10. Income Taxes
The provision for income taxes on loss from continuing operations for fiscal 2017, 2016 and 2015 consists of the following (in thousands):
| 2017 | 2016 | 2015 | ||||||||||
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Federal: |
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Current |
$ | — | $ | — | $ | — | ||||||
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Deferred |
— | — | — | |||||||||
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| — | — | — | ||||||||||
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State: |
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Current |
13 | 5 | 6 | |||||||||
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Deferred |
— | — | — | |||||||||
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| 13 | 5 | 6 | ||||||||||
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Foreign: |
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Current |
1,091 | 237 | 561 | |||||||||
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Deferred |
(1 | ) | 9 | (12 | ) | |||||||
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| 1,090 | 246 | 549 | ||||||||||
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Total |
$ | 1,103 | $ | 251 | $ | 555 | ||||||
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Income (loss) before income taxes for fiscal 2017, 2016 and 2015 consisted of the following (in thousands):
| 2017 | 2016 | 2015 | ||||||||||
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U.S |
$ | (794 | ) | $ | (8,703 | ) | $ | (9,538 | ) | |||
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Foreign |
6,015 | 1,513 | 927 | |||||||||
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| $ | 5,221 | $ | (7,190 | ) | $ | (8,611 | ) | |||||
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Effective tax rate |
21.1 | % | (3.5 | )% | (6.4 | )% | ||||||
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Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts for income tax purposes. Significant components of deferred tax assets are as follows (in thousands):
| December 30, 2017 |
December 31, 2016 |
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Deferred tax assets: |
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Vacation, warranty and other accruals |
$ | 601 | $ | 926 | ||||
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Depreciation and amortization |
91 | 600 | ||||||
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Intangible amortization |
1,071 | 2,060 | ||||||
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Inventory valuation |
1,341 | 3,091 | ||||||
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Deferred income |
22 | 29 | ||||||
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Equity-based compensation |
2,636 | 3,821 | ||||||
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Net operating loss, research and other tax credit carryforwards |
52,882 | 54,844 | ||||||
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Other |
543 | 918 | ||||||
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| 59,187 | 66,289 | |||||||
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Valuation allowance for deferred tax assets |
(58,455 | ) | (65,189 | ) | ||||
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Total deferred tax assets |
732 | 1,100 | ||||||
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Deferred tax liabilities: |
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Purchased technology |
(307 | ) | (720 | ) | ||||
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Unbilled revenue |
(421 | ) | (377 | ) | ||||
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Total deferred tax liabilities |
(728 | ) | (1,097 | ) | ||||
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Net deferred tax assets |
$ | 4 | $ | 3 | ||||
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As reported on the balance sheet: |
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Non-current deferred tax assets |
$ | 4 | $ | 3 | ||||
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Intevac accounts for income taxes in accordance with accounting standards for such taxes, which requires that deferred tax assets and liabilities be recognized using enacted tax rates for the effect of temporary differences between the financial reporting and tax bases of recorded assets and liabilities.
Accounting standards also require that deferred tax assets be reduced by a valuation allowance if it is more likely than not that some portion of or all of the deferred tax asset will not be realized. Management assesses the available positive and negative evidence to estimate if sufficient future taxable income will be generated to use the existing deferred tax assets. In fiscal 2014, a valuation allowance of $9.4 million was established to record the portion of the Singapore deferred tax asset that more likely than not will not be realized. The Company recorded valuation allowance decreases of $603,000 for fiscal 2017 and $136,000 for fiscal 2016, respectively, for the Singapore deferred tax asset. The Company recorded a valuation allowance increase of $631,000 for fiscal 2015 for the Singapore deferred tax asset.
In fiscal 2012, a valuation allowance of $23.4 million was established to record the portion of the U.S. federal deferred tax asset that more likely than not will not be realized. For fiscal 2017, a valuation allowance decrease of $6.9 million for the U.S. federal deferred tax asset was recorded. This decrease was a result of revaluing our deferred tax assets and liabilities at the newly enacted U.S federal tax rate. For fiscal 2016, 2015, 2014 and 2013, valuation allowance increases of $3.3 million, $1.6 million, $4.7 million and $7.2 million, respectively, for the U.S. federal deferred tax asset were recorded. A valuation allowance is recorded against the entire state deferred tax asset which consists of state income tax temporary differences and deferred research and other tax credits that are not realizable in the foreseeable future.
The amount of the deferred tax asset considered realizable, however, could be adjusted if estimates of future taxable income during the carryforward period are reduced or increased, or if objective negative evidence in the form of cumulative losses is no longer present and additional weight may be given to subjective evidence such as our projections for growth.
As of December 30, 2017, our federal, foreign and state net operating loss carryforwards for income tax purposes were approximately $65.1 million, $54.8 million and $56.2 million, respectively. The federal and state net operating loss carryforwards are subject to various limitations under Section 382 of the Internal Revenue Code and applicable state tax laws. If not utilized, the federal net operating loss carryforwards and the state net operating loss carryforwards will begin to expire in 2028. The foreign net operating loss carryforwards do not expire. As of December 30, 2017, our federal and state tax credit carryforwards for income tax purposes were approximately $15.5 million and $14.3 million, respectively. If not utilized, the federal tax credit carryforwards will begin to expire in 2019 and the state tax credits carry forward indefinitely.
The Tax Cuts and Jobs Act (“the Act”) was enacted on December 22, 2017. The Act reduces the U.S. federal corporate tax rate from 35% to 21%, requires companies to pay a one-time transition tax on earnings of certain foreign subsidiaries that were previously tax deferred and creates new taxes on certain foreign sourced earnings. At December 30, 2017, we have not completed our accounting for the tax effects of enactment of the Act; however, in certain cases, as described below, we have made a reasonable estimate of the effects on our existing deferred tax balances and the one-time transition tax. In other cases, we have not been able to make a reasonable estimate and continue to account for those items based on our existing accounting under ASC 740, Income Taxes. For the items for which we were able to determine a reasonable estimate, we recognized a provisional amount of $1.8 million, which is included as a component of income tax expense from continuing operations and fully offset by the current operating loss.
Deferred tax assets and liabilities: We re-measured certain deferred tax assets and liabilities based on the rates at which they are expected to reverse in the future, which is generally 21%. However, we are still analyzing certain aspects of the Act and refining our calculations, which could potentially affect the measurement of these balances or potentially give rise to new deferred tax amounts. The provisional amount recorded related to the re-measurement of our deferred tax balance was $9.2 million.
Foreign tax effects: The one-time transition tax is based on our total post-1986 earnings and profits (“E&P”) for which we have previously deferred from U.S. income taxes. We recorded a provisional amount for our one-time transition tax liability for seven of our foreign subsidiaries, resulting in no increase in income tax expense due to current losses. We have not yet completed our calculation of the total post-1986 foreign E&P for these foreign subsidiaries. Further, the transition tax is based in part on the amount of those earnings held in cash and other specified assets. This amount may change when we finalize the calculation of post-1986 foreign E&P previously deferred from U.S. federal taxation and finalize the amounts held in cash or other specified assets. No additional income taxes have been provided for any remaining undistributed foreign earnings not subject to the transition tax and any additional outside basis difference inherent in these entities as these amounts continue to be indefinitely reinvested in foreign operations. The Company did not have the necessary information prepared or analyzed to develop a reasonable estimate of the tax liability, if any, for its remaining outside basis difference including any deferred tax accounting that may be required due to other provisions in the Act beyond the one-time transition tax, including how that accounting may be affected by the Company’s ongoing accounting position to indefinitely reinvest unremitted foreign earnings.
The difference between the tax provision (benefit) at the statutory federal income tax rate and the tax provision (benefit) for fiscal 2017, 2016 and 2015 was as follows (in thousands):
| 2017 | 2016 | 2015 | ||||||||||
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Income tax (benefit) at the federal statutory rate |
$ | 1,827 | $ | (2,517 | ) | $ | (3,014 | ) | ||||
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State income taxes, net of federal benefit |
13 | 5 | 6 | |||||||||
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Change in valuation allowance: |
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U.S |
(6,873 | ) | 3,333 | 1,625 | ||||||||
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Foreign |
(603 | ) | (136 | ) | 631 | |||||||
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Effect of foreign operations taxed at various rates |
(1,036 | ) | (232 | ) | (140 | ) | ||||||
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Research tax credits |
(2,267 | ) | (1,058 | ) | (931 | ) | ||||||
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Change in federal tax rate |
9,201 | — | — | |||||||||
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Effect of tax rate changes, permanent differences and adjustments of prior deferrals |
639 | 1,137 | 2,114 | |||||||||
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Unrecognized tax benefits |
202 | (281 | ) | 264 | ||||||||
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Total |
$ | 1,103 | $ | 251 | $ | 555 | ||||||
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Intevac has not provided for foreign withholding taxes on approximately $1.2 million of undistributed earnings from non-U.S. operations as of December 30, 2017 because Intevac intends to reinvest such earnings indefinitely outside of the United States. If Intevac were to distribute these earnings, foreign withholding tax would be payable. Intevac will remit the non-indefinitely reinvested earnings, if any, of Intevac’s non-U.S. subsidiaries where excess cash has accumulated and Intevac determines that it is advantageous for business operations, tax or cash reasons.
The total amount of gross unrecognized tax benefits was $5.7 million as of December 30, 2017, of which $73,000 would affect Intevac’s effective tax rate if realized. The aggregate changes in the balance of gross unrecognized tax benefits were as follows for fiscal 2017, 2016 and 2015:
| 2017 | 2016 | 2015 | ||||||||||
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Beginning balance |
$ | 7,544 | $ | 7,173 | $ | 6,578 | ||||||
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Additions based on tax positions related to the current year |
898 | 652 | 574 | |||||||||
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Additions for tax positions of prior years |
— | — | 21 | |||||||||
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Settlements |
— | (281 | ) | — | ||||||||
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Change in federal tax rate |
(2,764 | ) | — | — | ||||||||
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Lapse of statute of limitations |
— | — | — | |||||||||
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Ending balance |
$ | 5,678 | $ | 7,544 | $ | 7,173 | ||||||
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The Company does not anticipate any changes in the amount of unrecognized tax benefits in the next twelve months. It is Intevac’s policy to include interest and penalties related to unrecognized tax benefits in the provision for income taxes on the consolidated statements of operations. During fiscal 2017, 2016 and 2015, Intevac recognized a net tax expense (benefit) for interest of $2,000, ($1,000) and $2,000, respectively. As of December 30, 2017 Intevac had $11,000 of accrued interest related to unrecognized tax benefits, which was classified as a long-term liability in the consolidated balance sheets. Intevac did not accrue any penalties related to these unrecognized tax benefits because Intevac has other tax attributes which would offset any potential taxes due.
Intevac is subject to income taxes in the U.S. federal jurisdiction, and various state and foreign jurisdictions. Tax regulations within each jurisdiction are subject to the interpretation of the related tax laws and regulations and require significant judgment to apply. The material jurisdictions where Intevac is subject to potential examination by tax authorities for tax years after 2009 include the U.S. (Federal and California) and Singapore.
The Inland Revenue Authority of Singapore (“IRAS”) is currently conducting a review of the fiscal 2009 through 2012 tax returns of the Company’s wholly-owned subsidiary, Intevac Asia Pte. Ltd. IRAS has challenged the Company’s tax position with respect to certain aspects of the Company’s transfer pricing. Under Singapore tax law, the Company must pay all contested taxes and the related interest to have the right to defend its position. As a result, the Company made deposits of $318,000 for the 2009 tax year in fiscal 2014 and $1.1 million for the 2010 tax year in fiscal 2015, respectively. In fiscal 2016, IRAS allowed the deduction of a portion of the challenged deductions and the Company received a partial refund of $517,000 of the contested taxes. Accordingly, the Company derecognized a portion of the tax accrual of approximately $281,000 by reducing the income tax provision by $281,000. The contested tax deposits of $743,000 and $871,000 are included in other long-term assets at December 30, 2017 and December 31, 2016, respectively, on the consolidated balance sheets. The ultimate outcome of this examination is subject to uncertainty. The Company’s management and its advisors continue to believe that the Company is “more likely than not” to successfully defend that the tax treatment was proper and in accordance with Singapore tax regulations. Based on the information currently available, the Company does not anticipate a significant increase or decrease to its unrecognized tax benefits for this matter within the next twelve months. We believe that adequate amounts have been reserved for any adjustments that may ultimately result from this or other examinations. Presently, there are no other active income tax examinations in the jurisdictions where Intevac operates.