12. Income Taxes
The Company is subject to income taxes in the United States and Israel. In general, the U.S. federal and state income tax returns remain open to examination by taxing authorities for tax years beginning in June 30, 2014 to present. The Israeli income tax returns remain open to examination beginning in 2013 to present. However, if and when the Company claims net operating loss (“NOL”) carryforwards from any prior years against future taxable income, those losses may be examined by the taxing authorities.
The United States enacted the Tax Cuts and Jobs Act (“Tax Act”) on December 22, 2017, most provisions of which will take effect starting in years beginning after December 31, 2017. The Tax Act makes substantial changes to U.S. taxation of corporations, including lowering the U.S. federal corporate income tax rate from 34% to 21%. The effect on deferred tax assets and liabilities of a change in law or tax rates is recognized in income in the period that includes the enactment date. The Tax Act also includes a provision designed to currently tax global intangible low-taxed income (“GILTI”). The Company will record the U.S. income tax effect of future GILTI inclusions in the period in which they arise, if ever.
After the enactment of the Tax Act, the SEC issued Staff Accounting Bulletin No. 118 (“SAB 118”) to address the application of U.S. GAAP in situations when a registrant does not have the necessary information available, prepared, or analyzed (including computations) in reasonable detail to complete the accounting for certain income tax effects of the Tax Act. We have calculated an estimate of the impact of the Tax Act in our year-end income tax provision in accordance with our understanding of the Tax Act and guidance available as of the date of this filing. The provisional amount related to the remeasurement of our net U.S. deferred tax asset, based on the rate at which they are now expected to reverse in the future, was deferred tax expense of $10.2 million, but which was fully and equally offset by a corresponding reduction in our valuation allowance. The effect of the change in federal corporate tax rate from 34% to 21% is subject to change based on resolution of estimates used in determining the amounts of deferred tax assets and liabilities that were remeasured. The Company will reflect any adjustments to the provisional amounts in the period the accounting is completed and expects to complete this analysis within the one-year measurement period provided by SAB 118.
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 used for income tax purposes. A deferred tax liability or asset shall be recognized for all of the Company’s estimated future tax effects attributable to temporary differences and carryforwards, unless an exception applies. A common exception for businesses that operate in multiple jurisdictions is a temporary difference that is essentially permanent in duration related to the excess of the amount for financial reporting over the tax basis of an investment attributable to unremitted earnings in a foreign subsidiary. However, there are no or trivial unremitted earnings in foreign jurisdictions, so no provision for deferred taxes thereupon is required for the Company.
Significant components of the Company’s deferred tax assets are as follows (in thousands):
| December 31, | ||||||||
| 2017 | 2016 | |||||||
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Deferred tax assets: |
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Net operation loss carryforward |
$ | 23,689 | $ | 2,811 | ||||
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Stock-based compensation |
1,125 | — | ||||||
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Reserves and allowances |
11 | 17 | ||||||
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U.S. tax credits and other |
714 | — | ||||||
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Research and development |
2,604 | 1,195 | ||||||
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Net deferred tax asset before valuation allowance |
28,143 | 4,023 | ||||||
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Valuation allowance |
(28,143 | ) | (4,023 | ) | ||||
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Net deferred tax asset |
$ | — | $ | — | ||||
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In assessing the realization of deferred tax assets, management considers whether it is more likely than not that all or some portion of the deferred tax assets will not be realized. The ultimate realization of the deferred tax assets is dependent upon the generation of future taxable income during the periods in which temporary differences are deductible and net operating losses are utilized. Based on consideration of these factors, the Company recorded a full valuation allowance at December 31, 2017 and 2016. As of December 31, 2017 and 2016, we have provided a valuation allowance of approximately $28.1 million and $4.0 million, respectively, on U.S. federal and state and Israeli tax jurisdiction deferred tax assets to reduce the amount of these assets to zero. The net change in our valuation allowance was an increase of $24.1 million for the year ended December 31, 2017 of which $30.2 million was related to the Reverse Merger of Sevion on December 19, 2017, that was partially offset by a $10.2 million decrease related to the reduction in the U.S. federal corporate tax rate on December 22, 2017. The remaining $4.1 million increase was primarily related to losses generated in the current period.
As of December 31, 2017, we had U.S. federal and state NOL carryforwards of $77.2 million and $27.4 million, respectively, and federal research tax credit carryforwards of $0.7 million. Our U.S. net operating loss carryforwards will begin to expire, if not utilized, beginning in 2019 through 2037, and the research tax credits will expire beginning in 2027 through 2037. These NOL carryforwards could expire unused and be unavailable to offset future income tax liabilities. Under the newly enacted Tax Act, federal net operating losses incurred in 2018 and in future years may be carried forward indefinitely, but the deductibility of such federal net operating losses is limited. It is uncertain if and to what extent various states will conform to the newly enacted federal tax law.
In addition, under Section 382 of the Code and corresponding provisions of state law, if a corporation undergoes an “ownership change,” which is generally defined as a greater than 50 percent change, by value, in its equity ownership over a three-year period, the corporation’s ability to use its pre-change NOL carryforwards and other pre-change tax attributes to offset its post-change income or taxes may be limited. We may have experienced ownership changes in the past, including the Reverse Merger of Sevion Therapeutics, Inc. on December 19, 2017 at which time our pre-change U.S. federal NOL carryforward was $77.1 million and research tax credit was $0.7 million. We may experience additional ownership changes in the future as a result of subsequent shifts in our stock ownership, some of which may be outside of our control. Although we have not completed our analysis, it is reasonably possible that our federal NOLs available to offset future taxable income could materially decrease. This reduction will be offset by an adjustment to the existing valuation allowance for an equal and offsetting amount. Additionally, our state NOLs available to offset future state income could similarly decrease which would also be offset by an equal and offsetting adjustment to the existing valuation allowance. Given the offsetting adjustments to the existing valuation allowance, any ownership change is not expected to have an adverse material effect on our Consolidated Financial Statements. Finally, as of December 31, 2017, we had Israeli NOL carryforwards of $24.9 million, which carryforward indefinitely.
The components of income (loss) before taxes on income are as follows (in thousands):
| Year ended December 31, | ||||||||||||
| 2017 | 2016 | 2015 | ||||||||||
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U.S. |
$ | (21 | ) | $ | 44 | $ | 16 | |||||
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Israel |
(21,145 | ) | (9,883 | ) | (6,418 | ) | ||||||
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Income (loss) before taxes on income |
$ | (21,166 | ) | $ | (9,839 | ) | $ | (6,402 | ) | |||
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Taxes on income during the years ended December 31, 2017 and 2016 are comprised from taxes incurred as a result of the implementation of the cost-plus method between the Company and its subsidiary were immaterial.
The main reconciling item between the statutory tax rate of the Company and the effective tax rate is the recognition of valuation allowances in respect to deferred taxes relating to accumulated net operating losses carried forward and temporary differences due to the uncertainty of the realization of such deferred taxes.