ACHIEVE LIFE SCIENCES, INC.

11. INCOME TAX

[a] On August 2, 2017, OncoGenex completed a reverse takeover with Achieve. OncoGenex changed its name to Achieve Life Sciences, Inc. We are a Delaware incorporated company subject to blended US Federal and state statutory rates for December 31, 2017, 2016 and 2015 of 34%, 34% and 34%, respectively. For the purposes of estimating the tax rate in effect at the time that deferred tax assets and liabilities are expected to reverse, management uses the furthest out available future tax rate in the applicable jurisdictions.

Income tax expense consisted of the following (in thousands):

(In thousands)	2017			2016			2015
Income taxes at statutory rates (at a rate of 34% for all years presented)	$	(4,636	)	$	(504	)	$	(407	)
Expenses not deducted for tax purposes		(174	)		—			—
Effect of tax rate changes on deferred tax assets and liabilities		3,158			—			—
Rate differential on foreign earnings		314			—			—
Reduction in benefit of operating losses		—			—			—
Reduction in the benefit of other tax attributes		—			—			—
Investment tax credits		—			—			—
Change in valuation allowance		(1,683	)		—			—
Book to tax return adjustments		—			—			—
Other		(14	)		—			—
Income tax expense	$	(3,035	)	$	(504	)	$	(407	)

[b] At December 31, 2017, we have investment tax credits of $2.6 million (2016—$2.6 million) available to reduce future Canadian income taxes otherwise payable. We also have non-capital loss carryforwards of $120.4 million (2016—$115.9 million) available to offset future taxable income in Canada, UK net operating loss carryforwards of $0.8 million (2016—$0.2 million) to offset future taxable income in the UK and federal net operating loss carryforwards of $9.9 million (2016—$1.3 million) to offset future taxable income in the United States.

The investment tax credits and non-capital losses and net operating losses for income tax purposes expire as follows (in thousands):

			US		Canadian			UK
	Investment		Net Operating		Non-capital			Net Operating
	Tax Credits		Losses		Losses			Losses
2022		—		—		—			—
2023		—		—		—			—
2024		—		—		—			—
2025		—		—		—			—
2026		244		—		7,335			—
2027		71		—		4,949			—
2028		148		—		8,020			—
2029		317		9		(9	)		35
2030		346		5		6,288			21
2031		486		17		12,121			37
2032		363		43		17,278			43
2033		193		2		23,240			56
2034		215		3		17,077			48
2035		122		654		3,112			28
2036		79		611		16,664			3
2037		19		8,530		4,348			578
	$	2,603	$	9,874	$	120,423		$	849

In addition, we have unclaimed tax deductions of approximately $15.5 million related to scientific research and experimental development expenditures available to carry forward indefinitely to reduce Canadian taxable income of future years. We also have research and development tax credits of $19,000 available to reduce future taxes payable in the United States. The research and development tax credits expire between 2018 and 2037.

[c] Significant components of our deferred tax assets as of December 31 are shown below (in thousands):

	2017			2016
Deferred tax assets
Tax basis in excess of book value of assets	$	850		$	—
Non-capital loss carryforwards		33,524			496
Research and development deductions and credits		5,506			—
Stock options		51			—
§59(e) Capitalized R&D expenses		3,252			—
Accrued expenses		—			363
Other		246			—
Total deferred tax assets		43,429			859
Valuation allowance		(42,914	)		(46	)
Net deferred assets		515			813
Deferred tax liabilities
Intangible assets		(513	)		(937	)
Other		(2	)		—
Total deferred tax liabilities		(515	)		(937	)

Net deferred tax assets		—			(124	)

The potential income tax benefits relating to these deferred tax assets have not been recognized in the accounts as their realization did not meet the requirements of “more likely than not” under the liability method of tax allocation. Accordingly, a valuation allowance has been recorded and no deferred tax assets have been recognized in all jurisdictions as at December 31, 2017 and in the UK as of December 31, 2016.

[d] Under ASC 740, the benefit of an uncertain tax position that is more likely than not of being sustained upon audit by the relevant taxing authority must be recognized at the largest amount that is more likely than not to be sustained. No portion of the benefit of an uncertain tax position may be recognized if the position has less than a 50% likelihood of being sustained.

A reconciliation of the unrecognized tax benefits of uncertain tax positions for the year ended December 31, 2017 is as follows (in thousands):

	Year ended
	December 31,
	2017		2016		2015
Balance at January 1	$	715	$	699	$	683
Additions based on tax positions related to the current year		—		16		16
Additions based on tax positions related to prior years		—		—		—
Balance at December 31	$	715	$	715	$	699

As of December 31, 2017, unrecognized benefits of approximately $0.7 million, if recognized, would affect our effective tax rate, and would reduce our deferred tax assets.

Our accounting policy is to treat interest and penalties relating to unrecognized tax benefits as a component of income taxes. As of December 31, 2017 and December 31, 2016 we had no accrued interest and penalties related to income taxes.

We are subject to taxes in Canada, the UK and the U.S. until the applicable statute of limitations expires. Tax audits by their very nature are often complex and can require several years to complete.

Tax		Years open to
Jurisdiction		examination
Canada		2009 to 2017
United Kingdom		2010 to 2017
US		2009 to 2017

On December 22, 2017, the U.S. government enacted comprehensive tax legislation commonly referred to as the Tax Cuts and Jobs Act (the “Tax Act”). The Tax Act makes broad and complex changes to the U.S. tax code, including, but not limited to,

(1) reducing the U.S. federal corporate tax rate from 34 percent to 21 percent;
(2) eliminating the corporate alternative minimum tax;
(3) creating a new limitation on deductible interest expense; and
(4) changing rules related to uses and limitations of net operating loss carryforwards created in tax years beginning after December 31, 2017.

As a result of when the Act was signed into law, our deferred tax assets and liabilities were required to be remeasured using the lower 21% federal rate as of December 31, 2017.