Note 14 – Income Taxes

China XD and Xinda Holding (HK) US Sub Inc. ("Xinda Holding (US) ") (collectively referred to as the "U.S. Entities") are each subject to a tax rate of 34% before 2018 and 21% per the new tax rules beginning 2018, and file separate U.S. federal income tax returns.  Xinda Holding (US) was dissolved in 2016 as a result of the group re-organization.

The actual impact of the U.S. Tax Reform on the Company may differ from management's estimates, and management may update the provisional amount upon obtaining, preparing or analyzing additional information, based on its review of future regulations or guidance issued by the U.S. Department of the Treasury, and specific actions the Company may take in the future.

Under the current laws of the British Virgin Island ("BVI"), Favor Sea (BVI) and Xinda Deluxe Faith Limited, subsidiaries of China XD, these two are not subject to tax on its income or capital gains.

No provision for Hong Kong Profits Tax was made for Xinda Holding (HK) Co., Ltd. ("Xinda Holding (HK) "), (formerly known as Hong Kong Engineering Plastics Co., Ltd.), Xinda (HK) International Trading Co., Ltd. ("Xinda Trading", liquidated in February 2015), Xinda (HONGKONG) Macromolecule Material Limited and Xinda (HK) Trading as they did not have any assessable profits arising in or derived from Hong Kong for any of the periods presented.

Under the current laws of Dubai, AL Composites Materials FZE ("Dubai Xinda"), a subsidiary of China XD, is exempted from income taxes.

The Company's PRC subsidiaries file separate income tax returns in the PRC.  Effective from January 1, 2008, the PRC statutory income tax rate is 25% according to the Corporate Income Tax ("CIT") Law which was passed by the National People's Congress on March 16, 2007.

Pursuant to an approval from the local tax authority in July 2013, Sichuan Xinda, a subsidiary of China XD, became a qualified enterprise located in the western region of the PRC, which entitled it to a preferential income tax rate of 15% from January 1, 2013 to December 31, 2020.

The CIT Law and its implementation rules impose a withholding income tax at 10%, unless reduced by a tax treaty or arrangement, on the amount of dividends distributed by a PRC-resident enterprise to its immediate holding company outside the PRC that are related to earnings accumulated beginning on January 1, 2008. Dividends relating to undistributed earnings generated prior to January 1, 2008 are exempt from such withholding income tax.

China XD earnings from its subsidiaries in PRC and Dubai are subject to the U.S. federal income tax at 34%, less any applicable foreign tax credits. Due to its plan to indefinitely reinvest its earnings in the PRC, the Company has not provided for deferred income tax liabilities related to PRC withholding income tax on undistributed earnings of US$673,784,710 and US$546,430,378 as of December 31, 2017 and 2016, respectively. In addition, due to its plan to indefinitely reinvest its earnings in Dubai, the Company has not provided for deferred income tax liabilities related to Dubai on undistributed earnings of US$206,128,306 and US$172,774,247 as of December 31, 2017 and 2016, respectively. It is not practicable to estimate the amounts of unrecognized deferred income tax liabilities thereof.

 

The components of income (loss) before income taxes are as follows:

The Company's income tax expense (benefit) recognized in the consolidated statements of comprehensive income consists of the following:

		Years Ended December 31,
		2017				2016				2015
		US$				US$				US$
Current income tax expense-PRC			21,966,937				19,715,649				20,618,211
Current income tax expense-US			70,965,148				-				-
Deferred income tax benefit-PRC			(2,407,706	)			(2,292,830	)			(2,380,236	)
Total income tax expense			90,524,379				17,422,819				18,237,975

The effective income tax rate based on income tax expense and income before income taxes reported in the consolidated statements of comprehensive income differs from the PRC statutory income tax rate of 25% due to the following:

 

 

The principal components of the Company's deferred income tax assets and deferred income tax liabilities are as follows:

The Research Institute was established with a registered capital of approximately US$0.4 million in 2007.  The Research Institute provided research and development services to the Company's ultimate end customers.  In December 2010, for tax purposes and because the Research Institute could not meet the Company's development needs, the Company dissolved the Research Institute and formed a new legal entity, Heilongjiang Xinda Enterprise Group Macromolecule Materials R&D Center Company Limited ("Xinda Group Material Research"). Based on applicable regulations promulgated by the local Civil Affairs Bureau, only the local government has the authority for the distribution of the assets of the Research Institute upon liquidation.  Therefore, the Company dissolved the Research Institute by distributing the net assets of the Research Institute in the amount of US$84.0 million to the local government. The difference between the net assets in the amount of US$84.0 million and the amount of the initial registered capital of US$0.4 million represents undistributed accumulated profit generated by the Research Institute from its inception date to its liquidation date.  Simultaneously, the local government granted the net assets back to the Research Center, the newly established subsidiary of Harbin Xinda in December 2010. The Research Center was established with a registered capital of approximately US$0.5 million funded by cash.  A loss equal to the net assets of the Research Institute distributed to the local government was recognized in other expenses and a government grant for the receipts of the same assets back from the local government was recognized as other income in the consolidated statements of comprehensive income. Pursuant to the local tax regulations, the net assets granted to the Research Center are not subject to income tax to the extent the Research Center spends a total of US$84.0 million in five years from the date of grant.  The expenditures of US$84.0 million will not be deductible for income tax purposes.  As a result, the Company recognized a deferred income tax liability in the amount of US$21.5 million in connection with the net assets granted to the Research Center as of December 31, 2010.  To the extent that the Company has spent on research and development equipment during the five years from the date of grant, deferred income tax liabilities relating to the net assets of Research Institute granted to Research Center will be reclassified to deferred income tax liabilities relating to property, plant and equipment, and recognized in profit or loss over the useful life of the asset. The Company spent a total of US$84.0 million on research and development equipment by the end of December 31, 2015, and the deferred income tax liabilities was US$9,267,501 and US$10,818,305 as of December 31, 2017 and 2016, respectively.

The movements of the valuation allowance are as follows:

The valuation allowance as of December 31, 2017, 2016 and 2015 was primarily provided for the deferred income tax assets of certain entities, which were at cumulative loss positions. As of December 31, 2017, for U.S. federal income tax purposes, the Company had tax loss carry forwards of (i) US$673,763 from US Entity, of which US$153,565, US$520,617 and nil would expire by 2035, 2036 and 2037, respectively, if unused, (ii) US$18,804,872 from subsidiaries in PRC, of which  US$3,423,410, US$6,900,933 and US$8,480,529 would expire by 2020, 2021 and 2022, respectively, if unused, and (iii) US$18,298,922 from subsidiaries in HK, which could be carried forward indefinitely to be offset against future profits. In view of the cumulative losses for the entities concerned, 100% valuation allowances were provided against their deferred income tax assets as of December 31, 2017, 2016 and 2015, which in the judgment of the management, are not more likely than not to be realized.

 

A reconciliation of the beginning and ending amount of total unrecognized tax benefits is as follows:

At December 31, 2017, 2016 and 2015, there are US$28,149,386, US$21,547,559 and US$18,370,729 of unrecognized tax benefits that if recognized, would affect the annual effective tax rate.

The Company recognizes interest accrued related to unrecognized tax benefits in interest expense and does not recognize penalties. During the years ended December 31, 2017, 2016 and 2015, the Company recognized approximately US$4,092,605, US$2,982,479, and US$1,905,191 interest expense. The Company had approximately US$10,342,390 and US$5,757,273 for the interest accrued related to unrecognized tax benefits amounting to US$34,045,550 and US$25,845,041 as of December 31, 2017 and 2016, respectively. The unrecognized tax benefits in 2012 amounting to US$2,934,853 and related accrued interest amounting to US$2,432,993 was classified as current liabilities as the five-year tax assessment period will expire on May 31, 2018. US$151,520 of unrecognized tax benefit were presented as a reduction of the deferred income tax assets for tax loss carry forwards since the uncertain tax position would reduce the tax loss carry forwards under the tax law. The unrecognized tax benefits represent the estimated income tax expenses the Company would be required to pay, should the income tax rate used, taxable income and deductible expenses for tax purpose recognized in accordance with tax laws and regulations. The Company is currently unable to provide an estimate of a range of the total amount of unrecognized tax benefits that is reasonably possible to change significantly within the next twelve months.

The tax returns of the U.S. Entities are subject to U.S. federal income tax examination by tax authorities for the years from 2015 to 2017.  According to the PRC Tax Administration and Collection Law, the statute of limitations is three years if the underpayment of taxes is due to computational errors made by the taxpayer or the withholding agent.  The statute of limitations is extended to five years under special circumstances where the underpayment of taxes is more than US$15,000.  In the case of transfer pricing issues, the statute of limitations is ten years.  There is no statute of limitations in the case of tax evasion.  The tax returns of the Company's PRC subsidiaries for the years from 2015 to 2017 are open to examination by the PRC tax authorities.