Exelon (EXC) Sees FY13 non-Cash Charge of $270M

January 31, 2013 5:34 PM EST
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As previously disclosed, in 1999, Commonwealth Edison Company (ComEd) deferred $1.2 billion of gain on the sale of its fossil generating facilities by acquiring like-kind property via a purchase leaseback transaction. The IRS has asserted that the Exelon Corporation (NYSE: EXC) purchase leaseback transaction is substantially similar to a leasing transaction known as a sale-in, lease-out transaction (SILO). A SILO is a “listed transaction” that the IRS has identified as a potentially abusive tax shelter under guidance issued in 2005. Exelon continues to believe that its like-kind exchange transaction is not the same as or substantially similar to a SILO. Exelon expects to initiate litigation in 2013 to contest the IRS’s disallowance of the like-kind exchange position.

On January 9, 2013, the U.S. Court of Appeals for the Federal Circuit reversed the U.S. Court of Federal Claims and reached a decision for the government in Consolidated Edison v. United States. The Court disallowed Consolidated Edison’s deductions stemming from its participation in a lease-in, lease-out transaction that the IRS also has characterized as a tax shelter.

In accordance with applicable accounting standards, Exelon is required to assess whether it is more likely than not that it will prevail in litigation. Exelon continues to believe that its transaction is not a SILO and that it has a strong case on the merits. However, in light of the Consolidated Edison decision and Exelon’s current determination that settlement is unlikely, Exelon has concluded that it no longer meets the more likely than not standard. As a result, Exelon expects to record in the first quarter of 2013 a non-cash charge to earnings of approximately $270 million, which represents the full amount of interest expense (after-tax) and incremental state tax expense in the event that Exelon is unsuccessful in litigation. Of this amount, approximately $185 million will be recorded at ComEd and the balance at Exelon. These charges to expense will not be reflected in adjusted (non-GAAP) operating earnings. Exelon and ComEd will continue to accrue interest on the uncertain tax position, and the charges arising from future interest accruals are not expected to be material to the annual operating earnings of Exelon or ComEd. Further, Exelon intends to hold ComEd harmless from any unfavorable impacts of the after-tax interest amounts on ComEd’s equity. As a result of this hold harmless, ComEd will record on its consolidated balance sheet non-cash equity contributions from Exelon in the amount of the net after-tax interest charges attributable to ComEd in connection with the like-kind exchange position. The IRS also continues to assert an $86 million penalty for a substantial understatement of tax with respect to the like-kind exchange position. Exelon continues to believe that it is unlikely that the penalty assertion will ultimately be sustained and therefore no liability for the penalty will be recorded.

This determination for accounting purposes does not alter Exelon’s intent to aggressively litigate the issue through appeals, if necessary, which could take three to five years. Exelon currently expects to initiate the litigation in the United States Tax Court, whose decisions are not controlled by the Federal Circuit’s decision in Consolidated Edison.

In connection with this reassessment of the like-kind exchange position and the charge to ComEd’s earnings, ComEd will be assessing in the first quarter of 2013 whether its goodwill has been impaired. A goodwill impairment, if any, would result in a non-cash charge to expense in the first quarter of 2013, which would not be reflected in Exelon’s adjusted (non-GAAP) operating earnings.

As of March 31, 2013, in the event of a fully successful IRS challenge to Exelon’s like-kind exchange position, the potential tax and after-tax interest, exclusive of penalties, that could become currently payable may be as much as $860 million, of which approximately $260 million would be attributable to ComEd and the remainder to Exelon. ComEd does not intend to seek recovery from its customers of any of the like-kind exchange tax liability should Exelon be unsuccessful in litigation. In addition, Exelon’s portion of this charge and any tax liability in the event of unsuccessful litigation will not have any impact on PECO Energy Company or Baltimore Gas and Electric Company or their customers.

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