MODUSLINK GLOBAL SOLUTIONS INC

(14) INCOME TAXES

The components of loss from continuing operations before provision for income taxes are as follows:


	Twelve Months Ended July 31,
	2017			2016			2015
	(In thousands)
Income (loss) from operations before income taxes:
U.S.	$	(34,884	)	$	(69,861	)	$	(8,476	)
Foreign		10,475			13,234			(7,878	)

Total loss from operations before income taxes	$	(24,409	)	$	(56,627	)	$	(16,354	)

The components of income tax expense have been recorded in the Company’s consolidated financial statements as follows:


	Twelve Months Ended July 31,
	2017		2016		2015
	(In thousands)
Income tax expense from continuing operations		2,696		5,443		2,283

Total income tax expense	$	2,696	$	5,443	$	2,283

The components of income tax expense from continuing operations consist of the following:


	Twelve Months Ended July 31,
	2017		2016		2015
	(In thousands)
Current provision
Federal	$	—	$	—	$	—
State		—		—		—
Foreign		2,298		3,090		4,323

		2,298		3,090		4,323

Deferred provision:
Federal		—		—		—
State		—		—		—
Foreign		398		2,353		(2,040	)

		398		2,353		(2,040	)

Total tax provision	$	2,696	$	5,443	$	2,283

Deferred income tax assets and liabilities have been classified on the Consolidated Balance Sheets in accordance with the nature of the item giving rise to the temporary differences. During the year ended July 31, 2016, the Company elected to early adopt ASU No. 2015-17, which requires companies to classify all deferred tax assets and liabilities as noncurrent on the balance sheet instead of separating deferred taxes into current and noncurrent amounts. This guidance allows for adoption on either a prospective or retrospective basis. As of July 31, 2017, the Company recorded a non-current deferred tax asset of $1.9 million and a non-current deferred tax liability of $0.7 million in Other Assets, and Other Long-term Liabilities, respectively. As of July 31, 2016, the Company recorded a non-current deferred tax asset of $2.3 million and a non-current deferred tax liability of $0.8 million in Other Assets and Other Long-term Liabilities, respectively. The components of deferred tax assets and liabilities are as follows:


	July 31, 2017			July 31, 2016
	(In thousands)
Deferred tax assets:
Accruals and reserves	$	12,193		$	12,240
Tax basis in excess of financial basis of investments in affiliates		18,332			19,051
Tax basis in excess of financial basis for intangible and fixed assets		7,689			8,455
Net operating loss and capital loss carry forwards		751,435			744,357

Total gross deferred tax assets		789,649			784,103
Less: valuation allowance		(771,884	)		(760,906	)

Net deferred tax assets	$	17,765		$	23,197

Deferred tax liabilities:
Financial basis in excess of tax basis for intangible and fixed assets	$	(784	)	$	(861	)
Convertible Debt		(2,655	)		(4,241	)
Undistributed accumulated earnings of foreign subsidiaries		(13,150	)		(16,554	)

Total gross deferred tax liabilities		(16,589	)		(21,656	)

Net deferred tax asset	$	1,176		$	1,541

Subsequently reported tax benefits relating to the valuation allowance for deferred tax assets as of July 31, 2017 will be allocated as follows (in thousands):


Income tax benefit recognized in the consolidated statement of operations	$	(756,423	)
Additional paid in capital		(15,461	)

	$	(771,884	)

The net change in the total valuation allowance for the fiscal year ended July 31, 2017 was an increase of approximately $11.0 million. This increase is primarily due to the U.S. valuation allowance as well as the valuation allowance provided for Taiwan and France for the year ended July 31, 2017. A valuation allowance has been recorded against the gross deferred tax asset in the U.S and certain foreign subsidiaries since management believes that after considering all the available objective evidence, both positive and negative, historical and prospective, it is more likely than not that certain assets will not be realized. The net change in the total valuation allowance for the fiscal year ended July 31, 2016 was an increase of approximately $10.3 million.

The Company has certain deferred tax benefits, including those generated by net operating losses and certain other tax attributes (collectively, the “Tax Benefits”). The Company’s ability to use these Tax Benefits could be substantially limited if it were to experience an “ownership change,” as defined under Section 382 of the Internal Revenue Code of 1986, as amended (the “Code”). In general, an ownership change would occur if there is a greater than 50-percentage point change in ownership of securities by stockholders owning (or deemed to own under Section 382 of the Code) five percent or more of a corporation’s securities over a rolling three-year period.

On October 17, 2011, the Company’s Board of Directors adopted a Tax Benefit Preservation Plan between the Company and American Stock Transfer & Trust Company, LLC, as rights agent (as amended from time to time, the “Tax Plan”). The Tax Plan reduces the likelihood that changes in the Company’s investor base would have the unintended effect of limiting the Company’s use of its Tax Benefits. The Tax Plan is intended to require any person acquiring shares of the Company’s securities equal to or exceeding 4.99% of the Company’s outstanding shares to obtain the approval of the Board of Directors. This would protect the Tax Benefits because changes in ownership by a person owning less than 4.99% of the Company’s stock are considered and included in one or more public groups in the calculation of “ownership change” for purposes of Section 382 of the Code. On October 9, 2014, the Tax Plan was amended by the Company’s Board of Directors to extend the expiration of the Tax Plan until October 17, 2017. Following the stockholders’ approval of the Protective Amendment (as described in the following paragraphs) at the Company’s 2014 Annual Meeting, the Tax Plan was further amended so that it expired at the close of business on December 31, 2014.

On December 29, 2014, the Company filed an Amendment to its Restated Certificate of Incorporation (the “Protective Amendment”) with the Delaware Secretary of State to protect the significant potential long-term tax benefits presented by its net operating losses and other tax benefits (collectively, the “NOLs”). The Protective Amendment was approved by the Company’s stockholders at the Company’s 2014 Annual Meeting of Stockholders held on December 9, 2014. As a result of the filing of the Protective Amendment with the Delaware Secretary of State, the Company amended its Tax Benefit Preservation Plan so that it expired at the close of business on December 31, 2014.

The Protective Amendment limits certain transfers of the Company’s common stock, to assist the Company in protecting the long-term value of its accumulated NOLs. The Protective Amendment’s transfer restrictions generally restrict any direct or indirect transfers of the common stock if the effect would be to increase the direct or indirect ownership of the common stock by any person (as defined in the Protective Amendment) from less than 4.99% to 4.99% or more of the common stock, or increase the percentage of the common stock owned directly or indirectly by a Person owning or deemed to own 4.99% or more of the common stock. Any direct or indirect transfer attempted in violation of the Protective Amendment will be void as of the date of the prohibited transfer as to the purported transferee. The Board of Directors of the Company has discretion to grant waivers to permit transfers otherwise restricted by the Protective Amendment.

In accordance with the Protective Amendment, Handy & Harman (“HNH”), a related party, requested, and the Company granted HNH and its affiliates, a waiver under the Protective Amendment to permit their acquisition of up to 45% of the Company’s outstanding shares of common stock in the aggregate (subject to proportionate adjustment, the “45% Cap”), in addition to acquisitions of common stock in connection with the exercise of certain warrants of the Company (the “Warrants”) held by Steel Partners Holdings L.P. (“SPH”), an affiliate of HNH, as well as a limited waiver under Section 203 of the Delaware General Corporation Law for this purpose. Notwithstanding the foregoing, HNH and its affiliates (and any group of which HNH or any of its affiliates is a member) are not permitted to acquire securities that would result in an “ownership change” of the Company for purposes of Section 382 of the Internal Revenue Code of 1986, as amended, that would have the effect of impairing any of the Company’s NOLs. The foregoing waiver was approved by the independent directors of the Company.

The Company has net operating loss carryforwards for federal and state tax purposes of approximately $2.1 billion and $209.8 million, respectively, at July 31, 2017. The federal net operating losses will expire from fiscal year 2022 through 2037 and the state net operating losses will expire from fiscal year 2018 through 2037. The Company has a foreign net operating loss carryforward of approximately $84.1 million, of which $58.8 million has an indefinite carryforward period. In addition, the Company has an immaterial amount of capital loss carryforwards for federal and state tax purposes. The federal and state capital losses will expire in fiscal year 2018.

The Company’s ModusLink Corporation subsidiary has undistributed earnings from its foreign subsidiaries of approximately $39.1 million at July 31, 2017, of which approximately $2.0 million is considered to be permanently reinvested due to certain restrictions under local laws as well as the Company’s plans to reinvest such earnings for future expansion in certain foreign jurisdictions. The amount of taxes attributable to the permanently undistributed earnings is estimated at $0.7 million. The Company has recorded a deferred tax liability of $13.2 million on the remaining $37.1 million of undistributed earnings that are not considered to be permanently reinvested.

Income tax expense attributable to income from continuing operations differs from the expense computed by applying the U.S. federal income tax rate of 35% to income (loss) from continuing operations before income taxes as a result of the following:


	Twelve Months Ended July 31,
	2017			2016			2015
	(In thousands)
Computed “expected” income tax expense (benefit)	$	(8,106	)	$	(19,368	)	$	(5,653	)
Increase (decrease) in income tax expense resulting from:
Change in valuation allowance		10,978			22,907			2,067
Foreign dividends		2,724			4,730			732
Foreign tax rate differential		(2,386	)		(1,082	)		1,262
Capitalized costs		—			—			(478	)
Nondeductible goodwill impairment		—			—			1,070
Nondeductible expenses		20			262			417
Foreign withholding taxes		239			762			(19	)
Reversal of uncertain tax position reserves		(481	)		(2,768	)		—
Other		(292	)		—			2,885

Actual income tax expense	$	2,696		$	5,443		$	2,283

The calculation of the Company’s tax liabilities involves dealing with uncertainties in the application of complex tax regulations in several tax jurisdictions. The Company is periodically reviewed by domestic and foreign tax authorities regarding the amount of taxes due. These reviews include questions regarding the timing and amount of deductions and the allocation of income among various tax jurisdictions. In evaluating the exposure associated with various filing positions, the Company records estimated reserves when necessary. Based on the evaluation of current tax positions, the Company believes it has appropriately accrued for exposures.

The Company operates in multiple taxing jurisdictions, both within and outside of the United States. At July 31, 2017, 2016 and 2015, the total amount of the liability for unrecognized tax benefits, including interest, related to federal, state and foreign taxes was approximately $0.7 million, $1.2 million and $3.9 million, respectively. To the extent the unrecognized tax benefits are recognized, the entire amount would impact income tax expense.

The Company files income tax returns in the U.S., various states and in foreign jurisdictions. The federal and state income tax returns are generally subject to tax examinations for the tax years ended July 31, 2013 through July 31, 2017. To the extent the Company has tax attribute carryforwards, the tax year in which the attribute was generated may still be adjusted upon examination by the Internal Revenue Service or state tax authorities to the extent utilized in a future period. In addition, a number of tax years remain subject to examination by the appropriate government agencies for certain countries in the Europe and Asia regions. In Europe, the Company’s 2009 through 2016 tax years remain subject to examination in most locations while the Company’s 2005 through 2016 tax years remain subject to examination in most Asia locations.

A reconciliation of the beginning and ending balances of the total amounts of gross unrecognized tax benefits is as follows:


	Twelve Months Ended July 31,
	2017			2016			2015
	(In thousands)
Balance as of beginning of year	$	994		$	3,756		$	1,028
Additions for current year tax positions		—			19			2,884
Currency translation		18			—			(156	)
Reductions for lapses in statute of limitations		(331	)		(27	)		—
Reductions of prior year tax positions		—			(2,754	)		—

Balance as of end of year	$	681		$	994		$	3,756

In accordance with the Company’s accounting policy, interest related to income taxes is included in the provision of income taxes line of the Consolidated Statements of Operations. For the fiscal year ended July 31, 2017, the Company has not recognized any material interest expense related to uncertain tax positions. As of July 31, 2017, 2016 and 2015, the Company had recorded liabilities for increases (decreases) in interest expense related to uncertain tax positions in the amount of ($168,000), $40,000 and $48,000, respectively. The Company did not accrue for penalties related to income tax positions as there were no income tax positions that required the Company to accrue penalties. The Company does not expect that any unrecognized tax benefits will reverse in the next twelve months.