Income Taxes
The Company accounts for income taxes in accordance with authoritative guidance, which requires the use of the asset and liability method. Under this method, deferred income tax assets and liabilities are determined based upon the difference between the consolidated financial statement carrying amounts and the tax basis of assets and liabilities and are measured using the enacted tax rate expected to apply in the years in which the differences are expected to be reversed.
The following table presents domestic and foreign components of income (loss) before income taxes for the periods presented:
|
| | | | | | | | | | | |
| Year Ended December 31, |
| 2015 | | 2016 | | 2017 |
| (in thousands) |
United States | $ | 1,258 |
| | $ | (137,197 | ) | | $ | (117,715 | ) |
Foreign | (1,046 | ) | | (52,593 | ) | | 540 |
|
Total income (loss) before income taxes | $ | 212 |
| | $ | (189,790 | ) | | $ | (117,175 | ) |
The components of the provision (benefit) for income taxes consisted of the following:
|
| | | | | | | | | | | |
| Year Ended December 31, |
| 2015 | | 2016 | | 2017 |
| (in thousands) |
Current: | | | | | |
U.S. federal | $ | 1,827 |
| | $ | 328 |
| | $ | 319 |
|
State | 696 |
| | 744 |
| | 2,610 |
|
Foreign | 1,699 |
| | 2,312 |
| | 2,597 |
|
Total current provision | 4,222 |
| | 3,384 |
| | 5,526 |
|
Deferred: |
| |
| |
|
U.S. federal | (1,103 | ) | | (44,447 | ) | | (36,854 | ) |
State | 1,952 |
| | (6,225 | ) | | (3,243 | ) |
Foreign | (818 | ) | | (10,037 | ) | | 9,377 |
|
Change in valuation allowance | 7,089 |
| | (52,533 | ) | | 7,913 |
|
Total deferred provision | 7,120 |
| | (113,242 | ) | | (22,807 | ) |
Total expense (benefit) | $ | 11,342 |
| | $ | (109,858 | ) | | $ | (17,281 | ) |
The Company established a valuation allowance on substantially all of its deferred tax assets during the year ended December 31, 2013. The benefit had been reduced after the establishment of the valuation allowance by the deferred tax expense associated with the tax amortization of assets that have an indefinite life for U.S. GAAP purposes. The Company maintained a valuation allowance against certain U.S. deferred tax assets until the acquisition of Constant Contact. The acquisition of Constant Contact resulted in a significant increase in deferred tax liabilities, which far exceeded deferred tax assets. The Company scheduled out the reversal of the consolidated U.S. deferred tax assets and liabilities as of March 31, 2016, and determined that these reversals would be sufficient to realize most domestic deferred tax assets. The deferred tax liabilities supporting the realizability of these deferred tax assets will reverse in the same period, are in the same jurisdiction and are of the same character as the temporary differences that gave rise to these deferred tax assets. As a result, the Company recorded a deferred tax benefit to reverse the valuation allowances during the year ended December 31, 2016. The Company recorded a valuation allowance against the majority of the state research and development tax credits and state investment tax credits, a portion of state operating loss credit carry-forwards, federal and state capital loss carry-forwards, and federal research credits which the Company projected to expire prior to utilization. During the year ended December 31, 2017, the Company recorded a deferred tax benefit of $22.8 million, which was mostly attributable to the lower tax rates from the 2017 Tax and Jobs Act.
The following table presents a reconciliation of the statutory federal rate, and the Company’s effective tax rate, for the periods presented:
|
| | | | | | | | |
| Year Ended December 31, |
| 2015 | | 2016 | | 2017 |
U.S. federal taxes at statutory rate | 34.0 | % | | 35.0 | % | | 35.0 | % |
State income taxes, net of federal benefit | 685.0 |
| | 0.9 |
| | 0.6 |
|
Nondeductible stock-based compensation | 827.3 |
| | (1.5 | ) | | (7.9 | ) |
Nondeductible litigation expenses | — |
| | — |
| | (7.9 | ) |
Nondeductible transaction costs | 856.5 |
| | (2.9 | ) | | — |
|
Nontaxable gain on redemption of equity interest | (674.9 | ) | | — |
| | — |
|
Other foreign permanent differences | 187.8 |
| | (0.4 | ) | | (2.9 | ) |
Credits | — |
| | 3.7 |
| | 1.1 |
|
Foreign rate differential | 299.7 |
| | (4.6 | ) | | 1.2 |
|
Change in valuation allowance—U.S. | 3,398.6 |
| | 31.2 |
| | (16.1 | ) |
Change in valuation allowance—foreign | (130.8 | ) | | (4.1 | ) | | 9.5 |
|
Rate change | 216.5 |
| | 0.4 |
| | 7.5 |
|
Prior year true-up stock-based compensation—U.S. | (132.8 | ) | | — |
| | — |
|
Other | (217.5 | ) | | (0.5 | ) | | (5.2 | ) |
Total | 5,349.4 | % | | 57.2 | % | | 14.9 | % |
The favorable impact of the change in valuation allowance in the U.S., which reduced the Company's effective rate by 16.1%, was mostly attributable to the enactment of lower tax rates as part of the 2017 Tax and Jobs Act.
The provision (benefit) for income taxes shown on the consolidated statements of operations differs from amounts that would result from applying the statutory tax rates to income before taxes primarily because of the release of the valuation allowance on U.S. deferred tax assets, state income taxes, the impact of changes in state apportionment, jurisdiction mix of earnings, nondeductible expenses, as well as the application of valuation allowances against foreign deferred tax assets.
The significant components of the Company’s deferred income tax assets and liabilities are as follows:
|
| | | | | | | |
| As of December 31, |
| 2016 | | 2017 |
Deferred income tax assets: | | | |
Net operating loss carry forward | $ | 76,060 |
| | $ | 47,098 |
|
Credit carryforward | 28,271 |
| | 27,337 |
|
Other | 5,414 |
| | (327 | ) |
Deferred compensation | 364 |
| | 215 |
|
Deferred revenue | 26,291 |
| | 19,729 |
|
Other reserves | 3,545 |
| | (72 | ) |
Stock-based compensation | 25,424 |
| | 14,887 |
|
Total deferred income tax assets | 165,369 |
| | 108,867 |
|
Deferred income tax liabilities: | | | |
Purchased intangible assets | (119,719 | ) | | (47,580 | ) |
Goodwill | (37,099 | ) | | (27,922 | ) |
Property and equipment | (12,403 | ) | | (9,024 | ) |
Total deferred income tax liabilities | (169,221 | ) | | (84,526 | ) |
Valuation allowance | (36,091 | ) | | (44,068 | ) |
Net deferred income tax liabilities | $ | (39,943 | ) | | $ | (19,727 | ) |
The Company conducts business globally and, as a result, its subsidiaries file income tax returns in U.S. federal and state jurisdictions and various foreign jurisdictions. In the normal course of business, the Company may be subject to examination by taxing authorities throughout the world, including such major jurisdictions as Brazil, India, the United Kingdom, the Netherlands and the United States.
In the normal course of business, the Company is subject to examination by tax authorities throughout the world. Since the Company is in a loss carry-forward position, the Company is generally subject to U.S. federal and state income tax examinations by tax authorities for all years for which a loss carry-forward is utilized. The Company's Constant Contact subsidiary is currently under an Internal Revenue Service audit in the United states for the periods ended December 31, 2015 and February 9, 2016 (short period), India for fiscal years ended March 31, 2014 and 2015 and Israel for the fiscal years ended December 31, 2012, 2013, 2014 and 2015. At this time, the Company does not expect material changes as a result of the audits.
The statute of limitations in the Company’s other tax jurisdictions, in the United Kingdom and Brazil, remains open for various periods between 2011 and the present. However, carryforward attributes from prior years may still be adjusted upon examination by tax authorities if they are used in an open period.
The Company recognizes, in its consolidated financial statements, the effect of a tax position when it is more likely than not, based on the technical merits, that the position will be sustained upon examination. The Company has unrecognized tax benefits for uncertain tax positions of $0.0 million and $1.1 million at December 31, 2016 and 2017, respectively, that would affect its effective tax rate. The Company records interest related to unrecognized tax benefits in interest expense and penalties in operating expense. The Company recognized immaterial interest and penalties related to unrecognized tax benefits during the years ended December 31, 2015, 2016 and 2017.
The Company does not expect a significant change in the liability for unrecognized tax benefits in the next 12 months. |
| | | |
Unrecognized tax benefits at December 31, 2016 | $ | — |
|
Addition for tax positions of prior years | 734 |
|
Addition for tax positions of current year | 395 |
|
Unrecognized tax benefits at December 31, 2017 | $ | 1,129 |
|
The Company regularly assesses its ability to realize its deferred tax assets. Assessing the realization of deferred tax assets requires significant management judgment. In determining whether its deferred tax assets are more likely than not realizable, the Company evaluated all available positive and negative evidence, and weighted the evidence based on its objectivity. Evidence the Company considered included:
•Net Operating Losses (“NOL”) incurred from the Company’s inception to December 31, 2017;
•Expiration of various federal and state tax attributes;
•Reversals of existing temporary differences;
•Composition and cumulative amounts of existing temporary differences; and
•Forecasted profit before tax.
Prior to the acquisition of Constant Contact, the Company maintained a valuation allowance against certain deferred tax assets. The acquisition of Constant Contact resulted in a significant increase in deferred tax liabilities, which far exceeded pre-acquisition deferred tax assets. The Company, with the significant deferred tax liabilities resulting from the acquisition, scheduled out the reversal of the consolidated U.S. deferred tax assets and liabilities as of March 31, 2016, and determined that these reversals would be sufficient to realize most domestic deferred tax assets.
The deferred tax liabilities supporting the realizability of these deferred tax assets in the acquisition will reverse in the same period, are in the same jurisdiction and are of the same character as the temporary differences that gave rise to these deferred tax assets. The Company maintained a valuation allowance on the acquired Massachusetts research and development tax credits and limited life investment tax credit carry-forwards and a portion of the acquired Colorado and Utah operating loss carry-forwards. The Company maintained its valuation allowance on the several of the legacy state net operating loss carry-forwards expected to expire unused as a result of the scheduling analysis. As a result, the Company recorded a tax benefit of $70.6 million to reverse valuation allowances during the year ended December 31, 2016. The Company performed a deferred scheduling analysis as of December 31, 2016, and as a result recorded a valuation allowance against $7.8 million of federal research credits, $1.2 million of federal and state capital loss carry-forwards, and $1.0 million of additional state net operating losses, which resulted in Company recording an increase in tax expense of $10.0 million related to the increase in the U.S. valuation allowance.
The Company assessed its ability to realize its U.S. deferred tax assets as of December 31, 2017 and determined that it was more likely than not that the Company would not realize $37.9 million of net deferred tax assets. The Company assessed its ability to realize its foreign deferred tax assets as of December 31, 2017 and determined that it was more likely than not that the Company would not realize $2.4 million of net deferred tax assets in the United Kingdom, $3.4 million of net deferred tax assets in the Netherlands, $0.0 million of net deferred tax assets in Singapore, $0.2 million of net deferred tax assets in Israel, and $0.2 million of net deferred tax assets in China.
For the years ended December 31, 2015, 2016 and 2017, the Company has recognized a tax expense (benefit) of $11.3 million, $(109.9) million and $(17.3) million, respectively, in the consolidated statements of operations and comprehensive loss.
The income tax benefit for the year ended December 31, 2017 was primarily attributable to a federal and state deferred tax benefit of $21.8 million (which includes a $16.9 million tax benefit pertaining to the federal tax rate change as a result of the Tax Cut and Jobs Act of 2017 and the identification and recognition of $1.2 million of U.S. federal and state tax credits) and a foreign deferred tax benefit of $1.0 million, offset by a provision for federal and state current income taxes of $1.8 million, a reserve of $1.1 million for unrecognized tax benefits, and foreign current tax expense of $2.6 million.
The income tax expense for the year ended December 31, 2016 is primarily attributable to a provision for federal and state current income taxes of $1.1 million, foreign current tax expense of $2.3 million, federal and state deferred tax benefit of $111.2 million, which is attributable to the $70.6 million release of valuation allowance and $40.6 million of deferred tax benefit related to an increase in deferred tax assets, and foreign deferred benefit of $2.0 million related to the reductions of deferred liabilities created in purchase accounting.
The income tax expense for the year ended December 31, 2015 is primarily attributable to a provision for federal and state current income taxes of $2.5 million, foreign current tax expense of $1.7 million, federal and state deferred tax expense of $0.8 million and attributable to a $7.1 million increase in the valuation allowance, partially offset by a foreign deferred benefit of $0.8 million related to the reduction of deferred liabilities to fair value as as result of purchase accounting.
As of December 31, 2017, the Company had NOL carry-forwards available to offset future U.S. federal taxable income of approximately $157.6 million and future state taxable income of approximately $128.6 million. These NOL carry-forwards expire on various dates through 2037.
As of December 31, 2017, the Company had NOL carry-forwards in foreign jurisdictions available to offset future foreign taxable income by approximately $26.7 million. The Company has loss carry-forwards that begin to expire in 2021 in China totaling $0.7 million. The Company has loss carry-forwards that begin to expire in 2020 in the Netherlands totaling $12.6 million. The Company also has loss carry-forwards in the United Kingdom and Singapore of $13.2 million and $0.2 million, respectively, which have an indefinite carry-forward period.
In addition, the Company has $3.4 million of U.S. federal capital loss carry-forwards and $1.4 million in state capital loss-forwards, generally expiring through 2021. As of December 31, 2017, the Company had U.S. tax credit carry-forwards available to offset future U.S. federal and state taxes of approximately $17.6 million and $12.3 million, respectively. These credit carry-forwards expire on various dates through 2037.
Utilization of the NOL carry-forwards may be subject to an annual limitation due to the ownership percentage change limitations under Section 382 of the Internal Revenue Code (“Section 382 limitation”). Ownership changes can limit the amount of net operating loss and other tax attributes that a company can use each year to offset future taxable income and taxes payable. In connection with a change in control in 2011, the Company was subject to Section 382 annual limitations of $77.1 million against the balance of NOL carry-forwards generated prior to the change in control in 2011. Through December 31, 2013, the Company accumulated the unused amount of Section 382 limitations in excess of the amount of NOL carry-forwards that were originally subject to limitation. Therefore, these unused NOL carry-forwards are available for future use to offset taxable income. The Company has completed an analysis of changes in its ownership from 2011, through its IPO, to December 31, 2013. The Company concluded that there was not a Section 382 ownership change during this period and therefore any NOLs generated through December 31, 2013, are not subject to any new Section 382 annual limitations on NOL carry-forwards. On November 20, 2014, the Company completed a follow-on offering of 13,000,000 shares of common stock. The underwriters also exercised their overallotment option to purchase an additional 1,950,000 shares of common stock from the selling stockholders. The Company performed an analysis of the impact of this offering and determined that no Section 382 change in ownership had occurred.
On March 11, 2015, the Company closed a follow-on offering of its common stock, in which selling stockholders sold 12,000,000 shares of common stock at a public offering price of $19.00 per share. The underwriter also exercised its overallotment option to purchase an additional 1,800,000 shares of common stock from the selling stockholders. The Company completed an analysis of its ownership changes in the first half of 2016, which resulted in no ownership-change for tax purposes within the meaning of the Internal Revenue Code Section 382(g).
As of the date of the Company’s acquisition of Constant Contact, Constant Contact had approximately $60.2 million and $32.4 million of federal and state NOLs, respectively, and approximately $10.9 million of U.S. federal research and development credits and $9.2 million of state credits. These losses and credits are not subject to limitation under Internal Revenue Code Sections 382 and 383.
As a result, all unused NOL carry-forwards at December 31, 2017 are available for future use to offset taxable income.
Permanent Reinvestment of Foreign Earnings
As of December 31, 2017, the cumulative amount of undistributed earnings of the Company's foreign subsidiaries amounted to $24.8 million. The Company has not provided U.S. taxes on these undistributed earnings of its foreign subsidiaries that it considers indefinitely reinvested. This indefinite reinvestment determination is based on the future operational and capital requirements of the Company's domestic and foreign operations. The Company expects that the cash held by its foreign subsidiaries of $11.3 million will continue to be used for its foreign operations and therefore does not anticipate repatriating these funds.
Included within the Tax Cuts and Jobs Act of 2017 were changes to Subpart F rules and a requirement for taxation of the aggregate net unrepatriated foreign earnings accumulated before January 1, 2018. These changes did not impact the Company in 2017 and we do not expect the Subpart F changes to have a material impact in the future. Except for Subpart F income, the Company has not provided taxes for the remaining $24.8 million of undistributed earnings of its profitable foreign subsidiaries because we plan to keep these amounts permanently reinvested overseas except for instances where we can remit such earnings to the U.S. without an associated net tax cost. If the Company decides to repatriate the foreign earnings, it would need to adjust its income tax provision in the period it determines that the earnings will no longer be indefinitely invested outside the United States. Due to the timing and circumstances of repatriation of such earnings, if any, it is not practicable to determine the unrecognized deferred tax liability relating to such amounts.
Adoption of ASU 2016-09
In March 2016, the FASB issued ASU 2016-09, Compensation-Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting (“ASU 2016-09”). ASU 2016-09 intends to simplify various aspects of how share-based payments are accounted for and presented in the financial statements. The main provisions include: all tax effects related to stock awards will now be recorded through the income statement instead of through equity, all tax-related cash flows resulting from stock awards will be reported as operating activities on the cash flow statement, and entities can make an accounting policy election to either estimate forfeitures or account for forfeitures as they occur. The amendments in ASU 2016-09, required to be updated for all annual periods and interim reporting periods beginning after December 15, 2016, were adopted early by the Company in the fourth quarter of 2016 and were applied to its related consolidated financial statements on a prospective basis. The adoption of these amendments had an impact of $0.9 million on the consolidated statement of operations and comprehensive loss through December 31, 2016 due to the reclassification of shortfalls from additional paid in capital. The Company also elected to account for forfeitures as they occur with no adjustment for estimated forfeitures, which had an impact of $0.9 million to the Company’s consolidated statement of operations and comprehensive loss.
As previously mentioned, as a result of prior guidance that required excess tax benefits reduce taxes payable prior to recognition as an increase in paid in capital, the Company had not recognized certain deferred tax assets (loss carry-forwards) that could be attributed to tax deductions related to equity compensation in excess of compensation recognized for financial reporting. As of January 1, 2016, the Company had generated U.S. federal and state net operating loss carry-forwards due to excess tax benefits of $1.5 million and $0.7 million, respectively.
Tax Cuts and Jobs Act
On December 22, 2017, the United States enacted tax reform legislation through the Tax Cuts and Jobs Act,which significantly changes the existing U.S. tax laws, including a reduction in the corporate tax rate from 35% to 21%, a move from a worldwide tax system to a territorial system, as well as other changes. As a result of enactment of the legislation, we incurred an additional one-time income tax benefit on the re-measurement of certain deferred tax assets and liabilities in the amount of $16.9 million. The legislation also introduced substantial international tax reform that moves the U.S. toward a territorial system, in which income earned in other countries will generally not be subject to U.S. taxation. The accumulated foreign earnings of U.S. shareholders of certain foreign corporations will be subject to a one-time transition tax. Amounts held in cash or cash equivalents will be subject to a 15.5 percent tax, while amounts held in illiquid assets will be subject to an eight percent tax. Due to an accumulated deficit in the undistributed earnings of its foreign subsidiaries, the one-time transition tax will not apply to the Company. Although the Company has substantially completed its work on the effects of the Tax Reform Act, management continues to evaluate certain sections of the new law that may be pertinent to the Company's tax situation.