12. Income Taxes
For each of the years ended December 31, 2017, 2016 and 2015, the effective income tax rate and tax provision from continuing operations were zero, primarily attributable to losses generated which are not more likely than not to be realized.
The following is the reconciliation between the statutory federal income tax rate and the Company’s effective tax rate:
|
|
|
Year Ended December 31, |
|
|||||||||
|
|
|
2017 |
|
|
2016 |
|
|
2015 |
|
|||
|
Federal statutory income tax rate |
|
|
34.0 |
% |
|
|
34.0 |
% |
|
|
34.0 |
% |
|
State taxes (tax effected) |
|
|
7.5 |
|
|
|
7.9 |
|
|
|
7.2 |
|
|
Non-deductible expenses and other |
|
|
2.4 |
|
|
|
(10.2 |
) |
|
|
— |
|
|
Research and development credits |
|
|
7.4 |
|
|
|
14.1 |
|
|
|
3.0 |
|
|
Tax Act – net deferred tax rate change |
|
|
(29.0 |
) |
|
|
— |
|
|
|
— |
|
|
Change in valuation allowance |
|
|
(22.3 |
) |
|
|
(45.8 |
) |
|
|
(44.2 |
) |
|
Total |
|
|
— |
% |
|
|
— |
% |
|
|
— |
% |
As of December 31, 2017, and 2016, the components of the Company’s deferred tax assets are as follows (in thousands):
|
|
|
As of December 31, |
|
|||||
|
|
|
2017 |
|
|
2016 |
|
||
|
Deferred tax assets: |
|
|
|
|
|
|
|
|
|
Net operating loss carryforwards |
|
$ |
23,022 |
|
|
$ |
23,937 |
|
|
Deferred revenue |
|
|
6,296 |
|
|
|
— |
|
|
Start-up costs |
|
|
1,354 |
|
|
|
2,093 |
|
|
Research and development credits carryforwards |
|
|
8,631 |
|
|
|
4,450 |
|
|
Depreciation |
|
|
(457 |
) |
|
|
(527 |
) |
|
Other |
|
|
2,217 |
|
|
|
865 |
|
|
Total deferred tax assets |
|
|
41,063 |
|
|
|
30,818 |
|
|
Less: valuation allowance |
|
|
(41,063 |
) |
|
|
(30,818 |
) |
|
Net deferred tax assets |
|
$ |
— |
|
|
$ |
— |
|
In December 2017, Tax Act was signed into law making significant changes to the Internal Revenue Code. Changes include, but are not limited to, a corporate tax rate decrease from 34% to 21% effective for tax years beginning after December 21, 2017, the transition of U.S. international taxation from a worldwide tax system to a territorial system, and a one-time transition tax on the mandatory deemed repatriation of cumulative foreign earnings as of December 31, 2017.
The Tax Act reduces the corporate tax rate to 21% effective January 1, 2018. Consequently, the Company has recorded a decrease in net deferred tax assets of $13.3 million, with a corresponding adjustment to the valuation allowance of $13.3 million, for the year ended December 31, 2017. The state and foreign deferred tax effect on federal deferred tax assets has been calculated using 21% rather than the previous 34% federal tax rate. The increase in deferred tax assets has been offset against an increase to the valuation allowance.
In December 2017, the SEC staff issued SAB 118, which provides guidance for the tax effect of the Tax Act. SAB 118 provides a measurement period that should not extend beyond one year from the Tax Act’s enactment date for companies to complete the accounting under Accounting Standards Codification Topic 740, Income Taxes (“ASC 740”). In accordance with SAB 118, the Company must reflect the income tax effects of those aspects of the Tax Act for which the accounting under ASC 740 is complete. To the extent that the Company’s accounting for certain income tax effects of the Tax Act is incomplete, but it is able to determine a reasonable estimate, the Company must record a provisional estimate in its consolidated financial statements. If the Company cannot determine a provisional estimate to be included in its consolidated financial statements, it should continue to apply ASC 740 on the basis of the provisions of the tax laws that were in effect immediately before the enactment of the Tax Act. The $13.3 million decrease in deferred tax assets and corresponding adjustment to the valuation allowance described in the paragraphs above represent the Company’s reasonable estimates and are provisional amounts within the meaning of SAB 118. Also, it is expected that the U.S. Treasury will issue regulations and other guidance on the application of certain provisions of the Tax Act. In subsequent periods, but within the measurement period, the Company will analyze that guidance and other necessary information to refine its estimates and complete its accounting for the tax effects of the Tax Act as necessary.
The Company’s primary deferred tax asset of $23.0 million at December 31, 2017 and $23.9 million at December 31, 2016 relates to its net operating loss carryforwards. Based on a history of cumulative losses in recent periods and consideration of other available positive and negative evidence, the Company has recorded a valuation allowance to offset the net deferred tax assets at December 31, 2017 and December 31, 2016, respectively.
As of December 31, 2017, the Company had approximately $81.6 million and $84.3 million of federal and state net operating losses, respectively, that will begin to expire in 2032. As of December 31, 2017, the Company had approximately $3.7 million and $3.2 million of federal and state research and development tax credit carryovers, respectively. If not utilized, the federal credit carryforward will expire in 2032, and the state credit carryforward does not expire. As of December 31, 2017, the Company had approximately $4.6 million of federal orphan tax credit carryovers, which will begin to expire in 2036 if not utilized. The valuation allowance increased by approximately $10.2 million and $6.0 million and $10.1 million during the years ended December 31, 2017 , 2016 and 2015, respectively.
Under Sections 382 and 383 of the Internal Revenue Code of 1986, as amended (the “Code”) if a corporation undergoes an “ownership change,” generally defined as a greater than 50 percentage point change (by value) in its equity ownership over a rolling three-year period, the corporation’s ability to use its pre-change net operating loss carryforwards (“NOLs”) and other pre-change tax attributes (such as research tax credits) to offset its post-change income or taxes may be limited. Similar rules may apply under the laws of the state of California. The annual limitation generally is determined by multiplying the value of the Company’s stock at the time of such ownership change (subject to certain adjustments) by the applicable “long-term tax-exempt rate.” Such limitations may result in expiration of a portion of the NOLs and other tax attributes before utilization. While we have determined that an ownership change occurred in April 2015 in connection with our Series B redeemable convertible preferred stock financing and in August 14, 2017 due to a subsequent stock offering, we do not believe that these ownership changes will result in the expiration of any of our existing NOLs prior to utilization.
As of December 31, 2017, and 2016, the Company did not have a liability related to unrecognized tax benefits. All unrecognized tax benefits have been netted against the research and development and orphan drug credit carryforwards deferred tax asset.
The Company records interest and penalties related to unrecognized tax benefits within interest and other income, net. As of December 31, 2017 and 2016, the Company had not accrued any interest or penalties related to unrecognized tax benefits. The Company is subject to U.S. federal and California income tax assessment for years beginning in 2012 and Australia beginning in 2015. However, since the Company has incurred federal and California net operating losses every year since inception, all of its income tax returns are subject to examination and adjustments by the Internal Revenue Service for at least three years and by California Franchise Tax Board for four years following the year in which the tax attributes are utilized. The Company does not believe that there will be a material change in it unrecognized tax positions over the next twelve months. There is no amount of unrecognized tax benefit that, if recognized, would affect the effective tax rate.
Uncertain Tax Positions
The Company has not been audited by the Internal Revenue Service, any state tax authority, or foreign tax authorities. It is subject to taxation in the United States and Australia. Because of the net operating loss, research credit carryforwards, and orphan drug tax credit carryforwards, substantially all of its tax years, from 2012 to 2017, remain open to U.S. federal and California tax examinations. The statute of limitation in Australia is four years.
There were no interest or penalties accrued at December 31, 2017, and 2016.
At December 31, 2017, 2016 and 2015, the Company's reserve for unrecognized tax benefits is approximately $2.5 million, $1.5 million and $0.7 million, respectively. Due to the full valuation allowance at December 31, 2017, current adjustments to the unrecognized benefits will have no impact to the Company's effective income tax rate.
A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows (in thousands):
|
|
|
For the Year Ended December 31, |
|
|||||||||
|
|
|
2017 |
|
|
2016 |
|
|
2015 |
|
|||
|
Beginning balance |
|
$ |
1,474 |
|
|
$ |
719 |
|
|
$ |
465 |
|
|
Decreases of unrecognized tax benefits related to prior year |
|
|
(97 |
) |
|
|
— |
|
|
|
— |
|
|
Increases of unrecognized tax benefits related to current year |
|
|
1,094 |
|
|
|
755 |
|
|
|
254 |
|
|
Ending balance |
|
$ |
2,471 |
|
|
$ |
1,474 |
|
|
$ |
719 |
|
The Company does not anticipate material changes to its uncertain tax positions through the next twelve months.