Prudential 2007 Annual Report Download - page 23

Our accounting represents management’s best estimate of future events that can be appropriately reflected in the accounting estimates.
Certain changes or future events, such as changes in tax legislation, geographic mix of earnings and completion of tax audits could have an
impact on our estimates and effective tax rate. For example, the dividends received deduction reduces the amount of dividend income
subject to tax and is a significant component of the difference between our effective tax rate and the federal statutory tax rate of 35%. The
U.S. Treasury Department and the Internal Revenue Service, or Service, are addressing through new regulations the methodology to be
followed in determining the dividends received deduction related to variable life insurance and annuity contracts. A change in the dividends
received deduction, including the possible elimination of this deduction, could increase our effective tax rate and reduce our consolidated
net income.
On January 1, 2007, we adopted FIN No. 48, “Accounting for Uncertainty in Income Taxes,” an Interpretation of FASB Statement
No. 109. This interpretation prescribes a comprehensive model for how a company should recognize, measure, present, and disclose in its
financial statements uncertain tax positions that a company has taken or expects to take on a tax return. FIN No. 48 is a two-step process,
the first step being recognition. We determine whether it is more likely than not, based on the technical merits, that the tax position will be
sustained upon examination. If a tax position does not meet the more likely than not recognition threshold, the benefit of that position is not
recognized in the financial statements. The second step is measurement. We measure the tax position as the largest amount of benefit that is
greater than 50 percent likely of being realized upon ultimate resolution with a taxing authority that has full knowledge of all relevant
information. This measurement considers the amounts and probabilities of the outcomes that could be realized upon ultimate settlement
using the facts, circumstances, and information available at the reporting date.
An increase or decrease in our effective tax rate by one percent of income from continuing operations before income taxes and equity
in earnings of operating joint ventures, would have resulted in a decline or increase in consolidated income from continuing operations
before equity in earnings of operating joint ventures in 2007 of $47 million.
Our liability for income taxes includes the liability for unrecognized tax benefits, interest and penalties which relate to tax years still
subject to review by the Service or other taxing jurisdictions. Audit periods remain open for review until the statute of limitations has
passed. Generally, for tax years which produce net operating losses, capital losses or tax credit carryforwards, or tax attributes, the statute
of limitations does not close, to the extent of these tax attributes, until the tax year in which they are fully utilized. The completion of
review or the expiration of the statute of limitations for a given audit period could result in an adjustment to our liability for income taxes.
Any such adjustment could be material to our results of operations for any given quarterly or annual period based, in part, upon the results
of operations for the given period.
On January 26, 2006, the Service officially closed the audit of our consolidated federal income tax returns for the 1997 to 2001
periods. As a result of certain favorable resolutions, our consolidated statement of operations for the year ended December 31, 2005
included an income tax benefit of $720 million, reflecting a reduction in our liability for income taxes. The statute of limitations has closed
for these tax years; however, there were tax attributes in the closed years which were utilized in subsequent tax years for which the statute
of limitations remains open.
In December 2006, the Service completed all fieldwork with regards to its examination of the consolidated federal income tax returns
for tax years 2002-2003. The final report was submitted to the Joint Committee on Taxation for their review in April 2007. In July 2007,
the Joint Committee returned the report to the Service for additional review of an industry issue regarding the methodology for calculating
the dividends received deduction related to variable life insurance and annuity contracts. The Company is responding to the Service’s
request for additional information. As discussed above, the U.S. Treasury Department and the Service are addressing through new
regulations the methodology to be followed in determining the dividends received deduction related to variable life insurance and annuity
contracts. The statute of limitations for the 2002-2003 tax years expires in 2009.
The Company’s affiliates in Japan file separate tax returns and are subject to audits by the local taxing authority. For tax years after
April 1, 2004 the general statute of limitations is 5 years from when the return is filed. For tax years prior to April 1, 2004 the general
statute of limitations is 3 years from when the return is filed. The Tokyo Regional Taxation Bureau is currently conducting a routine tax
audit of the tax returns of Gibraltar Life Insurance Company, Ltd. for the three years ended March 31, 2005, 2006 and 2007.
In January 2007, the Service began an examination of tax years 2004 through 2006. For the tax year 2007, we participated in the
Service’s new Compliance Assurance Program, or CAP. Under CAP, the Service assigns an examination team to review completed
transactions contemporaneously during the 2007 tax year in order to reach agreement with us on how they should be reported in the tax
return. If disagreements arise, accelerated resolutions programs are available to resolve the disagreements in a timely manner before the tax
return is filed. It is management’s expectation this new program will significantly shorten the time period between the filing of our federal
income tax return and the Service’s completion of its examination of the return.
Reserves for Contingencies
A contingency is an existing condition that involves a degree of uncertainty that will ultimately be resolved upon the occurrence of
future events. Under U.S. GAAP, reserves for contingencies are required to be established when the future event is probable and its impact
can be reasonably estimated. An example is the establishment of a reserve for losses in connection with an unresolved legal matter. The
initial reserve reflects management’s best estimate of the probable cost of ultimate resolution of the matter and is revised accordingly as
facts and circumstances change and, ultimately, when the matter is brought to closure.
Prudential Financial 2007 Annual Report 21