11. Income Taxes
We provide for income taxes on taxable income at the statutory rates applicable. The following table summarizes the components of income tax expense from continuing operations for the years ended October 31, 2017, 2016 and 2015:
|
| | | | | | | | | | | |
| Year Ended October 31, |
| 2017 | | 2016 | | 2015 |
| (In thousands) |
Current | | | | | |
Federal | $ | 1,991 |
| | $ | 1,309 |
| | $ | 49 |
|
State and local | 873 |
| | 154 |
| | 216 |
|
Non-United States | 4,067 |
| | 3,241 |
| | 2,070 |
|
Total current | 6,931 |
| | 4,704 |
| | 2,335 |
|
Deferred | | | | | |
Federal | 1,860 |
| | (5,932 | ) | | 5,766 |
|
State and local | (450 | ) | | (712 | ) | | 439 |
|
Non-United States | (1,522 | ) | | (1,825 | ) | | (1,001 | ) |
Total deferred | (112 | ) | | (8,469 | ) | | 5,204 |
|
Total income tax provision (benefit) | $ | 6,819 |
| | $ | (3,765 | ) | | $ | 7,539 |
|
The following table reconciles our effective income tax rate to the federal statutory rate of 35% for the years ended October 31, 2017, 2016 and 2015:
|
| | | | | | | | |
| Year Ended October 31, |
| 2017 | | 2016 | | 2015 |
United States tax at statutory rate | 35.0 | % | | 35.0 | % | | 35.0 | % |
State and local income tax | 1.7 |
| | 7.4 |
| | 2.3 |
|
Non-United States income tax | (9.1 | ) | | 32.0 |
| | (1.5 | ) |
Deferred rate impact | (4.1 | ) | | 15.2 |
| | 0.5 |
|
General business credits | (0.5 | ) | | 6.4 |
| | (1.0 | ) |
Transaction costs | — |
| | (17.0 | ) | | 2.5 |
|
Uncertain tax positions | — |
| | — |
| | (3.4 | ) |
Change in valuation allowance | (0.6 | ) | | (0.9 | ) | | (0.5 | ) |
Other permanent differences | 3.3 |
| | (5.8 | ) | | (1.5 | ) |
Return to actual adjustments | 1.0 |
| | (5.4 | ) | | 0.2 |
|
Effective tax rate | 26.7 | % | | 66.9 | % | | 32.6 | % |
The decrease in the 2017 effective tax rate is due primarily to a greater proportion of United States taxable income in relation to foreign taxable income for the year. The United States tax rate is generally higher than the foreign tax rate. The effective rate is also lower due to a change over a period of three years in the deferred tax rate, primarily in the United Kingdom, from 19% to 17%. The foreign tax rate differential and the mix of earnings by jurisdiction also impacted the rate in 2016. The increase in the 2016 effective tax rate benefit was due primarily to a greater proportion of foreign taxable income in relation to United States taxable income for the year. The overall change in the 2016 effective rate was also impacted by transaction costs and a change in the deferred rate in the United Kingdom from 20% to 19%. The decrease in the 2015 effective tax rate is attributable to a discrete benefit item resulting from the reassessment of our uncertain tax position related to the 2008 spin-off of Quanex from a predecessor company in January 2015. Excluding this item, the effective tax rate was 36.0%.
Significant components of our net deferred tax liabilities and assets were as follows: |
| | | | | | | |
| October 31, |
| 2017 | | 2016 |
| (In thousands) |
Deferred tax assets: | | | |
Employee benefit obligations | $ | 12,731 |
| | $ | 16,694 |
|
Accrued liabilities and reserves | 2,409 |
| | 2,929 |
|
Pension and other benefit obligations | 2,968 |
| | 4,087 |
|
Inventory | 1,614 |
| | 1,759 |
|
Loss and tax credit carry forwards | 8,098 |
| | 9,589 |
|
Other | 194 |
| | 193 |
|
Total gross deferred tax assets | 28,014 |
| | 35,251 |
|
Less: Valuation allowance | 1,304 |
| | 1,279 |
|
Total deferred tax assets, net of valuation allowance | 26,710 |
| | 33,972 |
|
Deferred tax liabilities: | | | |
Property, plant and equipment | 16,128 |
| | 18,946 |
|
Goodwill and intangibles | 32,542 |
| | 33,348 |
|
Total deferred tax liabilities | 48,670 |
| | 52,294 |
|
| | | |
Net deferred tax liabilities | $ | 21,960 |
| | $ | 18,322 |
|
At October 31, 2017, state operating loss carry forwards totaled $38.5 million. The majority of these losses begin to expire in 2025. Tax credits available to offset future tax liabilities totaled $4.2 million and are expected to be utilized within the next twelve months. We evaluate tax benefits of operating losses and tax credit carry forwards on an ongoing basis, including a review of historical and projected future operating results, the eligible carry forward period and other circumstances. We have recorded a valuation allowance for certain state net operating losses as of October 31, 2017 and 2016, totaling $1.3 million ($0.8 million net of federal taxes) for the respective periods. In assessing the need for a valuation allowance, we consider both positive and negative evidence related to the likelihood of realization of the deferred tax assets.
The following table reconciles the change in the unrecognized income tax benefit associated with uncertain tax positions for the years ended October 31, 2017, 2016 and 2015 (in thousands):
|
| | | | |
| | Unrecognized Income Tax Benefits |
Balance at October 31, 2014 | | $ | 11,431 |
|
Additions for tax positions related to the current year | | — |
|
Additions for tax positions related to the prior year | | 16 |
|
Lapse in statute of limitations | | (10,883 | ) |
Balance at October 31, 2015 | | $ | 564 |
|
Additions for tax positions related to the current year | | — |
|
Additions for tax positions related to the prior year | | 15 |
|
Balance at October 31, 2016 | | $ | 579 |
|
Additions for tax positions related to the current year | | — |
|
Additions for tax positions related to the prior year | | 12 |
|
Balance at October 31, 2017 | | $ | 591 |
|
As of October 31, 2017, our unrecognized tax benefit (UTB) relates to certain state tax items regarding the interpretation of tax laws and regulations. In January 2015, we reassessed our unrecognized tax benefit related to the 2008 spin-off of Quanex from a predecessor company and recognized the full benefit of the tax positions taken. This reduced the liability for uncertain tax positions by $4.1 million and increased deferred income taxes (non-current assets) by $6.8 million and resulted in a non-cash increase in retained earnings of $10.1 million, with an increase in income tax benefit of $0.8 million. At October 31, 2017, $0.6 million is recorded as a liability for uncertain tax positions. The disallowance of the UTB would not materially affect the annual effective tax rate.
We, along with our subsidiaries, file income tax returns in the United States and various state jurisdictions as well as in the United Kingdom, Germany, Canada and Mexico. In certain jurisdictions the statute of limitations has not yet expired. We generally remain subject to examination of our United States income tax returns for 2014 and subsequent years. We generally remain subject to examination of our various state and foreign income tax returns for a period of four to five years from the date the return was filed. The state impact of any federal changes remains subject to examination by various states for a period of up to one year after formal notification to the state of the federal change.
Judgment is required in assessing the future tax consequences of events that have been recognized in our financial statements or tax returns. The final outcome of the future tax consequences of legal proceedings, if any, as well as the outcome of competent authority proceedings, changes in regulatory tax laws, or interpretation of those tax laws could impact our financial statements. We are subject to the effect of these matters occurring in various jurisdictions. We do not believe any of the UTB at October 31, 2017 will be recognized within the next twelve months.
Included in prepaid and other current assets on the accompanying consolidated balance sheets was an income tax receivable of $1.6 million as of October 31, 2016.
The acquisition of Woodcraft in November 2015 established a net noncurrent deferred tax liability of $37.4 million primarily reflecting the book to tax basis difference in intangibles, fixed assets and inventory. The acquisition of Flamstead Holdings, Ltd in June 2015 established a noncurrent deferred tax liability of $13.2 million reflecting the book to tax basis difference in intangibles, fixed assets and inventory at the then current United Kingdom tax rate of 20%. The HLP noncurrent deferred tax liability has been subsequently adjusted to the expected rate of 17%.
Management has determined that the earnings of our foreign subsidiaries are not required as a source of funding for United States operations and we intend to indefinitely reinvest these funds in our foreign jurisdictions. If the investment in our foreign subsidiaries were completely realized, a potential gain of $45.0 million could exist resulting in an estimated residual United States tax liability of $10.7 million.
Our federal income tax return for the pre-acquisition short period of January 1, 2015 to November 2, 2015 for Woodcraft is currently under audit by the United States Internal Revenue Service.