Income Taxes
On December 22, 2017, the United States enacted tax reform legislation through the Tax Cuts and Jobs Act (“Tax Act”), which significantly changes the existing U.S. tax laws. The Tax Act includes a reduction in the U.S. corporate tax rate from 34% to 21%, a transition from a worldwide tax system to a modified territorial tax system, new taxes on certain foreign-sourced earnings, limitations on the deductibility of interest expense and executive compensation, as well as other changes.
In response to the Tax Act, the SEC staff issued Staff Accounting Bulletin No. 118 (“SAB 118”) which allows registrants to record provisional amounts during a measurement period, not to extend beyond one year. Pursuant to SAB 118, the Company will complete the accounting for the tax effects of all of the provisions of the Tax Act within the required measurement period not to extend beyond one year from the enactment date.
The Company has remeasured all deferred tax assets and liabilities as of December 31, 2017, based on the provisions of the Tax Act, which include a reduction in the federal statutory tax rate from 34% to 21%. The impact of the remeasurement to the net deferred tax asset is a reduction of $8.9 million, which is fully offset by changes in the pre-existing valuation allowance. For the year ended December 31, 2017, the Company recorded a benefit of $0.2 million related to the Federal Alternative Minimum Tax ("AMT") credit, which is now refundable under the Tax Act. In regard to the Tax Act’s one-time tax on unrepatriated foreign earnings, the Company has performed an analysis and has determined that the Company does not have a liability as the Company has a net deficit of unrepatriated foreign earnings.
The domestic and foreign components of loss before (benefit) provision for income taxes were as follows (in thousands):
|
| | | | | | | | | | | |
| Years Ended December 31, |
| 2017 | | 2016 | | 2015 |
Domestic | $ | (14,171 | ) | | $ | (1,911 | ) | | $ | (10,120 | ) |
Foreign | (3,508 | ) | | (805 | ) | | (11,393 | ) |
Total loss before (benefit) provision for income taxes | $ | (17,679 | ) | | $ | (2,716 | ) | | $ | (21,513 | ) |
The components of the (benefit) provision for income taxes are as follows (in thousands):
|
| | | | | | | | | | | |
| Years Ended December 31, |
| 2017 | | 2016 | | 2015 |
Current tax provision: | | | | | |
Federal | $ | (395 | ) | | $ | 90 |
| | $ | 131 |
|
State | (24 | ) | | 219 |
| | 113 |
|
Foreign | 2,134 |
| | 1,089 |
| | (118 | ) |
Total current provision | 1,715 |
| | 1,398 |
| | 126 |
|
Deferred tax benefit: | | | | | |
Federal | (12,514 | ) | | — |
| | — |
|
State | (1,906 | ) | | 10 |
| | 4 |
|
Foreign | (972 | ) | | (25 | ) | | (28 | ) |
Total deferred benefit | (15,392 | ) | | (15 | ) | | (24 | ) |
Total (benefit) provision for income taxes | $ | (13,677 | ) | | $ | 1,383 |
| | $ | 102 |
|
A reconciliation of our income tax (benefit) provision to the statutory federal tax rate is as follows:
|
| | | | | | | | |
| Years Ended December 31, |
| 2017 | | 2016 | | 2015 |
U.S. federal income tax rate
| 34.0 | % | | 34.0 | % | | 34.0 | % |
Change in the valuation allowance | 83.8 |
| | (43.9 | ) | | (38.7 | ) |
Nondeductible stock-based compensation | 21.5 |
| | 0.7 |
| | (4.5 | ) |
State taxes, net of federal benefit | 5.9 |
| | 1.6 |
| | 1.4 |
|
Foreign rate differential | (11.2 | ) | | (30.9 | ) | | (11.8 | ) |
Corporate restructuring | — |
| | — |
| | 23.0 |
|
Income tax credits | 6.9 |
| | 41.5 |
| | 4.3 |
|
Provision for tax reserves | 0.7 |
| | (31.6 | ) | | (3.5 | ) |
Non-deductible compensation | (8.2 | ) | | (14.1 | ) | | (3.0 | ) |
Meals and entertainment | (1.2 | ) | | (2.4 | ) | | (0.3 | ) |
Transaction costs | (3.7 | ) | | (2.8 | ) | | (0.1 | ) |
Change in federal rate | (50.1 | ) | | — |
| | — |
|
Other | (1.0 | ) | | (3.0 | ) | | (1.3 | ) |
Effective income tax rate | 77.4 | % | | (50.9 | )% | | (0.5 | )% |
The Company recorded a (benefit) provision for income taxes of $(13.7) million, $1.4 million and $0.1 million for the years ended December 31, 2017, 2016, and 2015, respectively. For the year ended December 31, 2017, the Company’s tax provision was primarily driven by valuation allowance release, foreign income taxes, and refundable AMT. For the year ended December 31, 2016, the Company’s tax provision was primarily driven by foreign income taxes, federal AMT, and state income taxes. Our effective tax rate for the year ended December 31, 2017 differed due to the U.S. federal statutory rate primarily due to changes in the valuation allowance against deferred tax assets, stock-based compensation, offset by the impact of the federal tax rate change on the deferred tax assets, and a foreign rate differential associated with certain foreign jurisdictions which are subject to significantly lower tax rates than the 2017 U.S. federal statutory rate. Our effective tax rate for the year ended December 31, 2016 is lower than the U.S. federal statutory rate primarily due to changes in the valuation allowance against deferred tax assets, provisions for tax reserves, a foreign rate differential associated with certain foreign jurisdictions which are subject to significantly lower tax rates than the U.S. federal statutory rate, and nondeductible compensation, offset by income tax credits.
The components of the Company’s deferred tax assets and liabilities are as follows (in thousands):
|
| | | | | | | |
| 2017 | | 2016 |
Deferred tax assets: | | | |
Net operating loss carryforwards | $ | 27,792 |
| | $ | 34,292 |
|
Research and development tax credit carryforwards | 6,280 |
| | 5,751 |
|
Deferred revenue | 3,957 |
| | 7,213 |
|
Stock compensation | 2,339 |
| | 2,693 |
|
Other | 7,304 |
| | 7,230 |
|
Total deferred tax assets | 47,672 |
| | 57,179 |
|
Valuation allowance for deferred tax assets | (28,273 | ) | | (52,987 | ) |
Total deferred tax assets, net of valuation allowance | 19,399 |
| | 4,192 |
|
Deferred tax liabilities: | | | |
Amortization | (9,146 | ) | | (1,452 | ) |
Convertible debt | (7,948 | ) | | — |
|
Other | (3,450 | ) | | (4,133 | ) |
Total deferred tax liabilities | (20,544 | ) | | (5,585 | ) |
Net deferred tax liabilities | $ | (1,145 | ) | | $ | (1,393 | ) |
As of December 31, 2017, the Company had U.S. federal, state and foreign net operating loss carryforwards of $107.9 million, $72.7 million, and $6.1 million, respectively. The federal net operating loss carryforwards will expire at various dates beginning in 2027 through 2037. State net operating loss carryforwards will expire at various dates beginning in 2020 through 2037. At December 31, 2017, the Company had federal, state, and foreign research and development tax credit carryforwards available to reduce future income taxes payable of $4.0 million, $2.7 million, and $0.2 million respectively. These credits will expire at various dates beginning in the year 2025 through 2037. As of December 31, 2017, the Company also had refundable federal AMT credits of approximately $0.2 million.
Management has evaluated the positive and negative evidence bearing upon the realizability of its deferred tax assets. As required by the provisions of ASC 740, Income Taxes ("ASC 740"), management has determined that it is not more-likely-than-not that the tax benefits related to the federal, state and foreign deferred tax assets will be realized for financial reporting purposes. Accordingly, the federal, state and certain foreign deferred tax assets have been fully reserved at December 31, 2017 and 2016. The valuation allowance decreased approximately $24.7 million during the year ended December 31, 2017 primarily due to the partial release of U.S. valuation allowance as a result of a net deferred tax liability recorded in the acquisition of DoubleTake. The U.S. net deferred tax liability primarily relates to non-tax deductible intangible assets recognized in the financial statements which generate a deferred tax liability. The net deferred tax liability established is estimated to be a source of income to utilize previously unrecognized deferred tax assets in the U.S. Therefore, we have recorded a tax benefit of $14.6 million for the release of U.S. valuation allowance related to the deferred tax liability recorded in purchase accounting. The U.S. maintains a valuation allowance on the overall U.S. net deferred tax asset as it is deemed more likely than not the U.S. net deferred tax asset will not be realized. Furthermore, the 2017 change in valuation allowance is also impacted by a deferred tax liability related to the Convertible Notes as well as federal tax rate changes on the U.S. deferred tax assets and liabilities. The valuation allowance decreased approximately $2.0 million during the year ended December 31, 2016 due primarily to changes in the net operating loss carryforwards and decreases in the deferred tax assets related to stock-based compensation, offset by increases in other deferred tax assets.
Future changes in Company ownership may limit the amount of net operating loss carryforwards and research and development credit carryforwards that can be utilized annually to offset future taxable income and taxes, respectively. In general, an ownership change, as defined by Section 382 of the Internal Revenue Code of 1986, as amended, results from transactions increasing the ownership of certain shareholders or public groups in the stock of a corporation by more than 50 percentage points over a three-year period. Based upon the Company’s analysis as of December 31, 2017, there was no ownership change experienced during 2017.
Unrecognized Tax Benefits
A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows (in thousands): |
| | | | | | | | | | | |
| 2017 | | 2016 | | 2015 |
Unrecognized tax benefits, beginning of year | $ | (4,108 | ) | | $ | (3,231 | ) | | $ | (2,615 | ) |
Additions based on tax positions related to the current year | (673 | ) | | (943 | ) | | (1,323 | ) |
Additions for tax positions of prior years | — |
| | (14 | ) | | (35 | ) |
Reductions for tax positions of prior years | 1,081 |
| | 80 |
| | 142 |
|
Settlements | — |
| | — |
| | 600 |
|
Unrecognized tax benefits, end of year | $ | (3,700 | ) | | $ | (4,108 | ) | | $ | (3,231 | ) |
The Company accounts for uncertain tax positions under the recognition and measurement criteria of ASC 740. For those tax positions for which it is more likely than not that a tax benefit will be sustained, we record the largest amount of tax benefit with a greater than 50% likelihood of being realized upon settlement with a taxing authority that has full knowledge of all relevant information. If we do not believe that it is not more likely than not that a tax benefit will be sustained, no tax benefit is recognized. As of December 31, 2017, the Company had a total amount of unrecognized tax benefits of $3.7 million, of which $0.1 million represents the amount of unrecognized tax benefits that, if recognized, would favorably affect the effective income tax rate in future periods. The difference between the total amount of unrecognized tax benefits and the amount that would impact the effective tax rate consists of items that, if recognized, would result in a corresponding increase in the valuation allowance.
The Company recognizes interest and penalties related to uncertain tax positions as a component in income tax expense. As of December 31, 2017, the Company had no accrued interest or penalties related to uncertain tax positions and no amounts have been recognized in the Company’s consolidated statements of operations. The statute of limitations for assessment by the Internal Revenue Service ("IRS") and state tax authorities is open for tax years ending December 31, 2014, 2015, 2016 and 2017, although carryforward attributes that were generated prior to tax year 2014 may still be adjusted upon examination by the IRS or state tax authorities if they either have been or will be used in a future period. The statute of limitations for assessments by foreign taxing authorities is generally not open for years prior to 2013, although carryforward attributes that were generated prior to tax year 2013 may still be adjusted upon examinations.
The Company is subject to U.S. federal income tax and various state and local taxes in both domestic and foreign jurisdictions. In the normal course of business, the Company is subject to examination by taxing authorities within these jurisdictions. The IRS completed its audit of the Company's U.S. federal income tax return for the tax year ended December 31, 2011 during 2014. The closing of the audit did not result in any proposed adjustments or assessments of tax relating to the 2011 tax year. Additionally, during 2015 the Company completed a German tax audit for MailStore for the tax years ended December 31, 2011, 2012, 2013 and 2014 with immaterial adjustments.
The Company does not reasonably expect that the unrecognized tax benefit will change significantly within the next twelve months.
As of December 31, 2017, a deferred tax liability has not been established for approximately $9.3 million of cumulative undistributed earnings of non-U.S. subsidiaries, which are expected to be reinvested indefinitely in operations outside the U.S. Determination of the unrecognized deferred tax liability on unremitted earnings is not practical due to uncertainty regarding the remittance structure, the mix of earnings and earnings for profit pools in the year of remittance, and overall complexity of the calculation.