Rockwell Collins (COL)

Income Taxes

        Current tax liabilities and assets are based upon an estimate of taxes payable or refundable in the current year for each of the jurisdictions in which the Company transacts business. As part of the determination of its tax liability, management exercises considerable judgment in evaluating tax positions taken by the Company in determining the income tax provision under Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes (SFAS 109) and establishes reserves for tax

54

ROCKWELL COLLINS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

contingencies in accordance with FASB Interpretation No. 48, Accounting for uncertainty in income taxes, an interpretation of SFAS 109 (FIN 48). Deferred tax assets and liabilities are recorded for the estimated future tax effects attributable to temporary differences between the carrying amounts of assets and liabilities used for financial reporting purposes and their respective carrying amounts for income tax purposes. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized.

Income Taxes

        Current tax liabilities and assets are based upon an estimate of taxes payable or refundable in the current year for each of the
jurisdictions in which the Company transacts business. As part of the determination of its tax liability, management exercises considerable judgment in evaluating tax positions taken by the Company in
determining the income tax provision under Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes (SFAS 109) and
establishes reserves for tax

54

ROCKWELL COLLINS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

contingencies
in accordance with FASB Interpretation No. 48, Accounting for uncertainty in income taxes, an interpretation of SFAS 109
(FIN 48). Deferred tax assets and liabilities are recorded for the estimated future tax effects attributable to temporary differences between the carrying amounts of assets and liabilities used
for financial reporting purposes and their respective carrying amounts for income tax purposes. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more
likely than not that some portion or all of the deferred tax assets will not be realized.

Income Taxes

At the end of each interim reporting period, we make an estimate of the annual effective income tax rate. Tax items included in the annual effective tax rate are pro-rated for the full year and tax items discrete to a specific quarter are included in the effective tax rate for that quarter. The estimate used in providing for income taxes on a year-to-date basis may change in subsequent interim periods.

The federal Research and Development Tax Credit expired December 31, 2005. On December 20, 2006, the Tax Relief and Health Care Act of 2006 was enacted, which retroactively reinstated and extended the Research and Development Tax Credit from January 1, 2006 to December 31, 2007. The retroactive benefit for the previously expired period from January 1, 2006 to September 30, 2006 is reflected as a discrete item which lowered our effective tax rate by about 3 percentage points for the six months ended March 31, 2007.

The phase-out period for the federal Extraterritorial Income Exclusion (ETI) tax benefit ended on December 31, 2006. The enacted federal replacement tax benefit for ETI, the Domestic Manufacturing Deduction (DMD), will apply to the full 2007 year. For 2007, the available DMD tax benefit is one-third of the full benefit that will be available in 2011. The amount of DMD tax benefit available in 2008, 2009 and 2010 will be two-thirds of the full benefit.

During the three months ended March 31, 2007 and 2006, our effective income tax rate was 33.3 percent and 29.6 percent, respectively. The effective tax rate was higher for the three months ended March 31, 2007 than the same period in the prior year primarily due to incremental pre-tax earnings and the impact of diminished tax benefits from ETI. During the six months ended March 31, 2007 and 2006, our effective income tax rate was 30.1 percent and 30.8 percent, respectively. The effective tax rate was lower for the six months ended March 31, 2007 than the same period in the prior year primarily due to the retroactive reinstatement of the Research and Development Tax Credit partially offset by incremental pre-tax earnings and the impact of diminished tax benefits from ETI. Including the impact of these items, we currently expect our annual effective income tax rate to be about 31.5 percent in 2007.

Income Taxes

At the end of each interim reporting period, we make an estimate of the annual effective income tax rate. Tax items included in the annual effective tax rate are pro-rated for the full year and tax items discrete to a specific quarter are included in the effective tax rate for that quarter. The estimate used in providing for income taxes on a year-to-date basis may change in subsequent interim periods.

The federal Research and Development Tax Credit expired December 31, 2005. On December 20, 2006, the Tax Relief and Health Care Act of 2006 was enacted, which retroactively reinstated and extended the Research and Development Tax Credit from January 1, 2006 to December 31, 2007. The retroactive benefit for the previously expired period from January 1, 2006 to September 30, 2006 is reflected as a discrete item which lowered the Company’s effective tax rate by about 7 percent for the three months ended December 31, 2006.

The phase-out period for the federal Extraterritorial Income Exclusion (ETI) tax benefit ended on December 31, 2006. The enacted federal replacement tax benefit for ETI, the Domestic Manufacturing Deduction (DMD), will apply to the full 2007 year. For 2007, the available DMD tax benefit is one-third of the full benefit that will be available in 2011. The amount of DMD tax benefit available in 2008, 2009 and 2010 will be two-thirds of the full benefit.

During the three months ended December 31, 2006 and 2005, our effective income tax rate was 26.7 percent and 32.0 percent, respectively. The effective tax rate was lower for the three months ended December 31, 2006 than the same period in the prior year primarily due to the retroactive reinstatement of the Research and Development Tax Credit partially offset by the combined impact of lower tax benefits from the ETI and DMD. Including the impact of these items, we currently expect our annual effective income tax rate to be about 31.0 percent in 2007.

Income Taxes

Current tax liabilities and assets are based upon an estimate of taxes payable or refundable in the current year for each of the jurisdictions in which the Company transacts business. As part of the determination of its tax liability, management exercises considerable judgment in assessing the positions taken by the Company in its tax returns and establishes reserves for probable tax exposures. These reserves represent the best estimate of amounts expected to be paid and are adjusted over time as more information regarding tax audits becomes available. Deferred tax assets and liabilities are recorded for the estimated future tax effects attributable to temporary differences between the carrying amounts of assets and liabilities used for financial reporting purposes and their respective carrying amounts for income tax purposes. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized.

Income Taxes

At the end of each interim reporting period we make an estimate of the annual effective income tax rate. Tax items included in the annual effective tax rate are pro-rated for the full year and tax items discrete to a specific quarter are included in the effective tax rate for that quarter. The estimate used in providing for income taxes on a year-to-date basis may change in subsequent interim periods. During the three months ended June 30, 2006 and 2005, the effective income tax rate was 31.6 percent and 29.9 percent, respectively. During the nine months ended June 30, 2006 and 2005, the effective income tax rate was 31.1 percent and 29.6 percent, respectively. The effective tax rate was higher for the three and nine months ended June 30, 2006 than the prior year because the Federal Research and Development (R&D) Tax Credit was not extended beyond December 31, 2005. For the full year, we anticipate the effective tax rate to be approximately 30 percent if the R&D Tax Credit, which provides a tax benefit on certain incremental R&D expenditures, is extended retroactively to January 1, 2006 and expires no earlier than September 30, 2006. If the R&D Tax Credit is not extended, our effective tax rate for the full year is expected to be in the range of 31 to 32 percent. The difference between our effective tax rate and the statutory tax rate of 35 percent is primarily the result of the tax benefits derived from the R&D Tax Credit and the Extraterritorial Income Exclusion (ETI), which provides a tax benefit on export sales.

The American Jobs Creation Act of 2004 (the Act) provides for a special one-time deduction of 85 percent of certain foreign earnings repatriated into the U.S. from non-U.S. subsidiaries through September 30, 2006. As of June 30, 2006, we repatriated $91 million in cash from non-U.S. subsidiaries into the U.S. under the provisions of the Act. The repatriation did not impact our effective income tax rate for the three or nine months ended June 30, 2006 as a tax liability was established during 2005 when the decision was made to repatriate the foreign earnings.

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Table of Contents

Income Taxes

At the end of each interim reporting period we make an estimate of the annual effective income tax rate. Tax items included in the annual effective tax rate are pro-rated for the full year and tax items discrete to a specific quarter are included in the effective tax rate for that quarter. The estimate used in providing for income taxes on a year-to-date basis may change in subsequent interim periods. During the three months ended March 31, 2006 and 2005, the effective income tax rate was 29.6 percent and 28.6 percent, respectively. During the six months ended March 31, 2006 and 2005, the effective income tax rate was 30.8 percent and 29.4 percent, respectively. The effective tax rate was higher for the three and six months ended March 31, 2006 than the prior year because the Federal Research and Development (“R&D”) Tax Credit was not extended beyond December 31, 2005. For the full year, we anticipate the effective tax rate to be approximately 30 percent if the R&D Tax Credit, which provides a tax benefit on certain incremental R&D expenditures, is extended retroactively to January 1, 2006 and expires no earlier than September 30, 2006, as currently proposed in both the House and Senate tax bills. If the R&D Tax Credit is not extended, our effective tax rate for the full year is expected to be approximately 32 percent. The difference between our effective tax rate and the statutory tax rate of 35 percent is primarily the result of the tax benefits derived from the R&D Tax Credit and the Extraterritorial Income Exclusion (“ETI”), which provides a tax benefit on export sales.

The American Jobs Creation Act of 2004 (“the Act”) provides for a special one-time deduction of 85 percent of certain foreign earnings repatriated into the U.S. from non-U.S. subsidiaries through September 30, 2006. Based on the guidance provided from the IRS to date, we have completed our evaluation of the merits of repatriating funds under the Act. We plan to repatriate approximately $100 million of unremitted non-U.S. earnings in 2006 in accordance with the provisions of the Act and recorded a $2 million tax liability in fiscal 2005 related to the planned repatriation.

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Table of Contents

Income Taxes

At the end of each interim reporting period we make an estimate of the annual effective tax rate. Tax items included in the annual effective tax rate are pro-rated for the full year and tax items discrete to a specific quarter are included in the effective tax rate for that quarter. The estimate used in providing for income taxes on a year-to-date basis may change in subsequent interim periods. During the three months ended December 31, 2005 and 2004, the effective income tax rate was 32.0 percent and 30.2 percent, respectively. The effective tax rate was higher than 30 percent for the three months ended December 31, 2005 because the Federal Research and Development (“R&D”) Tax Credit was not extended beyond December 31, 2005. For the full year, we anticipate the effective tax rate to be approximately 30 percent if the R&D Tax Credit, which provides a tax benefit on certain incremental R&D expenditures, is extended to December 31, 2006, as currently proposed in both the House and Senate tax bills. If the R&D Tax Credit is not extended beyond December 31, 2005 to December 31, 2006, our effective tax rate for the full year is expected to be approximately 32 percent. The difference between our effective tax rate and the statutory tax rate of 35% is primarily the result of the tax benefits derived from the R&D Tax Credit and the Extraterritorial Income Exclusion (“ETI”), which provides a tax benefit on export sales.

The American Jobs Creation Act of 2004 (“the Act”) provides for a special one-time deduction of 85 percent of certain foreign earnings repatriated into the U.S. from non-U.S. subsidiaries through September 30, 2006. Based on the guidance provided from the IRS to date, we have completed our evaluation of the merits of repatriating funds under the Act. We plan to repatriate approximately $100 million of unremitted non-U.S. earnings in 2006 in accordance with the provisions of the Act and recorded a $2 million tax liability in fiscal 2005 related to the planned repatriation.

Income Taxes

Current tax liabilities and assets are based upon an estimate of taxes payable or refundable in the current year for each of the jurisdictions in which the Company transacts business. As part of the determination of its tax liability, management exercises considerable judgment in assessing the positions taken by the Company in its tax returns and establishes reserves for probable tax exposures. These reserves represent the best estimate of amounts expected to be paid and are adjusted over time as more information regarding tax audits becomes available. Deferred tax assets and liabilities are recorded for the estimated future tax effects attributable to temporary differences between the carrying amounts of assets and liabilities used for financial reporting purposes and their respective carrying amounts for income tax purposes. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized.

Income Taxes

At the end of each interim reporting period we make an estimate of the effective tax rate, which includes tax items that are discrete to a specific quarter. Tax items discrete to a specific quarter are included in the effective tax rate for that quarter and are not pro-rated for the full year. The estimate used in providing for income taxes on a year-to-date basis may change in subsequent interim periods. During the three months ended June 30, 2005 and 2004, the effective income tax rate was 29.9 percent and 29.6 percent, respectively. During the nine months ended June 30, 2005 and 2004, the effective income tax rate was 29.6 percent and 30.0 percent, respectively. For the full year, the Company anticipates the effective income tax rate will be about 30 percent, excluding any impact from the completion of the IRS tax return audits for fiscal years 2003 and 2002, which is expected to occur in the fourth quarter of fiscal year 2005. The difference between our effective tax rate and the statutory tax rate of 35% is primarily the result of the tax benefits derived from the Research and Development (“R&D”) Tax Credit, which provides a tax benefit on certain incremental R&D expenditures, and the Extraterritorial Income Exclusion (“ETI”), which provides a tax benefit on export sales.

In October 2004, the American Jobs Creation Act of 2004 (“the Act”) was signed into law. The Act repeals and replaces the ETI with a new deduction for income generated from qualified production activities by U.S. manufacturers. The ETI will be phased out through calendar year 2006 and the new deduction under the Act will be phased in between calendar years 2005 and 2009. The ETI repeal and replacement under the Act is not expected to have a significant impact on our effective income tax rate in 2005. We are evaluating the impact of the ETI repeal and replacement under the Act on our effective income tax rate for years beyond fiscal 2005.

The Act also provides for a lower tax rate on funds repatriated into the U.S. from non-U.S. subsidiaries through September 30, 2006. The Internal Revenue Service has provided certain guidance related to the Act and is expected to provide additional guidance in the near future. We are evaluating the merits of repatriating funds under this new law. The range of reasonably possible amounts of funds that are being considered for repatriation is between zero and $20 million, which would require us to pay income taxes in the range of zero to $2 million. To date, we have not provided for income taxes on unremitted earnings generated by our non-U.S. subsidiaries as it has been our intent to permanently invest these earnings abroad.

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Table of Contents

Income Taxes

At the end of each interim reporting period we make an estimate of the effective tax rate, which includes tax items that are discrete to a specific quarter. Tax items discrete to a specific quarter are included in the effective tax rate for that quarter and are not pro-rated for the full year. The estimate used in providing for income taxes on a year-to-date basis may change in subsequent interim periods. During the three months ended March 31, 2005 and 2004, the effective income tax rate was 29.0 percent and 30.0 percent, respectively. During the six months ended March 31, 2005 and 2004, the effective income tax rate was 29.4 percent and 30.0 percent, respectively. For the full year, the Company anticipates the effective income tax rate will be 30 percent. The difference between our effective tax rate and the statutory tax rate of 35% is primarily the result of the tax benefits derived from the Research and Development (“R&D”) Tax Credit, which provides a tax benefit on certain incremental R&D expenditures, and the Extraterritorial Income Exclusion (“ETI”), which provides a tax benefit on export sales.

In October 2004, the American Jobs Creation Act of 2004 (“the Act”) was signed into law. The Act repeals and replaces the ETI with a new deduction for income generated from qualified production activities by U.S. manufacturers. The ETI will be phased out through calendar year 2006 and the new deduction under the Act will be phased in between calendar years 2005 and 2009. The ETI repeal and replacement under the Act is not expected to have a significant impact on our effective income tax rate in 2005. We are evaluating the impact of the ETI repeal and replacement under the Act on our effective income tax rate for years beyond fiscal 2005.

The Act also provides for a lower tax rate on funds repatriated into the U.S. from non-U.S. subsidiaries through September 30, 2006. We are evaluating the merits of repatriating funds under this new law. The range of reasonably possible amounts of funds that are being considered for repatriation is between zero and $15 million, which would require us to pay income taxes in the range of zero to $2 million. To date, we have not provided for income taxes on unremitted earnings generated by our non-U.S. subsidiaries as it has been our intent to permanently invest these earnings abroad.

Income Taxes

At the end of each interim reporting period we make an estimate of the effective tax rate, which includes the expected tax items that may be discrete to a specific quarter. Tax items discrete to a certain quarter are included in the effective tax rate for that quarter and are not pro-rated for the full year. The estimate used in providing for income taxes on a year-to-date basis may change in subsequent interim periods. The effective income tax rate for the three months ended December 31, 2004 and 2003 was 30 percent. The difference between our effective tax rate and the statutory tax rate of 35% is primarily the result of the tax benefits derived from the Research and Development (“R&D”) Tax Credit, which provides a tax benefit on certain incremental R&D expenditures, and the Extraterritorial Income Exclusion (“ETI”), which provides a tax benefit on export sales.

In October 2004, the American Jobs Creation Act of 2004 (“the Act”) was signed into law. The Act repeals and replaces the ETI with a new deduction for income generated from qualified production activities by U.S. manufacturers. The ETI will be phased out through calendar year 2006 and the new deduction under the Act will be phased in between calendar years 2005 and 2009. The ETI repeal and replacement under the Act is not expected to have a significant impact on our effective income tax rate in 2005. We are evaluating the impact of the ETI repeal and replacement under the Act on our effective income tax rate for years beyond fiscal 2005.

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Table of Contents

The Act also provides for a lower tax rate on funds repatriated into the U.S. from non-U.S. subsidiaries through September 30, 2006. We are evaluating the merits of repatriating funds under this new law. The range of reasonably possible amounts of funds that are being considered for repatriation is between zero and $15 million, which would require us to pay income taxes in the range of zero to $2 million. To date, we have not provided for income taxes on unremitted earnings generated by our non-U.S. subsidiaries as it has been our intent to permanently invest these earnings abroad.