15. Income Taxes
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 incorporates broad and complex changes to the U.S. tax code. The main provision of the Tax Act that is applicable to us is the reduction of a maximum federal tax rate of 35% to a flat tax rate of 21%, effective January 1, 2018. We incorporated the change in federal tax rates in our annual tax provision. As a result of the rate change, we reduced our net deferred tax asset balance by $2.0 million, with a corresponding reduction to our valuation allowance of $2.2 million, resulting in a deferred income tax benefit of $200,000. At December 31, 2017, we have not completed accounting for the tax effects of Tax Act. We have made reasonable estimates of the effects of the Tax Act on existing deferred tax balances. We will continue to refine our calculations as additional analysis is completed. Our estimates may be affected as we gain a more thorough understanding of the Tax Act.
Our entire income (loss) before taxes is considered domestic (United States) as we have no foreign operations.
We received $5.5 million in advanced payments from Kite in 2015. As of December 31, 2016, $2.0 million of this $5.5 million was deferred for financial reporting purposes but was included in taxable income for the year ended December 31, 2016. As a result of this timing difference, we incurred current federal and state income tax expense in the year ended December 31, 2016. We expect to be in a loss position for tax purposes in 2017 and thereafter for the foreseeable future.
The provision for income taxes is composed of the following (in thousands):
|
|
|
Years Ended December 31, |
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|||||
|
|
|
2017 |
|
|
2016 |
|
||
|
Current: |
|
|
|
|
|
|
|
|
|
U.S. - Federal |
|
$ |
(1 |
) |
|
$ |
4 |
|
|
U.S. - State |
|
|
5 |
|
|
|
62 |
|
|
Total current |
|
|
4 |
|
|
|
66 |
|
|
Deferred: |
|
|
|
|
|
|
|
|
|
U.S. - Federal |
|
|
(204 |
) |
|
|
— |
|
|
U.S. - State |
|
|
— |
|
|
|
— |
|
|
Total deferred |
|
|
(204 |
) |
|
|
— |
|
|
Total income tax expense |
|
$ |
(200 |
) |
|
$ |
66 |
|
The effective tax rate of the provision for income taxes differs from the federal statutory rate as follows:
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|
Years Ended December 31, |
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|||||
|
|
|
2017 |
|
|
2016 |
|
||
|
U.S. Statutory rate |
|
|
35.0 |
% |
|
|
34.0 |
% |
|
Effect of: |
|
|
|
|
|
|
|
|
|
State taxes (net of federal benefit) |
|
|
(1.6 |
%) |
|
|
5.6 |
% |
|
Permanent differences |
|
|
(0.1 |
%) |
|
|
(0.3 |
%) |
|
Federal research and development credit |
|
|
4.4 |
% |
|
|
9.4 |
% |
|
Change in valuation allowance |
|
|
(19.4 |
%) |
|
|
(54.0 |
%) |
|
Benefit of a lower tax rate |
|
|
0.2 |
% |
|
|
0.9 |
% |
|
Stock-based compensation |
|
|
(2.6 |
%) |
|
|
(1.2 |
%) |
|
Non-deductible merger costs |
|
|
(17.6 |
%) |
|
|
(— |
%) |
|
Bargain purchase gain |
|
|
28.9 |
% |
|
|
(— |
%) |
|
Tax rate change |
|
|
(24.7 |
%) |
|
|
(— |
%) |
|
Effective income tax rate |
|
|
2.5 |
% |
|
|
(5.6 |
%) |
We recorded a tax benefit of $200,000 for the year ended December 31, 2017 and tax expense of $66,000 for the year ended December 31, 2016, representing effective tax rates of 2.5% and (5.6)% for the years ended December 31, 2017 and 2016, respectively. The difference between the U.S. federal statutory tax rate of 35% and our effective tax rate in all periods is primarily due to a full valuation allowance related to our deferred tax assets, the generation, and consumption of, federal R&D tax credits, and, specific to 2017, a change in future federal income tax rates due to tax reform, non-deductible transaction costs, and the non-taxable bargain purchase gain recorded on the Nivalis merger.
Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. The following table represents the significant components of our deferred tax assets and liabilities for the periods presented (in thousands):
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|
December 31, |
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|
|
|
2017 |
|
|
2016 |
|
||
|
Deferred tax assets: |
|
|
|
|
|
|
|
|
|
Net operating loss |
|
$ |
2,475 |
|
|
$ |
— |
|
|
Deferred compensation |
|
|
— |
|
|
|
24 |
|
|
Research and development credits |
|
|
458 |
|
|
|
103 |
|
|
Intangible asset basis |
|
|
— |
|
|
|
16 |
|
|
Deferred revenue |
|
|
58 |
|
|
|
800 |
|
|
Deferred rent |
|
|
24 |
|
|
|
58 |
|
|
Stock based compensation |
|
|
810 |
|
|
|
3 |
|
|
Other |
|
|
12 |
|
|
|
— |
|
|
Gross deferred tax assets |
|
|
3,837 |
|
|
|
1,004 |
|
|
Valuation allowance |
|
|
(3,722 |
) |
|
|
(786 |
) |
|
Total deferred tax assets, net of valuation allowance |
|
|
115 |
|
|
|
218 |
|
|
Deferred tax liabilities: |
|
|
|
|
|
|
|
|
|
Prepaid expenses |
|
|
(63 |
) |
|
|
(12 |
) |
|
Fixed asset basis |
|
|
(110 |
) |
|
|
(206 |
) |
|
Intangible asset basis |
|
|
(247 |
) |
|
|
|
|
|
Total deferred tax liability |
|
|
(420 |
) |
|
|
(218 |
) |
|
Net deferred tax assets and liabilities |
|
$ |
(305 |
) |
|
$ |
— |
|
As part of the merger with Nivalis, we identified $1.5 million of acquired IPR&D. IPR&D acquired in a business combination is an indefinite-lived intangible asset until the completion or abandonment of the associated R&D efforts. Once the R&D efforts are completed or abandoned, the IPR&D will either be impaired or amortized over the asset life as a finite-lived intangible.
As the acquired IPR&D is not completed, and has not been abandoned, it is considered indefinite-lived for accounting purposes. Any future reversal of a deferred tax liability resulting from IPR&D costs cannot be scheduled for tax purposes and therefore cannot be considered as a source of future taxable income. Thus, we have recorded a deferred tax liability of $305,000 as a result of the acquired IPR&D having a financial reporting basis of $1.5 million and a tax basis of zero.
A valuation allowance is provided for deferred tax assets where the recoverability of the assets is uncertain. The determination to provide a valuation allowance is dependent upon the assessment of whether it is more likely than not that sufficient taxable income will be generated to utilize the deferred tax assets. Based on the weight of the available evidence, which includes our historical operating losses, uncertainty of future taxable income, and the accumulated deficit, we provided a full valuation allowance against our deferred tax assets. The valuation allowance increased by $2.9 million and $629,000 during the year ended December 31, 2017 and December 31, 2016, respectively.
We have net operating loss carryforwards as follows (in thousands):
|
|
|
December 31, |
|
|||||
|
|
|
2017 |
|
|
2016 |
|
||
|
Federal |
|
$ |
11,784 |
|
|
$ |
— |
|
Federal and state net operating loss carryforwards would begin to expire in 2037.
We have net research and development tax credit carryforwards as follows (in thousands):
|
|
|
December 31, |
|
|||||
|
|
|
2017 |
|
|
2016 |
|
||
|
Federal |
|
$ |
458 |
|
|
$ |
103 |
|
Federal research and development tax credit carryforwards begin to expire in 2035.
Current tax laws impose substantial restrictions on the utilization of R&D credit and net operating loss carryforwards in the event of an ownership change, as defined by the Internal Revenue Code Section 382 and 383. Such an event may limit our ability to utilize our net operating losses and R&D tax credit carryforwards. Under Internal Revenue Code Section 382 and 383, the Q3 2017 merger with Nivalis is likely considered an ownership change with respect to the potential limitation of the Nivalis federal tax credits and net operating losses. As such, it is likely that any future utilization of Nivalis federal tax credits and net operating losses is substantially limited.
Therefore, as of December 31, 2017, all Nivalis tax credit and net operating loss carryforwards have been reduced to zero.
We account for uncertainty in income taxes in accordance with ASC 740. Tax positions are evaluated in a two-step process, whereby we first determine whether it is more likely than not that a tax position will be sustained upon examination by the tax authority, including resolutions of any related appeals or litigation processes, based on technical merit. If a tax position meets the more-likely-than-not recognition threshold it is then measured to determine the amount of benefit to recognize in the financial statements. The tax position is measured as the largest amount of benefit that is greater than 50% likely of being realized upon ultimate settlement.
The following table summarized the activity related to unrecognized tax benefits (in thousands):
|
|
|
December 31, |
|
|||||
|
|
|
2017 |
|
|
2016 |
|
||
|
Unrecognized benefits – beginning of year |
|
$ |
34 |
|
|
$ |
7 |
|
|
Gross decreases – prior year tax positions |
|
|
(4 |
) |
|
|
— |
|
|
Gross increases – current year tax positions |
|
|
84 |
|
|
|
27 |
|
|
Unrecognized benefit – end of year |
|
$ |
114 |
|
|
$ |
34 |
|
All of the unrecognized tax benefits as of December 31, 2017 are accounted for as a reduction in our deferred tax assets. Due to our valuation allowance, none of the $114,000 of unrecognized tax benefits would affect our effective tax rate, if recognized. We do not believe it is reasonably possible that our unrecognized tax benefits will significantly change in the next twelve months.
We recognize interest and penalties related to unrecognized tax benefits as income tax expense. There were no accrued interest or penalties related to unrecognized tax benefits for 2017 and 2016.
We do not expect any significant change in our unrecognized tax benefits during the next twelve months.
Our material income tax jurisdictions are the United States (federal), and California (state). We are subject to audit for tax years 2012 and forward for federal purposes, and 2015 and forward for California.