Note 9—Income Taxes
Until the Spin-Off, the Company was a member of IDT’s consolidated group of entities for which income tax returns were filed for the consolidated group, and income taxes for the Company were calculated on a separate tax return basis.
The components of (loss) income before income taxes are as follows:
| Year ended July 31, (in thousands) |
2017 | 2016 | ||||||
| Domestic | $ | (717 | ) | $ | 604 | |||
| Foreign | 90 | 522 | ||||||
| (Loss) income before income taxes | $ | (627 | ) | $ | 1,126 | |||
Provision for (benefit from) income taxes consisted of the following:
| Year ended July 31, (in thousands) |
2017 | 2016 | ||||||
| Current: | ||||||||
| Foreign | $ | 12 | $ | 169 | ||||
| Federal | — | — | ||||||
| State | — | — | ||||||
| Total current expense | 12 | 169 | ||||||
| Deferred: | ||||||||
| Foreign | (28 | ) | (26 | ) | ||||
| Federal | — | — | ||||||
| State | — | — | ||||||
| Total deferred expense | (28 | ) | (26 | ) | ||||
| (Benefit from) Provision for income taxes | $ | (16 | ) | $ | 143 | |||
The differences between income taxes expected at the U.S. federal statutory income tax rate and income taxes reported were as follows:
| Year ended July 31, (in thousands) |
2017 | 2016 | ||||||
| U.S. federal income tax at statutory rate | $ | (213 | ) | $ | 383 | |||
| State income tax | (165 | ) | 69 | |||||
| Valuation allowance | 717 | (276 | ) | |||||
| Foreign tax rate differential | 16 | (34 | ) | |||||
| Meals | 5 | 4 | ||||||
| Stock compensation and employment credits | (381 | ) | — | |||||
| Other | 5 | (3 | ) | |||||
| (Benefit from) provision for income taxes | $ | (16 | ) | $ | 143 | |||
The Company has not recorded U.S. income tax expense for foreign earnings, as such earnings are permanently reinvested outside the United States. The cumulative undistributed foreign earnings are included in accumulated deficit in the Company’s consolidated balance sheets and consisted of approximately $1.8 million at July 31, 2017. Upon distribution of these foreign earnings to the Company’s domestic entities, the Company may be subject to U.S. income taxes and withholding of foreign taxes; however, it is not practicable to determine the amount, if any, which would be paid.
Significant components of the Company’s deferred tax assets and deferred tax liabilities are as follows:
| July 31, (in thousands) |
2017 | 2016 | ||||||
| Deferred tax assets: | ||||||||
| Net operating loss carryforwards | $ | 951 | $ | 305 | ||||
| Reserves and accruals | 377 | 352 | ||||||
| Stock-based compensation | 76 | 1 | ||||||
| Gross deferred tax assets | 1,404 | 658 | ||||||
| Less valuation allowance | (1,232 | ) | (515 | ) | ||||
| Total deferred tax assets | 172 | 143 | ||||||
| Total deferred tax liabilities | — | — | ||||||
| Deferred tax assets, net | $ | 172 | $ | 143 | ||||
Deferred tax assets, net are included in “Other assets” in the consolidated balance sheets.
At July 31, 2017 and 2016, the Company had available Federal and State net operating loss (“NOL”) carryforwards ("from domestic operations of approximately $2.0 million and $0.6 million, respectively, to offset future taxable income. The Federal and State NOL carryforwards will begin to expire in 2036. The Company had no available NOLs from foreign operations.
Due to its history of losses, the Company believes that it is not more-likely-than-not that all of the deferred tax assets can be realized. Therefore, the Company has a full valuation allowance on all U.S. deferred tax assets. The change in the valuation allowance is as follows:
| Year ended July 31 (in thousands) |
Balance at beginning of year |
Additions charged to costs and expenses |
Deductions | Balance at end of year |
||||||||||||
| 2017 | ||||||||||||||||
| Reserves deducted from deferred income taxes, net: | ||||||||||||||||
| Valuation allowance | $ | 515 | $ | 717 | $ | — | $ | 1,232 | ||||||||
| 2016 | ||||||||||||||||
| Reserves deducted from deferred income taxes, net: | ||||||||||||||||
| Valuation allowance | $ | 2,305 | $ | — | $ | (1,790 | ) | $ | 515 | |||||||
At July 31, 2017 and 2016, the Company did not have any unrecognized tax benefits and did not anticipate any significant changes to the unrecognized tax benefits within twelve months of this reporting date. In the years ended July 31, 2017 and 2016, the Company did not record any interest or penalties on income taxes. At July 31, 2017 and 2016, there was no accrued interest included in income taxes payable.
The Company currently remains subject to examinations of its tax returns as follows: U.S. federal tax returns for fiscal 2014 to fiscal 2015 as part of the IDT consolidated tax return and for pre and post spin periods for fiscal 2016, state and local tax returns generally for fiscal 2014 to fiscal 2016 and foreign tax returns generally for fiscal 2012 to fiscal 2016.
In September 2016, the Company was notified that the Zedge Europe AS tax returns for 2012 and 2016 were going to be audited by the tax authorities in Norway. The initial audit meeting took place in October 2016 and the audit is progressing. No significant issues have been identified at this time. Amounts asserted by taxing authorities or the amount ultimately assessed against the Company could be greater than any accrued amount. Accordingly, provisions may be recorded in the future as estimates are revised or underlying matters are settled or resolved. Imposition of assessments as a result of tax audits could have an adverse effect on the Company’s results of operations, cash flows and financial condition.
In connection with the Spin-Off, the Company and IDT entered into various agreements prior to the Spin-Off including a Separation and Distribution Agreement to effect the separation and provide a framework for the Company’s relationship with IDT after the Spin-Off, and a Tax Separation Agreement, which sets forth the responsibilities of the Company and IDT with respect to, among other things, liabilities for federal, state, local and foreign taxes for periods before and including the Spin-Off, the preparation and filing of tax returns for such periods and disputes with taxing authorities regarding taxes for such periods. Pursuant to Separation and Distribution Agreement, among other things, the Company indemnifies IDT and IDT indemnifies the Company for losses related to the failure of the other to pay, perform or otherwise discharge, any of the liabilities and obligations set forth in the agreement. Pursuant to the Tax Separation Agreement, among other things, IDT indemnifies the Company from all liability for taxes of the Company and any of its subsidiaries or relating to its business with respect to taxable periods ending on or before the Spin-Off, and the Company indemnifies IDT from all liability for taxes of the Company and any of its subsidiaries or relating to its business accruing after the Spin-Off. Notwithstanding the foregoing, the Company is responsible for, and IDT has no obligation to indemnify the Company for, any tax liability of the Company resulting from an audit, examination or other proceeding related to any tax returns that relate solely to it and its subsidiaries regardless of whether such tax return relates to a period prior to or following the Spin-Off.
Research and Development Credits
As of July 31, 2017, the balance of the Company’s receivable from Norway’s SkatteFUNN government program designed to stimulate research and development in Norwegian trade and industry was $260,000, which was included in “Other current assets” in the consolidated balance sheet and $289,000 was recorded as a reduction of selling, general and administrative expense for the year ended July 31, 2017.