| 8. | INCOME TAXES: |
Income before income tax expense consists of the following:
| Years Ended December 31, | ||||||||||||
| 2017 | 2016 | 2015 | ||||||||||
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United States |
$ | 2,270 | $ | 18,492 | $ | 5,302 | ||||||
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Canada |
38,762 | 1,831 | 3,530 | |||||||||
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| $ | 41,032 | $ | 20,323 | $ | 8,832 | |||||||
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The components of income tax expense are as follows:
| Years Ended December 31, | ||||||||||||
| 2017 | 2016 | 2015 | ||||||||||
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Current |
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Federal |
$ | — | $ | — | $ | — | ||||||
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State |
— | 250 | — | |||||||||
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Canada |
10,733 | 882 | 617 | |||||||||
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| 10,733 | 1,132 | 617 | ||||||||||
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Deferred |
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Federal |
10,297 | 6,508 | 1,511 | |||||||||
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State |
(827 | ) | 569 | 311 | ||||||||
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Canada |
(649 | ) | (529 | ) | 48 | |||||||
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| 8,821 | 6,548 | 1,870 | ||||||||||
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Decrease in valuation allowance |
(9,470 | ) | (7,077 | ) | (1,822 | ) | ||||||
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| (649 | ) | (529 | ) | 48 | ||||||||
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Total income tax expense |
$ | 10,084 | $ | 603 | $ | 665 | ||||||
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For the years ended December 31, 2017, 2016, and 2015 we recorded foreign income tax expense of $10,084, $353, and $665, respectively.
The Tax Cuts and Jobs Act
On December 22, 2017, the U.S. enacted the Tax Cuts and Jobs Act (“Tax Act”) that instituted fundamental changes to the taxation on multinational corporations. Although the Tax Act is generally effective January 1, 2018, U.S. generally accepted accounting principles requires recognition of the tax effects of new legislation during the reporting period that includes the enactment date, which was December 22, 2017. Among the numerous provisions, the Tax Act includes two provisions in particular which require consideration for 2017 financial reporting: a permanent reduction in the corporate tax rate to 21%; and a one-time transition tax imposed on a U.S. shareholder’s historical undistributed earnings of foreign affiliates.
The reduction in the U.S. corporate tax rate to 21% is effective in 2018. However, this change results in a re-measurement of our net deferred tax balance at the end of 2017 with no net financial statement impact due to a comparable decrease in our deferred tax valuation allowance.
The one-time tax on undistributed and previously untaxed post-1986 foreign earnings and profits (E&P) of foreign affiliates owned by U.S. shareholders as of December 31, 2017 was analyzed for our Canadian subsidiary. As of December 31, 2017, our U.S. federal taxable loss exceeded and offset the provisional mandatory repatriation net inclusion and as such, no additional taxes will be due as a result of the deemed repatriation of these foreign earnings.
In addition, the Tax Act also includes changes to the taxation of foreign earnings by implementing a dividend exemption system, expansion of the current anti-deferral rules, a minimum tax on low-taxed foreign earnings and new measures to deter base erosion and promote U.S. production. The Tax Act also includes repeal of the corporate alternative minimum tax, expensing of capital investment, changes to the Federal net operating loss (“NOL”) utilization and carryforward rules, and limitations of the deduction for interest expense and certain employee compensation.
As a result of the complex impact of the Tax Act, the SEC provided guidance under Staff Accounting Bulletin No. 118 (“SAB 118”) that allows the Company to record provisional amounts as of December 31, 2017 for the impact of the Tax Act, provided that the provisional amounts can be reasonably determined and with the requirement that the final accounting be completed in a period not to exceed one year from the date of enactment. As of December 31, 2017, the Company has not completed the accounting for the tax effects of the Tax Act, and therefore, has recorded provisional amounts which include:
| (a) | An estimate of the impact of the one-time transition tax on existing net operating loss and foreign tax credit carryforwards generated, as well as the related offsetting valuation allowances. These results are subject to change as there is limited information for federal and state taxing authorities regarding the application and interpretation of the recently enacted legislation. In addition, the results are based on estimates and are affected by the interaction of various provision of the Tax Act on future taxable income. The Company will disclose the impact to the provisional amount in the reporting period in which the accounting is completed, which will not exceed one year from the date of the enactment. |
| (b) | The valuation allowance for the Company’s deferred tax assets as of December 31, 2017, is primarily dependent on forecasted future taxable income in the U.S. and Canada and may be impacted by the provisions of the Tax Act. Any increase or reduction in estimated forecasted future taxable income may require the Company to adjust the valuation allowance against the remaining deferred tax asset. The Company will continue to assess the impact of the Tax Act on the valuation allowance during the provisional period. |
The Tax Act imposes a U.S. tax on global intangible low taxed income (“GILTI”) that is earned by certain foreign affiliates owned by a U.S. shareholder effective in 2018. GILTI is generally intended to impose tax on the earnings of a foreign corporation that are deemed to exceed a certain threshold return relative to the underlying tangible property. The computation of GILTI is still subject to interpretation and additional clarifying guidance is expected. The Company has not yet made a policy election related to its treatment of GILTI as either a current period expense in the reporting period in which the tax is incurred or recognizing deferred taxes when a basis differences exists that is expected to affect the amount of the GILTI inclusion upon reversal. The Company is still in the process of analyzing the expected impact of GILTI in future periods.
A reconciliation of the statutory United States federal income tax rate to our effective tax rate for each of the years ended December 31, 2017, 2016, and 2015 is as follows:
| 2017 | 2016 | 2015 | ||||||||||
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Statutory U.S. federal income tax rate |
34.0 | % | 34.0 | % | 34.0 | % | ||||||
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Deemed repatriation tax |
7.8 | — | — | |||||||||
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Statutory rate change, deferred tax impact |
29.4 | — | — | |||||||||
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Excess tax benefits for share-based payment awards |
(16.0 | ) | — | — | ||||||||
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Tax effect of Canadian items |
(9.8 | ) | (4.9 | ) | (13.1 | ) | ||||||
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State income taxes, net of federal benefit |
(1.1 | ) | 2.0 | 1.5 | ||||||||
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Nondeductible expenses and other |
3.4 | 6.7 | 5.7 | |||||||||
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Change in valuation allowance, federal and state |
(23.1 | ) | (34.8 | ) | (20.6 | ) | ||||||
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Effective tax rate |
24.6 | % | 3.0 | % | 7.5 | % | ||||||
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Deferred income taxes reflect the tax effects of temporary differences between the basis of assets and liabilities recognized for financial reporting purposes and tax purposes, and net operating loss and tax credit carryforwards. Significant components of our deferred tax assets (liabilities) as of December 31, 2017 and 2016 are as follows:
| 2017 | 2016 | |||||||
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Deferred tax assets (liabilities): |
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Net operating loss carryforwards |
$ | 15,338 | $ | 17,673 | ||||
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Inventories |
1,179 | 1,680 | ||||||
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Capitalized research and development costs |
2,402 | 4,711 | ||||||
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Accruals and reserves currently not deductible |
3,103 | 3,282 | ||||||
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Acquired intangible assets |
(1,825 | ) | (2,268 | ) | ||||
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Depreciation and amortization |
(621 | ) | (212 | ) | ||||
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Stock-based compensation |
976 | 6,110 | ||||||
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Tax credit carryforwards |
6,722 | 1,751 | ||||||
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Net deferred tax asset |
27,274 | 32,727 | ||||||
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Valuation allowance |
(29,225 | ) | (35,173 | ) | ||||
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Net deferred tax liability |
$ | (1,951 | ) | $ | (2,446 | ) | ||
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In assessing the realizability of our deferred tax asset, we consider all relevant positive and negative evidence in determining whether it is more likely than not that some portion or all of the deferred income tax assets will not be realized. The realization of the gross deferred tax assets is dependent upon several factors, including the generation of sufficient taxable income prior to the expiration of the NOL carryforwards. In 2008, we established a full valuation allowance against our U.S. deferred tax asset, and management believes the full valuation allowance is still appropriate as of December 31, 2017 and 2016 since the facts and circumstances necessitating the allowance have not changed. As a result, no U.S. federal income tax benefit was recorded for the years ended December 31, 2017, 2016, or 2015. The valuation allowance primarily decreased by $9,470 in 2017 due to its re-measurement to the new corporate tax rate of 21% effective in 2018.
Our Federal NOL carryforwards expire as follows:
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Year of Expiration |
NOLs | |||
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2020 - 2025 |
$ | 16,268 | ||
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2026 - 2030 |
11,956 | |||
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2031 - 2037 |
37,937 | |||
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| $ | 66,161 | |||
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The new accounting guidance under ASU 2016-09 allows for the recognition of excess tax benefits associated with stock based compensation awards regardless of whether the deduction reduces taxes payable. On January 1, 2017, we recorded a cumulative adjustment to retained earnings of $3,391 to recognize the increase in our net operating loss carryforwards from the cumulative excess tax benefits not recognized in periods prior to January 1, 2017. A corresponding $3,391 increase to our valuation allowance associated with this tax benefit was also recorded to retained earnings thereby resulting in no impact to retained earnings.
The Tax Reform Act of 1986 contains provisions under Internal Revenue Code (“IRC”) Section 382 that limit the annual amount of federal and state NOL carryforwards that can be used in any given year in the event a significant change in ownership. The Company does not believe that there is a Section 382 limitation that will impair our future ability to utilize NOLs to offset our future taxable income. The Company continues to review ownership changes on an annual basis and we do not believe we have had a subsequent ownership change that would impact the NOLs.
Effective January 1, 2018, there is a transition to a participation exemption system whereby distributions from foreign subsidiaries to U.S. shareholders are generally exempt from taxation; therefore, the deferred tax liability on undistributed earnings is limited to any foreign withholding or other local taxes. The Company’s intention is to continue to permanently reinvest the historical undistributed earnings of our Canadian subsidiary to the extent that we will not incur any additional tax expense associated with foreign withholding or other local tax expense on the future cash transfers.
As of December 31, 2017, our gross unrecognized tax benefits totaled $1,663, and based upon the valuation allowance for our U.S. operations, the recognition of any tax benefit would not impact our effective tax rate. We record interest and penalties related to unrecognized tax benefits as a component of income tax expense. Interest and penalties were immaterial in 2017, 2016 and 2015. As a result of our net operating loss carryforward position, we are subject to audit by the Internal Revenue Service since our inception, as well as by several state jurisdictions for the years ended September 30, 1998 through December 31, 2017.
A reconciliation of our unrecognized tax benefits is as follows:
| 2017 | 2016 | 2015 | ||||||||||
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Balance as of January 1 |
$ | 2,084 | $ | 2,088 | $ | 2,073 | ||||||
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Additions for tax positions of prior periods |
— | — | 22 | |||||||||
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Reductions for tax positions of prior periods |
(421 | ) | (4 | ) | (7 | ) | ||||||
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Balance as of December 31 |
$ | 1,663 | $ | 2,084 | $ | 2,088 | ||||||
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