16. Income Tax
| Year Ended December 31, | ||||||
| 2017 | 2016 | 2015 | ||||
| (in thousands) | ||||||
| Current income tax expense: | ||||||
| Federal and state | $ | 262 | $ | 170 | $ | (4) |
| Foreign | 297 | 790 | 677 | |||
| 559 | 960 | 673 | ||||
| Deferred income tax (benefit) expense: | ||||||
| Federal and state | (2,357) | 166 | 15,598 | |||
| Foreign | 575 | 103 | (840) | |||
| (1,782) | 269 | 14,758 | ||||
| Total income tax (benefit) expense | $ | (1,223) | $ | 1,229 | $ | 15,431 |
Income tax expense for the years ended December 31, 2017, 2016 and 2015 differed from the amount computed by applying the U.S. federal income tax rate of 34% to pre-tax operations income as a result of the following:
| Year Ended December 31, | ||||||
| 2017 | 2016 | 2015 | ||||
| (in thousands) | ||||||
| Computed "expected" income tax (benefit) expense | $ | (710) | $ | (1,046) | $ | (1,227) |
| Increase (decrease) in income taxes resulting from: | ||||||
| Permanent differences, net | (108) | (128) | 32 | |||
| Foreign tax rate differential | 23 | 165 | (12) | |||
| State income taxes, net of federal income tax benefit | (71) | (93) | 82 | |||
| Non-deductible stock compensation expense | 174 | 110 | (161) | |||
| Impact of foreign rate change | - | 30 | 89 | |||
| Impact of U.S. rate change | 2,521 | - | - | |||
| Tax credits | (14) | (89) | (169) | |||
| Change in reserve for uncertain tax position | (58) | 127 | 35 | |||
| Impact of change to prior year tax accruals | 72 | 291 | 370 | |||
| Impact of adoption of ASU 2016-09, Improvements to Employee | ||||||
| Share-based Payment Accounting | (486) | - | - | |||
| U.S. tax on foreign dividends | 3,149 | 497 | - | |||
| Foreign withholding taxes | 38 | 74 | - | |||
| Conversion of U.S. foreign tax credits from credit to deduction | 648 | 1,772 | - | |||
| Non-deductible loss on subsidiary stock sale | - | 501 | - | |||
| Change in valuation allowance allocated to income | ||||||
| tax expense (benefit) | (6,393) | (983) | 16,401 | |||
| Other | (8) | 1 | (9) | |||
| Total income tax (benefit) expense | $ | (1,223) | $ | 1,229 | $ | 15,431 |
Income tax (benefit) expense is based on the following pre-tax loss from operations for the years ended December 31, 2017, 2016 and 2015:
| Year Ended December 31, | ||||||
| 2017 | 2016 | 2015 | ||||
| (in thousands) | ||||||
| Domestic | $ | (3,129) | $ | (3,107) | $ | (3,331) |
| Foreign | 1,041 | 29 | (277) | |||
| Total | $ | (2,088) | $ | (3,078) | $ | (3,608) |
The tax effects of temporary differences that give rise to significant components of the deferred tax assets and deferred tax liabilities from operations at December 31, 2017 and 2016 are as follows:
| December 31, | ||||
| 2017 | 2016 | |||
| (in thousands) | ||||
| Deferred tax assets: | ||||
| Accounts receivable | $ | 93 | $ | 170 |
| Inventory | 891 | 1,336 | ||
| Operating loss and credit carryforwards | 8,287 | 12,586 | ||
| Property, plant and equipment | 3 | 5 | ||
| Pension liabilities | 151 | 631 | ||
| Contingent consideration | 2,273 | 3,262 | ||
| Stock compensation expense | 1,667 | 2,076 | ||
| Other assets | 119 | 23 | ||
| Total gross deferred assets | 13,484 | 20,089 | ||
| Less: valuation allowance | (11,447) | (17,840) | ||
| Deferred tax assets | $ | 2,037 | $ | 2,249 |
| Deferred tax liabilities: | ||||
| Indefinite-lived intangible assets | $ | 3,166 | $ | 4,567 |
| Definite-lived intangible assets | 2,383 | 2,593 | ||
| Other accrued liabilities | 270 | 349 | ||
| Total deferred tax liabilities | 5,819 | 7,509 | ||
| Net deferred tax liabilities | $ | (3,782) | $ | (5,260) |
Certain prior year amounts in the above table have been reclassified for consistency with the current year presentation. These reclassifications had no effect on the Company’s consolidated financial statements.
The Company adopted the provisions of ASU 2016-09, Improvements to Employee Share-based Payment Accounting, on January 1, 2017. Upon adoption, the company recorded previously unrecognized excess tax benefits from the exercise of employee stock options as an increase in its deferred tax asset for net operating losses of approximately $0.5 million. The tax benefit of this increased deferred tax asset is fully offset by an increase in the valuation allowance. Following adoption, excess tax benefits or tax deficit is reflected as income tax benefit or expense in the year the tax impact is generated. Approximately $96 thousand of tax deficit was recorded as income tax expense in 2017. Prior to the adoption of ASU 2016-09, these excess tax benefits could only be recognized when the related tax deduction reduces income taxes payable and the benefit would be reflected as a credit to additional paid-in capital if realized.
The amounts recorded as deferred tax assets as of December 31, 2017 and 2016 represent the amount of tax benefits of existing deductible temporary differences and carryforwards that are more likely than not to be realized through the generation of sufficient future taxable income within the carryforward period. Significant management judgment is required in determining any valuation allowance recorded against deferred tax assets and liabilities. During the year ended December 31, 2015, the Company determined that it was more likely than not that its U.S. deferred tax assets would not be realized and therefore recorded a net increase to the valuation allowance of $16.4 million to offset U.S. deferred tax assets net of deferred tax liabilities except for deferred tax liabilities associated with certain indefinite-lived intangible assets. The Company’s judgment was based on consideration of all available evidence. At December 31, 2017 and 2016, the Company continues to maintain a valuation allowance against substantially all net U.S. deferred tax assets, exclusive of deferred tax liabilities associated with certain indefinite-lived intangible assets. During the year ended December 31, 2017, the Company determined that it was more likely than not that deferred tax assets of certain foreign subsidiaries would not be realized and therefore recorded a valuation allowance of $0.5 million on net deferred tax assets.
On December 22, 2017, tax reform legislation known as the Tax Cuts and Jobs Act (the Tax Act) was signed into law. The Tax Act makes broad and complex changes to the U.S. Internal Revenue Code, including the reduction of the corporate income tax rate from 35% to 21% and the implementation of a modified territorial tax system; the latter includes a one-time transition tax on previously unremitted earnings of foreign subsidiaries. Recent SEC guidance under Staff Accounting Bulletin No. 118, Income Tax Accounting Implications of the Tax Cuts and Jobs Act (SAB 118) provides for a measurement-period approach for the recording of income tax effects related to tax reform for which the accounting is incomplete. The accounting for the impact of the Tax Act is incomplete, however the Company has recorded provisional estimates for the impact of changes related to the revaluation of deferred taxes, the impact of the mandatory repatriation of foreign earnings after electing the utilization of existing tax attributes, and for the reduction in valuation allowance on net federal deferred tax assets. Since these provisions were based on estimates, the Company will continue to measure the impact of these areas and record any changes in subsequent quarters when information and guidance become available. Those areas include the analysis of various elections available including the transition tax, state-tax impact and adoption by the various states, completion of foreign earnings and profits calculations and additional guidance from the Treasury on various provisions under the new law.
Other law changes implemented by the Act such as changes to the calculation for Section 162(m) executive compensation deduction, interest deduction limitation and Global Intangible Low Taxed Income (GILTI), and others will not have any impact on the Company until the year ended December 31, 2018. The Company will continue to monitor guidance regarding these changes for how it will impact the financial statements in later periods.
At December 31, 2017, the Company had federal net operating loss carryforwards of $14.4 million, which begin to expire in 2021 and state net operating loss carryforwards of $8.6 million, which begin to expire in 2018. Approximately $8.0 million of federal net operating loss carryforwards are expected to be utilized during 2017 to offset the transition impact. The Company also had research and development tax credit carryforwards of $1.7 million which begin to expire in 2020. The Company had $0.4 million of alternative minimum tax credit carryforwards which are not subject to expiration and become refundable under the Tax Act beginning in 2018 subject to sequestration. In addition, the Company had a total of $1.1 million of state investment tax credit carryforwards, research and development tax credit carryforwards, and EZ credit carryforwards, which begin to expire in 2018. Approximately $3.3 million of net operating losses are subject to an annual limitation of $0.7 million imposed by change in ownership provisions of Section 382 of the Internal Revenue Code. As mentioned above, these net operating loss and credit carryforwards have full valuation allowances set up against them.
Undistributed earnings of the Company’s foreign subsidiaries amounted to approximately $49.2 million, $48.6 million, and $48.7 million at December 31, 2017, 2016 and 2015, respectively. As of December 31, 2017, the Company changed its indefinite reinvestment assertion to provide that all foreign earnings above the level required for local operating expenses would be repatriated to the U.S. in tax years after 2017. Prior to 2017, this modified assertion only applied to the Company’s subsidiaries in France and Canada. At December 31, 2017, as the Company was considering a potential U.S. acquisition, the Company changed its assertion and it was anticipated that U.S. needs would require repatriation of all foreign subsidiaries’ earnings rather than just France and Canada. As a result of the Tax Act, all prior unremitted earnings are deemed paid and included in the current provision under the one-time repatriation tax calculation. Therefore, as a result of the change in this assertion, only $38 thousand of additional withholding has been accrued as of December 31, 2017.
In 2016, the Company recorded a tax reserve in the amount of $59 thousand related to the disposition of a foreign subsidiary. Additionally in 2016, the Company recorded a reserve for $62 thousand related to issues raised in an ongoing German income tax audit. In 2017, the Company recorded a $21 thousand adjustment to the reserve related to the disposition of a foreign subsidiary. Also in 2017, the German income tax audit was settled for $30 thousand and $32 thousand of the remaining reserve was reversed. A reconciliation of uncertain tax liabilities is as follows:
| (in thousands) | ||
| Balance at December 31, 2015 | $ | 285 |
| Additions based on current year tax positions | 59 | |
| Additions based on tax positions of prior years | 62 | |
| Balance at December 31, 2016 | 406 | |
| Decreases based on tax positions of prior years | (53) | |
| Settlements | (30) | |
| Balance at December 31, 2017 | $ | 323 |
At December 31, 2017 and 2016 the amount of unrecognized tax benefits that would affect the Company’s effective tax rate was $0.3 million and $0.4 million, respectively. The Company classifies interest and penalties related to unrecognized tax benefits as a component of income tax expense. For the years ended December 31, 2017 and 2016, respectively, interest recognized in the consolidated statement of operations was immaterial, and there were no penalties recognized.
The Company or one of its subsidiaries files income tax returns in the U.S. federal jurisdiction, and various states and foreign jurisdictions. With few exceptions, the Company is no longer subject to income tax examinations by tax authorities in foreign jurisdictions for years before 2013. In the U.S., the Company's net operating loss and tax credit carryforward amounts remain subject to federal and state examination for tax years starting in 2000 as a result of tax losses incurred in prior years. There are currently no pending federal or state tax examinations. The Company is subject to audits by various taxing jurisdictions. Additional reserves are established when necessary. No ongoing audits are expected to have a material impact.