Note 17. Income Taxes
On December 22, 2017, President Trump signed into law the Tax Cuts and Jobs Act (H.R. 1) (the "Act"). The Act includes a number of changes in existing tax law impacting businesses including, among other things, a permanent reduction in the corporate income tax rate from 35% to 21%. The rate reduction takes effect on January 1, 2018. Under ASC 740, the effects of changes in tax rates and laws are recognized in the period in which the new legislation is enacted. In the case of US federal income taxes, the enactment date is the date the bill becomes law (i.e., upon presidential signature). The Company does not expect any impact on recorded deferred tax balances, other than the reclassification of an alternative minimum tax credit of $0.2 million as a recoverable asset (due to changes under the Act), as the remeasurement of net deferred tax assets will be fully offset by a change in valuation allowance having no impact on the Company's financial position or results of operations.
The Act provided for a one-time deemed mandatory repatriation of post-1986 undistributed foreign subsidiary earnings and profits ("E&P") through the year ended December 31, 2017, with those earnings taxed at rates of 15.5% for earnings reflected by cash and cash equivalent items and 8% for other assets. Pernix has two wholly owned subsidiaries in Ireland operating under the names Pernix Ireland Limited and Pernix Ireland Pain Designated Activity Company. The Company's Irish subsidiaries have accumulated deficits in earnings and profits and thus the Company is not expecting a tax cost resulting from the deemed repatriation provisions.
The Act creates a new requirement that certain income (i.e., Global intangible low taxed income "GILTI") earned by foreign subsidiaries must be included currently in the gross income of the U.S. shareholder. Due to the complexity of the new GILTI tax rules, the Company is continuing to evaluate this provision of the Tax Act and the application of ASC 740. Under U.S. GAAP, the Company is permitted to make an accounting policy election to either treat taxes due on future inclusions in U.S. taxable income related to GILTI as a current-period expense when incurred or to factor such amounts into the Company's measurement of its deferred taxes. The Company has not yet completed its analysis of the GILTI tax rules and is not yet able to reasonably estimate the effect of this provision of the Tax Act or make an accounting policy election for the ASC 740 treatment of the GILTI tax. Therefore, the Company has not recorded any amounts related to potential GILTI tax in its financial statements and has not yet made a policy decision regarding whether to record deferred taxes on GILTI.
During the year ended December 31, 2015, the Company established a valuation allowance against its deferred tax assets. A valuation allowance, if needed, reduces deferred tax assets to the amount expected to be realized. In assessing the need for a valuation allowance, the Company considered both positive and negative evidence related to the likelihood of realization of the deferred tax assets. This evidence includes, but is not limited to, assessing changing business model(s) and market conditions, current and prior earnings history, expected future earnings, carry-back and carry-forward periods, and the feasibility of ongoing tax strategies that could potentially enhance the likelihood of the realization of a deferred tax asset. The weight given to the positive and negative evidence is commensurate with the extent the evidence may be objectively verified. As such, the Company concluded that as of the year ended December 31, 2017 there was not sufficient positive evidence to outweigh the objective negative evidence of recent financial reporting losses and expected future losses resulting from its new business model.
The components of the provision (benefit) for income taxes are as follows for the years ending December 31, 2017 and 2016 (in thousands):
| Year Ended December 31, | ||||||
| 2017 | 2016 | |||||
| Current: | ||||||
| Federal | $ | 113 | $ | 455 | ||
| State | 498 | 356 | ||||
| Foreign | - | (172) | ||||
| Total current provision | 611 | 639 | ||||
| Deferred Provision: | ||||||
| Federal | (238) | (189) | ||||
| State | - | (11) | ||||
| Foreign | - | - | ||||
| Total deferred provision (benefit) | (238) | (200) | ||||
| Total | $ | 373 | $ | 439 | ||
Deferred income taxes reflect the net tax effects of temporary differences between the carrying amount of the assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. The sources of the temporary differences and their effect on deferred taxes are as follows (in thousands):
| Year Ended December 31, | ||||||
| 2017 | 2016 | |||||
| Deferred tax assets: | ||||||
| Accruals and other reserves | $ | 19,752 | $ | 36,064 | ||
| Intangibles | 17,718 | 4,414 | ||||
| Inventory | 504 | 1,157 | ||||
| Stock awards | 3,570 | 4,531 | ||||
| Net operating loss carryovers | 25,030 | 34,582 | ||||
| Gross deferred tax assets | 64,574 | 80,748 | ||||
| Valuation allowance | (64,560) | (80,725) | ||||
| Net deferred tax asset | 14 | 23 | ||||
| Deferred tax liabilities: | ||||||
| Fixed Assets | (14) | (23) | ||||
| Intangibles | - | - | ||||
| Gross deferred tax liability | (14) | (23) | ||||
| Net deferred tax asset/(liability) | - | - | ||||
| Included in consolidated balance sheet: | ||||||
| Deferred income tax assets/(liabilities) - current | - | - | ||||
| Deferred income tax assets/(liabilities) - long-term | - | - | ||||
| Net deferred tax asset/(liability) | $ | - | $ | - | ||
The Company has federal net operating loss carryforwards (NOL's) of approximately $61.0 million at December 31, 2017 ranging in expiration from 2032 to 2037. Of this amount, the utilization of approximately $30.0 million will be subject to annual limitation due to the change in ownership provisions of IRC Section 382 ("382 regulations").
Somaxon has NOL's of approximately $250.2 million at December 31, 2017 ranging in expiration from 2032 to 2037. However, due to the 382 regulations, $22.4 million of those NOL are expected to be available for utilization, but subject to an annual limitation.
GTA has federal NOL's of approximately $85.3 million at December 31, 2017 ranging in expiration from 2032 to 2037. However, due to the 382 regulations, approximately $0.5 million of those NOL's are expected to be available for utilization.
Somaxon has federal research and development credit carryovers of approximately $4.5 million at December 31, 2017. However, due to the 382 regulations, approximately $0.3 million of those credits are expected to be available for utilization.
It should be noted that only those amounts that are available for utilization are included in the gross deferred tax assets (Somaxon and Pernix NOL's noted above).
The effective income tax rate from continuing operations is different from the federal statutory rate for the years ended December 31, 2017 and 2016 for the following reasons:
| Year Ended December 31, | |||||||
| 2017 | 2016 | ||||||
| Expected taxes at statutory rates | 35.0 | % | 35.0 | % | |||
| State taxes, net of federal tax benefit | (0.4) | % | (0.1) | % | |||
| Foreign income tax rate differential | (24.1) | % | (9.8) | % | |||
| Amortization and impairment of goodwill | (4.9) | % | (8.5) | % | |||
| Mark to market adjustment | 0.3 | % | 4.2 | % | |||
| Deductible inducement payment | (1.0) | % | 3.2 | % | |||
| Change in valuation allowance | 17.3 | % | (25.4) | % | |||
| Debt Reorganization and Exchangeable notes | 1.7 | % | - | % | |||
| Revaluation of deferred tax balances | (24.5) | - | % | ||||
| Permanent differences and other | 0.1 | % | 1.1 | % | |||
| (0.5) | % | (0.3) | % | ||||
Changes in tax laws or in their application or interpretation, such as to the transfer pricing between the Company's non-U.S. operations and the U.S., could increase the Company's effective tax rate and negatively affect the Company's results of operations.
The following summarizes the activity related to the Company's unrecognized tax benefits (in thousands):
| Year Ended December 31, | ||||||
| 2017 | 2016 | |||||
| Balance at beginning of year | $ | 7,410 | $ | 7,410 | ||
| Tax positions taken in prior periods | (2,514) | - | ||||
| Tax positions taken in current year | 5,347 | - | ||||
| Accrual of interest related to tax positions taken | - | - | ||||
| Settlements | - | - | ||||
| Foreign currency translation | - | - | ||||
| Balance at end of year | $ | 10,243 | $ | 7,410 | ||
As of December 31, 2017 and 2016, the total amount of gross unrecognized tax benefits was $10.2 million and $7.4 million respectively. None of these amounts would impact the effective tax rate as of December 31, 2017 and 2016, respectively, as the unrecognized tax benefits are associated with deferred tax assets subject to a full valuation allowance.
It is the Company's policy to classify accrued interest and penalties as part of the accrued unrecognized tax benefits liability and record the expense in the provision for income taxes. Due to the Company's net operating loss carryforward, interest and penalties related to unrecognized tax benefits have not been accrued to date. For unrecognized tax benefits that existed at December 31, 2017, the Company does not anticipate any significant changes within the next twelve months.
The Company files income tax returns in the U.S. federal jurisdiction, and various states and foreign jurisdictions. The associated tax filings remain subject to examination by applicable tax authorities for a certain length of time following the tax year to which those filings relate. As of December 31, 2017, the Company's 2014 & 2015 Federal tax returns are under examination by the Internal Revenue Service. Other years subject to examination include 2016 and 2017.