10. Income taxes
The Company’s pre-tax loss by jurisdiction consisted of the following (in thousands):
| December 31, | ||||||||||||
| 2017 | 2016 | 2015 | ||||||||||
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U.S. |
$ | (71,698 | ) | $ | (66,215 | ) | $ | (95,860 | ) | |||
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Foreign |
(87,189 | ) | (73,896 | ) | (24,626 | ) | ||||||
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Total |
$ | (158,887 | ) | $ | (140,111 | ) | $ | (120,486 | ) | |||
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The Tax Cuts and Jobs Act, or the Act, was enacted on December 22, 2017, which reduced the U.S. federal corporate tax rate from 35% to 21%, among other changes. The Company’s accounting for the elements of the Act is complete and resulted in a $114.8 million reduction in its net deferred tax assets as of December 31, 2017 to reflect the new statutory rate. The rate adjustment to the deferred tax assets was fully offset by a decrease in the valuation allowance, resulting in no rate impact to the Company.
A reconciliation of the federal statutory income tax rate to the effective income tax rate is as follows:
| Years ended December 31, | ||||||||||||
| 2017 | 2016 | 2015 | ||||||||||
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Statutory federal income tax rate |
(35 | %) | (35 | %) | (35 | %) | ||||||
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Tax credits |
(11 | ) | (25 | ) | (13 | ) | ||||||
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Foreign rate differential |
14 | 16 | 5 | |||||||||
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State income taxes and other |
(6 | ) | 4 | 2 | ||||||||
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Valuation allowance |
(55 | ) | 40 | 41 | ||||||||
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Impact of the Act |
72 | — | — | |||||||||
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Effective tax rate, before impact in other comprehensive income |
(21 | ) | 0 | 0 | ||||||||
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Impact in other comprehensive income |
21 | — | — | |||||||||
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Effective tax rate, after impact in other comprehensive income |
0 | % | 0 | % | 0 | % | ||||||
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The Company recorded an income tax benefit of $33.4 million due to unrealized gains on the Company’s common stock investment in Immunomedics, which was offset by an income tax provision for the same amount in other comprehensive income. The deferred tax liability related to the unrealized gain on the common stock investment in Immunomedics was recorded through other comprehensive income, which enabled the Company to recognize a benefit for the U.S. during 2017.
The foreign rate differential in the table above reflects the effect of operations in jurisdictions with tax rates that differ from the rate in the United States. This primarily resulted from the Company’s operations in Switzerland, which began in 2015. At December 31, 2017, unremitted earnings of the Company’s foreign subsidiaries, which were insignificant, will be retained indefinitely by the foreign subsidiaries for continuing investment. If foreign earnings were to be repatriated to the United States, the Company could be subject to additional state income and withholding taxes.
The Company’s net deferred tax assets consisted of the following (in thousands):
| December 31, | ||||||||
| 2017 | 2016 | |||||||
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Deferred tax assets |
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Net operating loss carryforwards |
$ | 158,951 | $ | 150,465 | ||||
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Foreign net operating loss carryforwards |
2,651 | 1,702 | ||||||
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Tax credit carryforwards |
148,027 | 124,396 | ||||||
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Deferred revenue |
13,779 | 30,731 | ||||||
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Share-based compensation |
26,454 | 33,041 | ||||||
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Capitalized research and development |
17,150 | 12,578 | ||||||
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Depreciation and amortization |
7,606 | 8,970 | ||||||
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Other |
15,178 | 19,468 | ||||||
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Total deferred tax assets |
389,796 | 381,351 | ||||||
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Less: valuation allowance |
(364,538 | ) | (381,351 | ) | ||||
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Total deferred tax assets, net of valuation allowance |
25,258 | — | ||||||
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Deferred tax liability |
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Unrealized gain on available-for-sale securities |
(25,258 | ) | — | |||||
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Net deferred tax assets (liability) |
$ | — | $ | — | ||||
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The Company’s deferred tax assets primarily consist of net operating loss, or NOL, carryforwards, tax credit carryforwards, share-based compensation, capitalized research and development expense and deferred revenue. Realization of deferred tax assets is dependent upon a number of factors, including future earnings, the timing and amount of which is uncertain. Accordingly, the deferred tax assets have been fully offset by a valuation allowance. At December 31, 2017, the Company had gross federal NOL carryforwards of $666.3 million expiring from 2021 to 2037 if not utilized, gross state NOL carryforwards of $287.9 million, gross foreign NOL carryforwards of $29.7 million and tax credit carryforwards of $166.2 million expiring from 2021 to 2037.
Utilization of the NOL and tax credit carryforwards may be subject to a substantial annual limitation in the event of a change in ownership as set forth in Section 382 of the Internal Revenue Code of 1986, as amended. The Company has evaluated ownership changes through the year ended December 31, 2016 and believes that it is likely that utilization of its NOLs would not be limited under Section 382 as of December 31, 2016. It is possible that there has been or may be a change in ownership after this date, which would limit the Company’s ability to utilize its NOLs. Any limitation may result in the expiration of the NOLs and tax credit carryforwards before utilization.
In 2017, the Company adopted Accounting Standards Update entitled “ASU 2016-09, Compensation – Stock Compensation.” As a result, the net operating loss deferred tax asset increased by $70.9 million as a result of the inclusion of the net operating losses related to excess tax benefits. The increase in the deferred tax asset has been offset by a full valuation allowance.
The valuation allowance decreased by $16.8 million in 2017, and increased by $59.2 million in 2016 and $4.5 million in 2015, all related to the changes in the Company’s deferred tax asset balances. The decrease in the valuation allowance in 2017 included the $114.8 million decrease to reflect the new statutory rate and the $33.4 million decrease related to the unrealized gain on the Immunomedics common stock investment recorded through other comprehensive income, offset by the $70.9 million increase in connection with the adoption of ASU 2016-09 and a $60.5 million increase for the current year loss, tax credits and other activity.
The financial statement recognition of the benefit for a tax position is dependent upon the benefit being more likely than not to be sustainable upon audit by the applicable taxing authority. If this threshold is met, the tax benefit is then measured and recognized at the largest amount that is greater than 50% likely of being realized upon ultimate settlement. A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows (in thousands):
| Years ended December 31, | ||||||||||||
| 2017 | 2016 | 2015 | ||||||||||
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Balance at January 1 |
$ | 16,023 | $ | 0 | $ | 0 | ||||||
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Increase (decrease) related to prior year tax positions |
(1,292 | ) | 12,631 | 0 | ||||||||
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Increase related to current year tax positions |
3,441 | 3,392 | 0 | |||||||||
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Lapses of statute of limitations |
0 | 0 | 0 | |||||||||
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Balance at December 31 |
$ | 18,172 | $ | 16,023 | $ | 0 | ||||||
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The Company does not anticipate any significant changes to its unrecognized tax positions or benefits during the next twelve months. Interest and penalties related to the settlement of uncertain tax positions, if any, will be reflected in income tax expense. Tax years 2001 to 2017 remain subject to future examination for federal income taxes.