First Data 2010 Annual Report Download - page 35

Table of Contents
FIRST DATA CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (Continued)
Non-operating foreign currency gains and (losses). For the years ended December 31, 2010, 2009 and 2008 net non-operating foreign currency
exchange gains and losses related to the mark-to-market of the Company's intercompany loans and the euro-denominated debt.
Income taxes. The Company's effective tax rates on pretax income (loss) were tax benefits of 27.7% in 2010, 36.3% in 2009, and 16.2% in 2008. The
calculation of the effective tax rate includes most of the equity earnings in affiliates in pretax income because this item relates principally to entities that are
considered pass-through entities for income tax purposes.
The effective tax rate benefit in 2010 was less than the statutory rate primarily due to an increase in the Company's valuation allowance against foreign
tax credits (discussed below). This negative adjustment was partially offset by state tax benefits, net income attributable to noncontrolling interests for which
there was no tax expense provided and a decrease in the Company's liability for unrecognized tax benefits.
The effective tax rate benefit in 2009 was greater than the statutory rate due primarily to state tax benefits, lower tax earnings and profits than book
income for foreign entities and net income attributable to noncontrolling interests for pass through entities for which there was no tax expense provided. These
positive adjustments were partially offset by an increase in the Company's liability for unrecognized tax benefits and an increase in the valuation allowance
established against certain state and foreign net operating losses.
The effective tax rate benefit in 2008 was less than the statutory rate due primarily to the non-deductibility of most of the goodwill impairment expense
recorded in the fourth quarter of 2008. Partially offsetting the tax disallowance of the goodwill impairment was the release of a valuation allowance against
foreign tax credits established since consummation of the merger with an affiliate of KKR in 2007.
Subsequent to the merger and as part of the First Data Holdings, Inc. ("Holdings") consolidated federal group and consolidated, combined or unitary
state groups for income tax purposes, the Company has been and continues to be in a tax net operating loss position. The Company currently anticipates being
able to utilize in the future most of its existing federal and state net operating loss carryforwards due to the existence of significant deferred tax liabilities
established in connection with purchase accounting for the merger. Accordingly, the Company has not established valuation allowances against most of such
loss carryforwards. The Company, however, may not be able to record a benefit related to losses in certain states and foreign countries, requiring the
establishment of valuation allowances.
Despite the net operating loss position discussed above, the Company continues to incur income taxes in states for which it files returns on a separate
entity basis and in certain foreign countries. Generally, these foreign income taxes would result in a foreign tax credit in the U.S. to the extent of any U.S.
income taxes on the income upon repatriation. However, on August 10, 2010, federal legislation was enacted which included a tax change that adversely
affects the Company's ability to utilize foreign tax credits recorded on the Company's balance sheet. As a result, the company recorded a valuation allowance
against foreign tax credits of approximately $182 million during the third and fourth quarters of 2010. This valuation allowance will increase over time as
foreign taxes are accrued, and will have a continuing adverse impact on the Company's effective tax rate in the future. The tax law change will also have an
adverse impact on the Company's cash flow in future periods, when and as the Company would be in a position to utilize foreign tax credits.
During the year ended December 31, 2010, the Company's liability for unrecognized tax benefits was reduced by $39 million upon the closure of the
2002 federal tax year and after negotiating settlements with the IRS regarding specific contested issues in the 2003 and 2004 federal tax years. The liability
for the interest accrued on the unrecognized tax benefits of $17 million and the contra-liability for the federal benefit on state income taxes of $1 million were
reduced at the same time. The total $55 million reduction in liabilities was recorded through a $43 million decrease to tax expense and a $12 million increase
to deferred tax liabilities. As of December 31, 2010, the Company anticipates it is reasonably possible that its liability for unrecognized tax benefits may
decrease by approximately $57 million within the next twelve months as the result of the possible closure of its 2003 and 2004 federal tax years, potential
settlements with certain states and the lapse of the statute of limitations in various state jurisdictions. The potential decrease relates to various federal and state
tax benefits including research and experimentation credits and certain amortization, loss and stock warrant deductions.
The IRS completed its examination of the U.S. federal consolidated income tax returns of the Company for 2003 and 2004 and issued a Notice of
Deficiency (the "Notice") in December 2008. The Notice claims that the Company and its subsidiaries, which included Western Union during the years at
issue, owe significant additional taxes, interest and penalties with respect to a variety of adjustments. The Company and Western Union agree with several of
the adjustments in the Notice. Additionally, during 2010 the IRS conceded certain of the adjustments. As to the adjustments that remain in dispute, for 2003
such issues represent total taxes and
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