10.INCOME TAXES

 

Income (loss) before income taxes, classified by source of income (loss), is as follows:

 

 

Income tax expense (benefit) consists of the following:

 

 

The actual income tax expense (benefit) for the years ended December 31, 2017, 2016 and 2015, differed from the amounts computed by applying the Canadian federal tax rate in 2017 and 2016 of 26.5% resulting from the Merger and the U.S. federal tax rate of 35% in 2015 to income (loss) before taxes as a result of the following:

 

 

Deferred income taxes reflect the net tax effects of temporary differences between the carrying amount of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of Aralez’s deferred tax assets are as follows:

 

 

The net deferred tax liability as of December 31, 2016 of $2.4 million consisted of the deferred tax liability of $11.1 million offset by a deferred tax asset of $8.6 million included within other long-term assets on the balance sheet.

 

At December 31, 2017, Aralez had Canadian net operating loss carryforwards of approximately $67.4 million, U.S. federal net operating loss carryforwards of approximately $33.8 million, U.S. state net operating loss carryforwards of approximately $20.5 million, Irish net operating loss carryforwards of $132.0 million and U.S. research and development credit carryforwards of approximately $14.5 million. The Canadian, U.S. federal and U.S. state net operating loss carryforwards begin to expire in 2026, 2030 and 2017, respectively, and the U.S. research and development credit carryforwards begin to expire in 2019. As a result of the adoption of ASU 2016-09, the Company will no longer include excess tax benefits in its U.S. federal and U.S. state net operating loss carryforwards. There was no net impact on our opening accumulated deficit upon application of this guidance using the modified retrospective transition method as the total cumulative-effect adjustment for previously deferred excess tax benefits was offset by a related change in the valuation allowance. Based upon the accumulation of historical losses in material jurisdictions, a valuation allowance has been recognized to offset a significant portion of the deferred tax assets due to the uncertainty surrounding Aralez’s ability to realize these deferred tax assets in future periods.  Certain deferred tax assets in Canada are considered to be realizable due to reversing deferred tax liabilities.

 

The utilization of the loss carryforwards to reduce future income taxes will depend on Aralez’s ability to generate sufficient taxable income prior to the expiration of the loss carryforwards. In addition, the maximum annual use of net operating loss and research credit carryforwards is limited in certain situations where changes occur in stock ownership, including the change in ownership resulting from the Merger. The cash tax benefit related to net operating loss carryforwards was approximately $2.1 million, $3.2 million and $2.5 million for the years ended December 31, 2017, 2016 and 2015, respectively.

 

On December 22, 2017, the U.S. government enacted the Tax Act, which significantly revises U.S. tax law by, among other provisions, lowering the U.S. federal statutory corporate income tax rate from 35% to 21%, imposing a mandatory one-time transition tax on previously deferred foreign earnings, and eliminating or reducing certain income tax deductions.

 

ASC 740, Income Taxes requires the effects of changes in tax laws to be recognized in the period in which the legislation is enacted. However, due to the complexity and significance of the Tax Act’s provisions, the SEC issued SAB 118, which allows companies to record the tax effects of the Tax Act on a provisional basis based on a reasonable estimate, and then, if necessary, subsequently adjust such amounts during a limited measurement period as more information becomes available. The measurement period ends when a company has obtained, prepared, and analyzed the information necessary to finalize its accounting, but cannot extend beyond one year from enactment.

 

The Tax Act did not have a material impact on the Company’s financial statements since its deferred temporary differences are fully offset by a valuation allowance and the Company does not have any significant off shore earnings from which to record the mandatory transition tax.  However, given the significant complexity of the Tax Act, anticipated guidance from the U.S. Treasury about implementing the Tax Act, and the potential for additional guidance from the SEC or the FASB related to the Tax Act, these estimates may be adjusted during the measurement period.  The provisional amounts disclosed in the Company’s footnotes were based on the its present interpretations of the Tax Act and current available information, including assumptions and expectations about future events, such as its projected financial performance, and are subject to further refinement as additional information becomes available and further analyses are completed.  The Company continues to analyze the changes in certain income tax deductions, assess calculations of earnings and profits in certain foreign subsidiaries, including if those earnings are held in cash or other assets and gather additional data to compute the full impacts on the Company’s deferred and current tax assets and liabilities. As a result of the reduction in the U.S. corporate income tax rate, the Company revalued its ending net deferred tax liabilities as of December 31, 2017 and recognized a provisional tax expense of $8.8 million.

 

Aralez had gross unrecognized tax benefits of approximately $0.7 million and $0.6 million as of December 31, 2017 and 2016, respectively, and of these amounts, none would reduce Aralez’s effective tax rate if recognized. Aralez does not anticipate a significant change in total unrecognized tax benefits or Aralez’s effective tax rate due to the settlement of audits or the expiration of statutes of limitations within the next 12 months.

 

The following table summarizes the activity related to the Company’s unrecognized tax benefits (in thousands):

 

 

Aralez’s policy for recording interest and penalties associated with tax audits is to record them as a component of provision for income taxes. Aralez has not recorded any interest or penalty since adoption of FASB ASC 740-10.

 

Aralez files federal and state income tax returns, as applicable, with the tax authorities in various jurisdictions including Canada, Ireland and the United States. Pozen is no longer subject to U.S. federal or North Carolina state income tax examinations by tax authorities for years before 2014. Aralez Canada is no longer subject to Canadian income tax examinations by tax authorities for years before 2011. However, the loss and credit carryforwards generated by Pozen and Aralez Canada may still be subject to change to the extent these losses and credits are utilized in a year that is subject to examination by tax authorities.

 

The Company has not provided for taxes as it relates to permanently reinvested foreign earnings.  While it is not practicable to estimate the potential income taxes the Company does not believe the distribution of existing foreign earnings would result in a material tax cost.