Vanda Pharmaceuticals Inc.

12. Income Taxes

The Company recorded total tax expense of $0.1 million on consolidated pretax loss of $15.4 million, consisting of $15.7 million of pretax loss in the U.S. and $0.3 million of pretax income from foreign subsidiaries for the year ended December 31, 2017. The Company recorded total tax expense of $0.1 million on consolidated pretax loss of $17.9 million, consisting of $18.1 million of pretax loss in the U.S. and $0.2 million of pretax income from foreign subsidiaries for the year ended December 31, 2016. The following is a summary of the provision (benefit) for income taxes for the years ended December 31, 2017, 2016 and 2015:


	Year Ended December 31,
*(in thousands)*	2017			2016			2015
Current:
Federal	$	—		$	—		$	—
State		65			66			—
Foreign		(66	)		142
Deferred:
Federal		—			—			—
State		—			—
Foreign		137			(104	)		—

Provision for income taxes	$	136		$	104		$	—

Deferred tax assets are reduce by a tax valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized. The fact that the Company has historically generated pretax losses in the U.S. serves as strong evidence that it is more likely than not that deferred tax assets in the U.S. will not be realized in the future. Therefore, the Company had a full tax valuation allowance against all deferred tax assets in the U.S. as of December 31, 2017 and 2016. As a result of the tax valuation allowance against deferred tax assets in the U.S., there was no benefit for income taxes associated with the loss before income taxes for each of the years ended December 31, 2017, 2016 and 2015. The following is reconciliation between the federal statutory tax rate and the Company’s effective tax rate for the years ended December 31, 2017, 2016 and 2015:


	Year Ended December 31,
	2017			2016			2015
Federal tax at statutory rate		35.0	%		35.0	%		35.0	%
State taxes		1.7	%		0.8	%		-0.1	%
The U.S. Tax Cuts and Job Act (1)		-262.6	%		0.0	%		0.0	%
Change in valuation allowance - U.S. Tax Cuts and Jobs Act		262.6	%		0.0	%		0.0	%
Other change in valuation allowance		-47.8	%		-38.4	%		-25.4	%
Research and development credit		9.0	%		3.8	%		1.5	%
Orphan drug credit		6.3	%		7.6	%		1.6	%
Section 162(m) limitation		8.1	%		0.0	%		-5.7	%
Other tax rate changes		-2.6	%		3.9	%		-0.3	%
Change in state NOLs		5.1	%		0.0	%		-1.4	%
Stock-based compensation		-13.0	%		-12.5	%		-5.1	%
Other items		-2.7	%		-0.8	%		-0.1	%

Effective tax rate		-0.9	%		-0.6	%		0.0	%

(1)	The effective tax rate for the year ended December 31, 2017 includes the estimate of the effect of the U.S. Tax Cuts and Jobs Act, which primarily relates to the remeasurement of existing deferred taxes as a result of the change to the U.S. federal tax rate.

The following is a summary of the components of the Company’s deferred tax assets, net, and the related tax valuation allowance as of December 31, 2017 and 2016:


	December 31,
*(in thousands)*	2017			2016
Deferred tax assets:
Net operating loss carryforwards	$	59,222		$	84,177
Stock-based compensation		5,383			12,443
Accrued and deferred expenses		1,967			2,558
Research and development and orphan drug credit carryforwards		43,976			41,104
Intangible assets		3,745			5,477
Other		2,174			1,019

Total deferred tax assets		116,467			146,778
Deferred tax liabilities:
Other		(386	)		(666	)

Total deferred tax liabilities		(386	)		(666	)
Deferred tax assets, net		116,081			146,112
Valuation allowance		116,110			146,012

Net deferred tax assets (liabilities)	$	(29	)	$	100

The Company’s net deferred tax liability of less than $0.1 million as of December 31, 2017 is included as a component of other non-current liabilities. The Company’s net deferred tax asset of $0.1 million as of December 31, 2016 is included as a component of non-current inventory and other in the consolidated balance sheet.

The following is a summary of changes in the Company’s tax valuation allowance for the years ended December 31, 2017, 2016 and 2015:


	Balance at							Balance at
	Beginning							End of
*(in thousands)*	of Year		Additions		Reductions			Year
Year Ended:
December 31, 2017	$	146,012	$	12,403	$	(42,305	)	$	116,110
December 31, 2016		139,037		11,031		(4,056	)		146,012
December 31, 2015		128,890		17,002		(6,855	)		139,037

The Company has net operating loss (NOL) and other tax credit carryforwards in several jurisdictions. As of December 31, 2017, the Company has $49 million of deferred tax assets relating to U.S. federal NOL carryforwards, along with deferred tax assets of $9 million and $35 million related to U.S. federal research and development credits and orphan drug credits, respectively. These tax attributes will begin to expire in 2028, 2024 and 2030, respectively. In addition, the Company has $10 million of deferred tax assets relating to U.S. state NOL carryforwards, which primarily relate to the District of Columbia. State NOLs for the District of Columbia will begin to expire in 2031 and other state NOLs will begin to expire in 2018. A valuation allowance is recorded against these U.S. federal and U.S. state deferred tax assets.

Because the Company has generated NOLs from inception through December, 31, 2017, all income tax returns filed by the Company are open to examination by tax jurisdictions. As of December 31, 2017, the Company’s income tax returns had not been under examination by any federal or state tax jurisdictions. As of December 31, 2017 and 2016, the Company had no uncertain tax positions.

Certain tax attributes of the Company, including NOLs and credits, would be subject to a limitation should an ownership change as defined under the Internal Revenue Code of 1986, as amended (IRC), Section 382, occur. The limitations resulting from a change in ownership could affect the Company’s ability to utilize its NOLs and credit carryforward (tax attributes). Ownership changes occurred in the years ending December 31, 2014 and December 31, 2008. The Company believes that the ownership changes in 2014 and 2008 will not impact its ability to utilize NOL and credit carryforwards; however, future ownership changes may cause the Company’s existing tax attributes to have additional limitations. Because the Company maintains a valuation allowance on its U.S. tax attributes, any limitation as a result of application of IRC Section 382 limitation would not have a material impact on the Company’s provision for income taxes for the year ended December 31, 2017.

The Tax Cuts and Jobs Act (TCJA) was enacted in December 2017. The TCJA 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 deferred and creates new taxes on certain foreign sourced earnings. At December 31, 2017, the Company has not completed our accounting for the tax effects of the TCJA. Certain U.S. federal deferred tax assets and liabilities were remeasured based on the rates at which they are expected to reverse in the future, which is generally 21%. However, the Company is still analyzing certain aspects of the U.S. international and executive compensation provisions of the TCJA and refining our calculations, which could potentially affect the measurement of these balances or potentially give rise to new deferred tax amounts. Because the Company has recorded a valuation allowance against deferred tax assets in the U.S., future adjustments recorded as we complete our analysis will not have a material impact to our net deferred tax asset or liability.