NOTE 13 – INCOME TAXES
The information in this note is on a consolidated basis, but uses the United States as the primary taxing authority as the Company’s primary operations are in the United States. The parent Company is an Israeli company, whose primary taxable income is from the provision, directly or indirectly through its affiliates, of telecommunication services.
Components of Income Before Tax Expense
The components of income (loss) before income tax expense are as follows (in thousands):
|
|
|
Year Ended December 31,
|
|
|
|
|
2017
|
|
|
2016
|
|
|
2015
|
|
|
|
|
|
|
|
|
|
|
|
|
|
United States
|
|
$
|
(32,246
|
)
|
|
$
|
8,513
|
|
|
$
|
18,343
|
|
|
Foreign
|
|
|
4,154
|
|
|
|
5,262
|
|
|
|
6,969
|
|
|
|
|
$
|
(28,092
|
)
|
|
$
|
13,775
|
|
|
$
|
25,312
|
|
Components of Income Tax Provision
The components of the income tax provision (benefit) in 2017, 2016 and 2015 are as follows (in thousands):
|
|
|
Year Ended December 31,
|
|
|
|
|
2017
|
|
|
2016
|
|
|
2015
|
|
|
Current:
|
|
|
|
|
|
|
|
|
|
|
Federal
|
|
$
|
(851
|
)
|
|
$
|
3,666
|
|
|
$
|
8,951
|
|
|
State
|
|
|
(36
|
)
|
|
|
949
|
|
|
|
76
|
|
|
Foreign
|
|
|
(266
|
) |
|
|
-
|
|
|
|
-
|
|
|
Current (benefit) provision
|
|
|
(1,153
|
)
|
|
|
4,615
|
|
|
|
9,027
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Deferred:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Federal
|
|
|
(3,805
|
)
|
|
|
(637
|
)
|
|
|
7,203
|
|
|
State
|
|
|
(1,251
|
)
|
|
|
(59
|
)
|
|
|
604
|
|
|
Foreign
|
|
|
451
|
|
|
|
5,114
|
|
|
|
5,056
|
|
|
Deferred (benefit) provision
|
|
|
(4,605
|
)
|
|
|
4,418
|
|
|
|
12,863
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Uncertain tax positions
|
|
|
2,629
|
|
|
|
(314
|
)
|
|
|
(10,088
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total income tax (benefit) provision
|
|
$
|
(3,129
|
)
|
|
$
|
8,719
|
|
|
$
|
11,802
|
|
Effective Tax Rate Reconciliation
The following is a reconciliation of the Company’s estimated annual effective income tax rate to the U.S. federal statutory rate for the years ended December 31, 2017, 2016 and 2015:
| |
|
Year Ended December 31,
|
|
| |
|
2017
|
|
|
2016
|
|
|
2015
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Federal tax at statutory rate
|
|
$
|
(9,551
|
)
|
|
|
34.00
|
%
|
|
$
|
4,684
|
|
|
|
34.00
|
%
|
|
$
|
8,606
|
|
|
|
34.00
|
%
|
|
State and local taxes, net of federal
|
|
|
(924
|
)
|
|
|
3.29
|
|
|
|
138
|
|
|
|
1.00
|
|
|
|
1,311
|
|
|
|
5.18
|
|
|
Foreign results at rates other than domestic
|
|
|
(728
|
)
|
|
|
2.60
|
|
|
|
(778
|
)
|
|
|
(5.65
|
)
|
|
|
(273
|
)
|
|
|
(1.08
|
)
|
|
Uncertain tax positions
|
|
|
2,629
|
|
|
|
(9.36
|
)
|
|
|
(798
|
)
|
|
|
(5.79
|
)
|
|
|
506
|
|
|
|
2.00
|
|
|
Expiration of stock options
|
|
|
2,682
|
|
|
|
(9.55
|
)
|
|
|
160
|
|
|
|
1.16
|
|
|
|
691
|
|
|
|
2.73
|
|
|
Noncontrolling interest
|
|
|
-
|
|
|
|
0.00
|
|
|
|
216
|
|
|
|
1.57
|
|
|
|
-
|
|
|
|
0.00
|
|
|
Israeli tax rate changes
|
|
|
-
|
|
|
|
0.00
|
|
|
|
5,252
|
|
|
|
38.13
|
|
|
|
-
|
|
|
|
0.00
|
|
|
U.S. tax rate changes
|
|
|
6,077
|
|
|
|
(21.63
|
)
|
|
|
-
|
|
|
|
0.00
|
|
|
|
-
|
|
|
|
0.00
|
|
|
Deferred tax charges on intercompany sales
|
|
|
297
|
|
|
|
(1.06
|
)
|
|
|
298
|
|
|
|
2.16
|
|
|
|
-
|
|
|
|
0.00
|
|
|
Return-to-provision adjustments
|
|
|
(2,607
|
)
|
|
|
9.28
|
|
|
|
959
|
|
|
|
6.96
|
|
|
|
(687
|
)
|
|
|
(2.71
|
) |
|
Other
|
|
|
(211
|
)
|
|
|
0.75
|
|
|
|
50
|
|
|
|
0.36
|
|
|
|
13
|
|
|
|
0.05
|
|
|
Valuation allowance
|
|
|
(793
|
) |
|
|
2.82
|
|
|
|
(1,461
|
)
|
|
|
(10.61
|
)
|
|
|
1,635
|
|
|
|
6.46
|
|
|
Effective tax rate
|
|
$
|
(3,129
|
)
|
|
|
11.14
|
%
|
|
$
|
8,719
|
|
|
|
63.30
|
%
|
|
$
|
11,802
|
|
|
|
46.63
|
%
|
The Company operates primarily in the U.S. and Israel. Its U.S. operations are subject to a federal statutory income tax rate of 34% in 2017, 2016 and 2015 and its Israeli operations are subject to statutory income tax rates of 24.0% in 2017, 25.0% in 2016 and 26.5% in 2015. The U.S. operations will be subject to a federal statutory income tax rate of 21% in 2018, and the Israel operations will be subject to statutory income tax rates of 23% in 2018. The income tax provision for 2017, 2016, and 2015 included items that have resulted in significant variances in the Company’s effective tax rate in comparison to statutory rates.
For the year ended December 31, 2017, the Company recorded an income tax benefit of ($3.1) million, which is lower than the expected tax benefit of ($9.6) million, using the statutory rate of 34%, due in part, to a change in the U.S. federal income tax rate which resulted in it revaluing its deferred tax assets and lowering their value by $6.1 million, state income taxes of ($0.9) million, the revaluation of the Israel net operating loss carryforwards of ($1.3) million, increases to uncertain tax positions of $2.6 million, return to provision adjustments of ($2.6) million, and a reduction to deferred tax assets related to the surrender of stock options and option forfeitures of $2.7 million. The discrete items noted above were partially offset by the lower jurisdictional tax rate charged on the operating income of the Company’s Israeli operations
For the year ended December 31, 2016, the Company recorded income tax expense of $8.7 million, which is higher than the expected tax provision of $4.7 million, using the statutory rate of 34%, due, in part, to the net impact of a decrease in the Israeli corporate tax rate from 26.5% to 23.0% which was effective in December 2016. The decrease in the rate resulted in the Company needing to reduce its Israeli deferred tax assets, primarily net operating loss carryforwards, which resulted in deferred tax expense and a reduction in the value of related deferred tax assets of $5.2 million. Additionally, the effective tax rate was impacted by increases to uncertain tax positions of ($0.8 million), decreases in valuation allowances of ($1.2 million) and other items of $0.8 million. The discrete items noted above were partially offset by the lower jurisdictional tax rate charged on the operating income of the Company’s Israeli operations.
For the year ended December 31, 2015, the Company recorded income tax expense of $11.8 million, which differed from the expected provision of $8.6 million, using the statutory rate of 34%, primarily due to changes in valuation allowances of $1.3 million established against certain Israeli capital losses and state net operating loss carryforwards, increases to uncertain tax positions of $0.5 million, a decrease to deferred tax assets associated with expired stock options of $0.7 million, and other one-time discrete items of $0.7 million. State income tax expense, net of federal tax benefit, is presented in the effective tax rate reconciliation exclusive of changes in valuation allowances on state income tax deferred items.
The effective tax rate in the future may be affected by the realization of previously unrecognized deferred tax assets being recovered from future taxable income, the mix of foreign sourced versus domestic income and the effect of any significant changes in foreign currency rates.
Components of Deferred Income Tax
The significant components of estimated deferred income tax assets and liabilities as of December 31, 2017 and 2016 are as follows (in thousands):
| |
|
December 31,
|
|
| |
|
2017
|
|
|
2016
|
|
|
Deferred tax assets:
|
|
|
|
|
|
|
|
Deferred revenue, net of deferred costs
|
|
$
|
830
|
|
|
$
|
1,043
|
|
|
Domestic net operating loss carryforwards
|
|
|
1,109
|
|
|
|
1,214
|
|
|
Foreign net operating loss carryforwards
|
|
|
31,466
|
|
|
|
30,103
|
|
|
Basis difference in intangible assets
|
|
|
9,638
|
|
|
|
5,343
|
|
|
Allowance for doubtful accounts
|
|
|
19
|
|
|
|
91
|
|
|
Currently non-deductible expenses and other
|
|
|
1,680
|
|
|
|
2,914
|
|
|
Capital loss carryforwards
|
|
|
1,665
|
|
|
|
1,413
|
|
|
Stock based compensation
|
|
|
950
|
|
|
|
2,198
|
|
|
Foreign tax credit carryforward
|
|
|
1,558
|
|
|
|
1,558
|
|
|
Basis difference in goodwill
|
|
|
-
|
|
|
|
(2,079
|
)
|
|
Basis difference in fixed assets
|
|
|
(395
|
)
|
|
|
(911
|
)
|
|
Total deferred tax assets
|
|
|
48,520
|
|
|
|
42,887
|
|
| |
|
|
|
|
|
|
|
|
|
Valuation allowance
|
|
|
(16,794
|
)
|
|
|
(16,319
|
)
|
| |
|
|
|
|
|
|
|
|
|
Gross deferred taxes
|
|
$
|
31,726
|
|
|
$
|
26,568
|
|
| |
|
|
|
|
|
|
|
|
|
Deferred tax liabilities:
|
|
|
|
|
|
|
|
|
|
Basis difference in long-lived assets
|
|
|
(256
|
)
|
|
|
-
|
|
|
Total deferred tax liabilities
|
|
|
(256
|
)
|
|
|
-
|
|
| |
|
|
|
|
|
|
|
|
|
Net deferred taxes
|
|
$
|
31,470
|
|
|
$
|
26,568
|
|
On December 22, 2017, the United States enacted tax reform legislation commonly known as the Tax Cuts and Jobs Act (the “Act”), resulting in significant modifications to existing law. Under ASC 740, Income Taxes, an entity is required to recognize the effect of tax law changes during the period of enactment. As such, the Company has reflected the impact of this law within its December 31, 2017 financial statements. Due to the complexities of the new legislation and associated accounting considerations, SEC SAB 118 provides for an entity to utilize a provisional estimate within its financial statements for the impact of the Act. Based upon currently available information, the Company has analyzed the accounting for the significant effects of the Act during the period ended December 31, 2017. The Company’s financial statements for the year ended December 31, 2017 reflect certain effects of the Act which includes a reduction in the corporate tax rate from 34% to 21%, as well as other changes. As a result of these changes to tax laws and tax rates under the Act, the Company has recorded a provisional incremental income tax expense of $6.1 million during the year ended December 31, 2017, which consisted primarily of the remeasurement of deferred tax assets and liabilities from 34% to 21%. The Company does not expect to incur a liability related to the one-time deemed repatriation transition tax on unrepatriated foreign earnings. However, we are still analyzing certain aspects of the Tax Act and refining our calculations, which could potentially affect the measurement of these balances or give rise to new deferred tax amounts.
Valuation Allowance
At December 31, 2017 and 2016, the Company had valuation allowances related to deferred tax assets associated with net operating losses of an inactive foreign subsidiary, foreign capital and revaluation losses, unrealized gains on prior year transactions associated with the Company’s common equity put options, and domestic state net operating losses. These deferred tax assets do not meet the more likely than not threshold that they will be realized.
More broadly, the Company’s assessment for the years ended December 31, 2017, 2016 and 2015 considered the following positive and negative evidence.
Positive evidence
The Company has generated cumulative pre-tax income in Israel of $16.4 million for the three year period ended December 31, 2017, and has utilized some of its available tax assets to reduce the tax liabilities that would have otherwise arisen in those periods.
The U.S. and Israel require approximately $44.7 million and $83.3 million in future taxable income, respectively, to realize the deferred tax assets at December 31, 2017. The Company’s Israeli net operating loss carryforwards are not subject to expiration and its financial performance has continued to generate pre-tax operating income despite challenging macroeconomic conditions.
Negative evidence
At December 31, 2017, the negative evidence consists primarily of a pre-tax (loss) of ($5.4) million in the United States for the three year period ended December 31, 2017. The cumulative pre-tax loss in the U.S. is primarily the result of a one-time impairment charge of $31.5 million related to the Enterprise segment which management does not expect to reoccur in future periods. The Company has reorganized the Enterprise segment which has reduced costs. The historical performance in the Consumer segment of the business is positive and is expected to continue. The Company believes that this positive evidence outweighs the negative evidence of the cumulative pre-tax loss in the United States and that it is more likely than not that the Company will be able to utilize the net deferred tax assets in the United States.
The Company has a history of significant pre-tax losses dating back to years prior to 2010 in Israel. In total, the U.S. group of companies has approximately $0.6 million of state deferred tax assets, before application of valuation allowances, related to $10.2 million of state net operating losses which expire over periods ranging through 2037. The Israeli group of companies has approximately $34.3 million of deferred tax assets, before application of valuation allowances, related to $138.9 million of net operating loss carryforwards, which has accumulated over many years. Of the total Israeli group combined net operating losses, $56.7 million are limited in use as these net operating losses relate to specific subsidiaries, which are currently inactive and a valuation allowance remains against those losses. The Company believes that the combined impact of a number of Company specific and industry specific developments over recent years makes it unlikely that the repeated annual losses incurred prior to the year ended December 31, 2012 would recur.
In addition, the Company considered negative evidence in connection with various industry specific factors. The market in which the Company participates is highly competitive and could be impacted by changes in technology. If the Company does not compete effectively, its operating results may be harmed by loss of market share and revenues. The Company may also face difficulty in attracting new customers, and if it fails to attract new customers, its business and results of operations may suffer. The Company also relies on independent retailers to sell the magicJack devices, and disruption to these channels would harm its business.
After consideration of both the positive and negative evidence, the Company believes that its positive evidence outweights the negative evidence. The operating profits in recent years compared to the historical operating losses prior to 2012 is an objectively verifiable piece of positive evidence and is the result of a number of factors, which have been present to a greater or lesser extent in prior years, but have only recently gathered sufficient weight to deliver consistent taxable profits. A key consideration in the Company’s analysis was that the unlimited carryforward periods of its Israel net operating losses make the realization of those assets less sensitive to variations in the Company’s projections of future taxable income than would otherwise be the case if the carryforward periods were time limited.
Valuation allowances of $16.8 million, $16.3 million and $17.5 million at December 31, 2017, 2016 and 2015, respectively, were provided for deferred tax assets associated with net operating losses of an inactive foreign subsidiary, foreign capital and revaluation losses, unrealized gains on prior year transactions associated with the Company’s common equity put options, and domestic state net operating losses.
The reconciliation of the valuation allowance for the years ended December 31, 2017 and 2016 is as follows (in thousands):
|
|
|
Years Ended December 31,
|
|
|
|
|
2017
|
|
|
2016
|
|
|
|
|
|
|
|
|
|
|
Balance, beginning of period
|
|
$
|
16,319
|
|
|
$
|
17,544
|
|
|
Changes to the valuation allowance
|
|
|
475
|
|
|
|
(1,225
|
)
|
|
Balance, end of period
|
|
$
|
16,794
|
|
|
$
|
16,319
|
|
Uncertain Tax Positions
The Company reassesses its income tax positions and records tax benefits for all years subject to examination based upon its evaluation of the facts, circumstances and information available at the reporting date. For those tax positions where it is more-likely-than-not that a tax benefit will be sustained, the Company has recorded the largest amount of tax benefit with a greater than 50% likelihood of being realized upon ultimate settlement with a taxing authority that has full knowledge of all relevant information. For those income tax positions where it is not more-likely-than-not that a tax benefit will be sustained, no tax benefit has been recognized in the Company’s consolidated financial statements.
The Company files U.S. federal and state and foreign income tax returns in jurisdictions with varying statutes of limitations. During 2013, the Company received notice that the IRS was going to examine its tax returns for 2010 and 2011. In October 2014, the Company was informed by the IRS that it was going to expand its audit to include the Company’s 2012 and 2013 tax returns. During 2015, the Company reached agreement with the IRS on a settlement of all years under audit. The settlement resulted in an increase to the jurisdictional income of the U.S. The additional tax and interest due to the IRS and various state taxing authorities as a result of the increased U.S. jurisdictional income was $6.8 million and $0.9 million, respectively. The Company was able to utilize approximately $4.2 million of benefits related to other favorable adjustments identified during the exam to satisfy a portion of the federal liability, resulting in net tax and interest paid to the IRS of $2.6 million. The $0.9 million state liability is reflected as a reduction to prepaid income taxes in the Company’s December 31, 2015 consolidated balance sheets. The increase to the U.S. jurisdictional income resulted in a decrease in the Company’s Israeli jurisdictional income. The decrease in Israeli income, in turn, increased the Company’s Israeli net operating losses, resulting in a tax benefit of $5.6 million. The tax years 2011 through 2017 remain open to examination by other major taxing jurisdictions to which the Company is subject.
A reconciliation of the gross amounts of unrecognized tax benefits, excluding accrued interest and penalties, is as follows (in thousands):
|
|
|
Years Ended December 31,
|
|
|
|
|
2017
|
|
|
2016
|
|
|
2015
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Unrecognized tax benefits, opening balance
|
|
$
|
9,136
|
|
|
$
|
9,929
|
|
|
$
|
18,860
|
|
|
Gross increases (decreases) - tax positions in prior periods
|
|
|
1,468
|
|
|
|
(356
|
)
|
|
|
(1,030
|
)
|
|
Gross increases - tax positions in current period
|
|
|
19
|
|
|
|
79
|
|
|
|
5
|
|
|
Settlements
|
|
|
-
|
|
|
|
(516
|
)
|
|
|
(7,906
|
)
|
|
Lapse of statute of limitations
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
Unrecognized tax benefits, ending balance
|
|
$
|
10,623
|
|
|
$
|
9,136
|
|
|
$
|
9,929
|
|
All amounts in the reconciliation above are reported on a gross basis and do not reflect a federal tax benefit on state income taxes. The Company does not anticipate a significant reduction in unrecognized tax benefits within the next twelve months due to lapse of statute of limitation.
As of December 31, 2017, 2016 and, 2015, there were $10.1 million, $8.3 million and $9.2 million, respectively, of unrecognized tax benefits, respectively, that if recognized, would favorably affect the Company’s annual effective tax rate. These amounts include a federal tax benefit on state income taxes and exclude interest and penalties. The Company recognizes interest and penalties accrued related to unrecognized tax benefits as income tax expense as a component of the income tax (benefit) expense in the Company’s consolidated statements of operations and the corresponding liability is included in income taxes payable and other non-current liabilities in its consolidated balance sheets.
As of December 31, 2017, 2016 and 2015, $13.1 million, $10.4 million and $10.8 million, respectively, was included in other non-current liabilities in the Company’s consolidated balance sheets for uncertain tax positions. The amount of accrued interest and penalties recognized by the Company in the years ended December 31, 2017, 2016 and 2015 was $3.0 million, $2.1 million and $1.6 million, respectively.