Income Taxes
For pre-Spin-Off periods, CTI was part of the Liberty federal consolidated tax group, and federal income taxes were paid to (or refunded by) Liberty pursuant to the terms of a tax sharing agreement under which taxes were computed on a separate company basis. Following the Spin-Off, CommerceHub is a separate, stand-alone federal taxpayer. The tax provision included in these consolidated financial statements has been prepared on a stand-alone basis, as if CommerceHub was not part of the Liberty consolidated group. Accordingly, the effective tax rate of the Company in future years could vary from its historical effective tax rates depending on, among other factors, the Company's legal structure and related tax elections from time to time.
Liberty filed income tax returns in the U.S. federal jurisdiction, various state jurisdictions and the United Kingdom. In the normal course of business, Liberty is subject to examination by various taxing authorities. All tax years prior to 2015 are closed. Liberty's 2015 and 2016 tax years are being examined currently under the IRS's Compliance Assurance Process ("CAP") program. The 2015 and 2016 examinations are substantially complete and are expected to be formally closed in the first quarter of 2018. The statute of limitations periods in the applicable state jurisdictions vary, but generally expire three to four years from the due date or filing of the tax return.
Beginning with the 2016 post-Spin-Off period and for subsequent periods, CommerceHub files income tax returns in the U.S. federal jurisdiction, various state jurisdictions and the United Kingdom. CommerceHub has historically filed stand-alone income tax returns in various state jurisdictions and has expanded the list of states in the post-Spin-Off period. In the normal course of business, CommerceHub is subject to examination by various taxing authorities. CommerceHub's 2016 post-Spin-Off tax return is currently "open" and is not eligible to participate in the CAP program. The statute of limitations periods in the various state jurisdictions in which CommerceHub historically filed stand-alone income tax returns vary, but generally expire three to four years from the due date or filing of the tax return.
Income tax expense (benefit) consists of the following at December 31 (in thousands): |
| | | | | | | | | | | |
| 2017 | | 2016 | | 2015 |
Current | |
| | |
| | |
Federal | $ | 10,884 |
| | $ | (11,497 | ) | | $ | 7,931 |
|
State and local | 1,411 |
| | (2,674 | ) | | 2,477 |
|
Foreign | 10 |
| | 7 |
| | — |
|
Total current | 12,305 |
| | (14,164 | ) | | 10,408 |
|
Deferred | |
| | |
| | |
|
Federal | 2,815 |
| | 15,869 |
| | (9,942 | ) |
State and local | 756 |
| | 5,457 |
| | (2,347 | ) |
Total deferred | 3,571 |
| | 21,326 |
| | (12,289 | ) |
Total tax expense (benefit) | $ | 15,876 |
| | $ | 7,162 |
| | $ | (1,881 | ) |
There were no uncertain tax positions as of December 31, 2017 or December 31, 2016. There were no accrued interest or penalties recognized in the consolidated balance sheet as of December 31, 2017 and December 31, 2016.
Income tax expense differed from the amounts computed by applying the U.S. federal income tax rate of 35% to income (loss) before taxes as a result of the following for the years ended December 31 (in thousands): |
| | | | | | | | | | | |
| 2017 | | 2016 | | 2015 |
Computed "expected" tax expense | $ | 9,007 |
| | $ | 5,690 |
| | $ | (2,222 | ) |
Increase (decrease) resulting from: | |
| | |
| | |
|
Impact of the Tax Act on deferred tax assets | 3,161 |
| | — |
| | — |
|
Section 162(m) adjustment | 3,276 |
| | — |
| | — |
|
State tax law change | — |
| | 1,524 |
| | — |
|
State and local income taxes, net of federal income tax benefit | 852 |
| | 284 |
| | (21 | ) |
Impact of state rate change on deferred taxes | 293 |
| | — |
| | 105 |
|
Non-deductible expenses | 21 |
| | 66 |
| | 228 |
|
Excess share-based compensation deduction | (157 | ) | | — |
| | — |
|
Market adjustment for options exercised | — |
| | 127 |
| | 319 |
|
Write-off federal NOL | — |
| | 122 |
| | — |
|
Research and development tax credits | (559 | ) | | (649 | ) | | (368 | ) |
Other | (18 | ) | | (2 | ) | | 78 |
|
Total tax expense (benefit) | $ | 15,876 |
| | $ | 7,162 |
| | $ | (1,881 | ) |
The increase in income tax expense was due to increased pre-tax book income of $25.7 million in the year ended December 31, 2017 as compared to pre-tax book income of $16.3 million in 2016. In addition, the U.S. Tax Cuts and Jobs Act ("Tax Act") was enacted on December 22, 2017 and introduces significant changes to U.S. income tax law. Effective in 2018, the Tax Act reduces the U.S. statutory tax rate from 35% to 21%, among other changes. Accordingly, we have adjusted our deferred income taxes as of December 22, 2017 to reflect the reduced rate that will apply in future periods when these deferred taxes are settled or realized, which resulted in a deferred tax expense of $3.2 million.
In addition, actual income tax expense for the year ended December 31, 2017 was greater than the federal income tax rate of 35% due to an immaterial error correction recorded in 2017 associated with limitations on deductions under Section 162(m) of the Internal Revenue Code (the “IRC”) with respect to certain share-based compensation awards granted prior to the Spin-Off, which limit the Company’s future deductions on these share-based compensation awards in our stand-alone provision beginning at the Spin-Off. The Company did not appropriately reflect these Section 162(m) limitations on our deferred tax asset at the time of the Spin-Off in 2016. As a result, fiscal 2016 deferred income tax expense was understated by approximately $3.3 million, with a corresponding overstatement of deferred tax assets. The $3.3 million effect of this error was corrected in the fourth quarter of 2017 and is incorporated in our 2017 tax expense and included in the “Section 162(m) adjustment” in the table above.
Furthermore, the increase in income tax expense in 2016 as compared to the benefit in 2015 is primarily due to pre-tax book income of $16.3 million in 2016 as compared to a pre-tax book loss of $6.3 million in 2015. In 2016, actual income tax expense was greater than the amounts computed by applying the U.S. federal income tax rate of 35%, primarily due to an immaterial error correction recorded in 2016 associated with a change in tax law in New York State (“NY”). This tax law change, which was enacted in 2014 and effective in 2015, revised the method used to determine NY apportionment. We did not appropriately update the NY apportionment rate to reflect the impact of this law change in 2014. The $1.5 million net effect of this error was corrected in the fourth quarter of 2016 and is incorporated in our 2016 income tax expense, and included in “State tax law change” in the table above.
Based on our assessment of the quantitative and qualitative factors, these errors and related impacts, both individually and in the aggregate, were not considered material to the consolidated financial statements for any periods in which these errors originated, and correction of these errors was not considered material to our 2016 or 2017 consolidated financial statements.
The write-off of federal net operating loss carryforwards ("NOLs") is the result of forfeiting one year of IRC Section 382 limitations described below and NOLs in conjunction with the Spin-Off, as both the pre- and post-Spin-Off periods in 2016 count against the available number of periods, while the amount of NOLs we are limited to in 2016 does not change.
The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities are presented below (in thousands) at December 31:
|
| | | | | | | |
| 2017 | | 2016 |
Deferred tax assets: | |
| | |
|
Accounts receivable allowances | $ | 268 |
| | $ | 75 |
|
Deferred revenue | 1,695 |
| | 2,721 |
|
Accrued liabilities | 965 |
| | 426 |
|
Shared-based compensation | 3,106 |
| | 5,948 |
|
Net operating loss | 1,852 |
| | 3,999 |
|
Other | 59 |
| | 1 |
|
Total deferred tax assets | 7,945 |
| | 13,170 |
|
Deferred tax liabilities: | |
| | |
|
Software and deferred costs | 1,909 |
| | 4,372 |
|
Property and equipment | 238 |
| | 1,084 |
|
Total gross deferred tax liabilities | 2,147 |
| | 5,456 |
|
Net deferred tax asset | $ | 5,798 |
| | $ | 7,714 |
|
In assessing the realizability of deferred tax assets, management considers whether it is more-likely-than-not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Management considered the scheduled reversal of deferred tax liabilities and projected future taxable income in making this assessment. Based upon the level of projections for future taxable income over the periods in which the deferred tax assets are deductible, management believes it is more-likely-than-not that the Company will realize the benefits of these deductible differences.
During the year ended December 31, 2016, the exercise of a significant portion of share-based compensation awards created a tax deductible expense, and reduced our deferred tax asset related to share-based compensation awards by $31.3 million. The deductions generated estimated gross federal NOLs of approximately $74.7 million. As allowed under the tax sharing agreement between the Company and Liberty entered into prior to the Spin-Off, $49.1 million of these NOLs were utilized to refund federal income taxes paid to Liberty in the prior two tax years. In accordance with the same tax sharing agreement, subject to finalizing our 2016 pre-Spin-Off federal tax return, the estimated remaining federal NOLs of $25.6 million were forfeited and recorded as an equity distribution to Liberty upon the Spin-Off in 2016. During the year ended December 31, 2017, upon finalizing our consolidated federal returns for the pre-spin period, we adjusted the amount of remaining gross federal NOLs we ultimately forfeited to Liberty. The adjustment totaled $5.1 million, which was recorded as an equity distribution to Liberty in 2017 and is included in the change in additional paid-in capital on our consolidated balances sheets for 2017.
As of December 31, 2017, we had unused federal NOLs that were acquired as part of the Mercent acquisition. Under IRC Section 382, if it is determined that, due to transactions involving CommerceHub's shares owned by its 5 percent or greater shareholders, a change of ownership has occurred under the provisions of IRC Section 382, our federal NOLs could be subject to IRC Section 382 limitations.
Based on studies of the changes in ownership of Mercent at acquisition, we have determined that IRC Section 382 ownership changes did occur, which limit the amount of NOLs that can be used in future years. As of December 31, 2017, we had a total of $7.9 million in unused NOLs, of which approximately $1.5 million of NOLs are available to be utilized each year from 2018 to 2019, and approximately $350 thousand of NOLs are available to be utilized each year from 2020 to 2033.