptions used in determining
benefit obligations and related expenses, such as demographic
factors like retirement age, mortality and turnover, are also
evaluated periodically and are updated to reflect our actual
and expected experience.
The discount rate enables us to state expected future cash
flows at a present value on the measurement date. The devel-
opment of the discount rate for our largest plans was based
on a bond matching model whereby the cash flows underlying
the projected benefit obligation are matched against a yield
curve constructed from a bond portfolio of high-quality, fixed-
income securities. Use of a lower discount rate would increase
the present value of benefit obligations and increase pension
expense. We used a discount rate of 5.9% in 2010, 6.4%
in 2009 and 6.0% in 2008 to determine pension expense.
A 50 basis point reduction in the discount rate would have
decreased income before income taxes by approximately
$1 million in 2010.
To determine the expected rate of return on plan assets,
we consider the current and target asset allocations, as well
as historical and expected future returns on various categories
of plan assets. A lower rate of return increases plan expenses.
We assumed rates of return on our plan investments were
7.1% in 2010 and 8.0% in 2009 and in 2008. A 50 basis
point reduction in the expected rate of return on assets of our
principal plans would have decreased income before income
taxes by approximately $4 million in 2010.