Note 13 — Income Taxes

The Company is incorporated in Switzerland but operates in various countries with differing tax laws and rates. Further, a portion of the Company's income before taxes and the provision for income taxes are generated outside of Switzerland.

Income before income taxes for the fiscal years ended March 31, 2011, 2010 and 2009 is summarized as follows (in thousands):


	Year ended March 31,
	2011		2010		2009
Income before income taxes:
Swiss	$	50,219	$	13,352	$	40,717
Non-Swiss		98,229		70,271		86,076

Total	$	148,448	$	83,623	$	126,793

The provision for income taxes is summarized as follows (in thousands):


	Year ended March 31,
	2011			2010			2009
Current:
Swiss	$	(1,073	)	$	1,463		$	53
Non-Swiss		26,218			22,279			32,274
Deferred:
Swiss		—			—			(36	)
Non-Swiss		(5,157	)		(5,076	)		(12,530	)

Total	$	19,988		$	18,666		$	19,761

The difference between the provision for income taxes and the expected tax provision at the statutory income tax rate is reconciled below (in thousands):


	Year ended March 31,
	2011			2010			2009
Expected tax provision at statutory income tax rates	$	12,618		$	7,108		$	10,777
Income taxes at different rates		6,476			10,473			9,370
Research and development tax credits		(2,315	)		(1,628	)		(2,524	)
Unrealized investment income		(315	)		(428	)		1,004
Stock compensation		551			713			618
Transaction costs		—			1,257			—
Valuation allowance		2,309			—			—
Other		664			1,171			516

Total provision for income taxes	$	19,988		$	18,666		$	19,761

The Company negotiated a tax holiday on certain earnings in China which was effective from January 2006 through December 2010. The tax holiday was a tax exemption aimed to attract foreign technological investment in China. The tax holiday decreased income tax expense by approximately $3.6 million, $2.4 million, and $4.0 million for fiscal years 2011, 2010 and 2009. The benefit of the tax holiday on net income per share (diluted) was approximately $0.02, $0.01 and $0.02 in fiscal years 2011, 2010 and 2009.

On December 17, 2010, the enactment in the U.S. of the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 extended retroactively through the end of calendar year 2011 the U.S. federal research and development credit, which had expired on December 31, 2009. Accordingly, the Company's income tax provision for the fiscal year ended March 31, 2011 includes a tax benefit of $2.2 million related to the U.S. federal research tax credit.

The U.S. state of California has enacted legislation affecting the methodology which must be used by corporate taxpayers to apportion income to California. These changes will become effective for our fiscal year ending March 31, 2012. The Company anticipates that the election to use only sales in apportioning income to California will lower the effective state tax rate in the future. The Company's income tax provision as of March 31, 2011 reflects an income tax expense of $0.4 million from adjustments to deferred tax assets resulting from the change in the effective state tax rate.

Deferred income tax assets and liabilities consist of the following (in thousands):


	March 31,
	2011			2010
Deferred tax assets:
Net operating loss carryforwards	$	33,029		$	40,878
Tax credit carryforwards		5,645			3,367
Accruals		35,172			35,346
Depreciation and amortization		12,310			11,473
Share-based compensation		21,997			17,438
Valuation allowance		(2,309	)		—

Gross deferred tax assets		105,844			108,502

Deferred tax liabilities:
Acquired intangible assets		(24,013	)		(37,264	)

Gross deferred tax liabilities		(24,013	)		(37,264	)

Net deferred tax assets	$	81,831		$	71,238

The current and deferred tax provision is calculated based on estimates and assumptions that could differ from the actual results reflected in income tax returns filed. Adjustments for differences between the tax provisions and tax returns are recorded when identified, which is generally in the third or fourth quarter of the subsequent year.

Management regularly assesses the ability to realize deferred tax assets recorded in the Company's entities based upon the weight of available evidence, including such factors as recent earnings history and expected future taxable income. In the event that future taxable income is below management's estimates or is generated in tax jurisdictions different than projected, the Company could be required to establish a valuation allowance for deferred tax assets. This would result in an increase in the Company's effective tax rate.

The Company established $2.3 million of valuation allowance in fiscal year 2011. In March 2011, the Company sold its equity interest in certain 3Dconnexion subsidiaries, and its intellectual property rights related to the manufacture and sale of certain 3Dconnexion products, to a group of third party individuals and certain 3Dconnexion employees. A full valuation allowance of $2.2 million was provided for $5.7 million of capital loss carryforward from the sale of 3Dconnexion Inc. in the U.S. as the Company determined that it is more likely than not that the Company would not generate adequate capital gains in the next five years before the capital loss expires under the U.S. tax law. The remaining valuation allowance of $0.1 million represents a full valuation allowance for certain foreign tax credit carryforwards in the U.S.

Deferred tax assets relating to tax benefits of employee stock option grants and RSUs have been reduced to reflect exercises in fiscal years 2011 and 2010. Some exercises resulted in tax deductions in excess of previously recorded benefits based on the option value at the time of grant ("windfalls"). Although these additional tax benefits are reflected in net operating loss carryforwards, the additional tax benefit associated with the windfall is not recorded until the deduction reduces cash taxes payable. During fiscal years 2011 and 2010, the Company recorded a credit to equity of $4.8 million and $0.3 million.

As of March 31, 2011, the Company had foreign net operating loss and tax credit carryforwards for income tax purposes of $285.9 million and $25.4 million. Approximately $121.7 million of the net operating loss carryforwards and $20.2 million of the tax credit carryforwards, if realized, will be credited to equity since they have not met the applicable realization criteria. A full valuation allowance has been provided for foreign tax credits of $0.1 million. Unused net operating loss carryforwards will expire at various dates in fiscal years 2014 to 2031, and the tax credit carryforwards will begin to expire in fiscal year 2012.

As of March 31, 2011, the Company had capital loss carryforwards of approximately $5.7 million for which a full valuation allowance has been provided. The loss will begin to expire in fiscal year 2016.

Swiss income taxes and non-Swiss withholding taxes associated with the repatriation of earnings or for other temporary differences related to investments in non-Swiss subsidiaries have not been provided for, as the Company intends to reinvest the earnings of such subsidiaries indefinitely or the Company has concluded that no additional tax liability would arise on the distribution of such earnings. If these earnings were distributed to Switzerland in the form of dividends or otherwise, or if the shares of the relevant non-Swiss subsidiaries were sold or otherwise transferred, the Company may be subject to additional Swiss income taxes and non-Swiss withholding taxes. Determination of the amount of unrecognized deferred income tax liability related to these earnings is not practicable.

The Company follows a two-step approach to recognizing and measuring uncertain tax positions. The first step is to evaluate the tax position for recognition by determining if the weight of available evidence indicates that it is more likely than not that the position will be sustained on audit, including resolution of related appeals or litigation processes, if any. The second step is to measure the tax benefit as the largest amount that is more than 50% likely of being realized upon ultimate settlement.

As of March 31, 2011 and 2010, the total amount of unrecognized tax benefits was $138.1 million and $125.2 million, of which $118.2 million and $101.4 million would affect the effective income tax rate if realized. The Company classified the unrecognized tax benefits as non-current income taxes payable.

The aggregate changes in gross unrecognized tax benefits in fiscal years 2011, 2010 and 2009 were as follow (in thousands):


Beginning balance as of March 31, 2008	$	92,647
Lapse of statute of limitations		(1,978	)
Increases in balances related to tax positions taken during the current period		6,958

Balance as of March 31, 2009	$	97,627
Lapse of statute of limitations		(3,667	)
Decreases in balances related to tax positions taken during prior periods		(229	)
Increases in balances related to tax positions taken during prior periods		2,690
Increases in balances related to tax positions taken during the current period		17,207

Balance as of March 31, 2010	$	113,628
Lapse of statute of limitations		(4,760	)
Settlements with tax authorities		(6,290	)
Increases in balances related to tax positions taken during the current period		27,550

Balance as of March 31, 2011	$	130,128

The Company continues to recognize interest and penalties related to unrecognized tax positions in income tax expense. The Company recognized $1.3 million, $1.9 million and $1.8 million in interest and penalties in income tax expense during fiscal years 2011, 2010 and 2009. As of March 31, 2011, 2010 and 2009, the Company had approximately $8.0 million, $12.5 million and $10.7 million of accrued interest and penalties related to uncertain tax positions.

The Company files Swiss and foreign tax returns. For all these tax returns, the Company is generally not subject to tax examinations for years prior to 1999. During the third quarter of fiscal year 2011, the U.S. Internal Revenue Service expanded its examination of the Company's U.S. subsidiary to include fiscal years 2008 and 2009 in addition to fiscal years 2006 and 2007. At this time it is not possible to estimate the potential impact that the examination may have on income tax expense. The Company is also under examination in other jurisdictions.

Although the Company has adequately provided for uncertain tax positions, the provisions on these positions may change as revised estimates are made or the underlying matters are settled or otherwise resolved. Although the timing of the resolution or closure on audits is highly uncertain, the Company does not believe it is reasonably possible that the unrecognized tax benefits would materially change in the next twelve months.