Kadmon Holdings, Inc.

20. Income Taxes

The Company files U.S. federal and state tax returns for Kadmon Holdings, Inc. and the required information returns for its international subsidiaries, all of which are wholly owned. The Company recorded an income tax benefit of $0.1 million for the year ended December 31, 2017, related to a $0.4 million adjustment to the deferred tax liability, as explained below, net of $0.3 million of income tax expense related to a $2.0 million milestone payment received from Jinghua. The Company recorded income tax expense of $0.3 million for the year ended December 31, 2016, related to a $2.0 million milestone payment received from Jinghua. The Company recorded an immaterial amount of income tax benefit for the year ended December 31, 2015.

The Tax Cuts and Jobs Act (the “Act”) was enacted in December 2017. The Act reduces the U.S. federal corporate tax rate from 35 percent to 21 percent, requires companies to pay a one-time transition tax on earnings of certain foreign subsidiaries that were previously tax deferred, creates new taxes on certain foreign earnings and reduces the orphan drug tax credit. The Company recognized a deferred income tax benefit of $0.4 million for the year ended December 31, 2017 due to the write-down of a deferred tax liability related to the reduction of the corporate income tax rate per the Act.

The income tax provision consists of the following components (in thousands):



	For the Year Ended December 31,
	2017		2016		2015
Current tax expense (benefit)
Foreign	$	316	$	315	$	—
Federal		—		—		—
State		—		—		—
Total current tax expense		316		315		—
Deferred tax expense (benefit)
Federal		(485)		(15)		1
State		48		42		(4)
Total deferred tax benefit		(437)		27		(3)
Total income tax expense (benefit)	$	(121)	$	342	$	(3)

The income tax expense (benefit) differs from the expense (benefit) that would result from applying federal statutory rates to loss before income taxes as follows (in thousands):



	For the Year Ended December 31,
	2017			2016			2015
	Amount		Rate	Amount		Rate	Amount		Rate
Expected federal statutory income tax	$	(27,821)	-35.0%	$	(72,945)	-35.0%	$	(51,480)	-35.0%
State income taxes, net of federal benefits		(8,314)	-10.5%		(9,485)	-4.6%		(4,544)	-3.1%
Change in federal tax rate used for deferred purposes		112,611	141.7%		200	0.1%		972	0.7%
Adjustment to deferred tax assets		15,210	19.1%		—	0.0%		(6,492)	-4.4%
Change in valuation allowance		(91,807)	-115.5%		82,572	39.6%		61,541	41.8%
Income tax expense (benefit )	$	(121)	-0.2%	$	342	0.1%	$	(3)	0.0%

Deferred income tax expense (benefit) results primarily from the timing of temporary differences between the tax and financial statement carrying amounts of goodwill. The net deferred tax asset and liability in the accompanying consolidated balance sheets consists of the following components (in thousands):



	For the Year Ended December 31,
	2017		2016
Deferred tax assets
Net operating loss carryforward	$	112,289	$	171,074
Foreign tax credit carryforward		631		315
Capitalized research and development		66,500		78,147
Share-based compensation		18,735		22,233
Loss on equity investment		6,294		5,900
Organization costs		30		46
Depreciation		772		1,050
Intangibles		30,788		47,595
Inventory reserve and other		2,145		3,631
Total deferred tax assets		238,184		329,991
Deferred tax liability
Goodwill		(939)		(1,376)
Total deferred tax liability		(939)		(1,376)
Total deferred tax assets, net		237,245		328,615
Valuation allowance		(238,184)		(329,991)
Deferred tax liability	$	(939)	$	(1,376)

At December 31, 2017, the Company has unused federal and state net operating loss carry-forwards of $419.2 million and $362.0 million, respectively, that may be applied against future taxable income. These carry-forwards expire at various dates through December 31, 2037. The Company experienced ownership changes under Internal Revenue Code Section 382 in 2010, 2011 and 2016, which limits the Company’s ability to utilize net operating loss carry-forwards. The Company did not reduce the gross deferred tax assets related to the net operating loss carry-forwards, however, because the limitations do not hinder the Company’s ability to potentially utilize all of the net operating loss carry-forwards.

In accordance with ASC 740, “Income Taxes,” the Company recorded a valuation allowance to fully offset the gross deferred tax asset, because it is more likely than not that the Company will not realize future benefits associated with these deferred tax assets at December 31, 2017 and 2016. The change in deferred tax liability has been recognized as an income tax benefit in the consolidated statements of operations for the years ended December 31, 2017 and 2015 and as income tax expense for the year ended December 31, 2016.

The federal income tax return for the period of September 16, 2010 through December 31, 2010 was audited by the Internal Revenue Service during 2012 and early 2013. As a result of the audit, the Company’s operating loss carry-forwards were reduced by $1.4 million, which is reflected in the table above.

The Company follows guidance on accounting for uncertainty in income taxes which prescribes a minimum threshold a tax position is required to meet before being recognized in the financial statements. The Company does not have any liabilities as of December 31, 2017 and 2016 to account for potential income tax exposure. The Company is obligated to file income tax returns in the U.S. federal jurisdiction and several U.S. States. Since the Company had losses in the past, all prior years that generated net operating loss carry-forwards are open and subject to audit examination in relation to the net operating loss generated from those years.