INCOME TAXES

Income tax expense is summarized as follows:

	Years Ended January 31,
	2017			2016			2015
	(in thousands)
Current:
Federal	$	437		$	(1,656	)	$	174
State		30			26			109
Foreign		3,894			2,591			3,010
Subtotal		4,361			961			3,293
Deferred:
Federal		11,564			(956	)		(786	)
State		3,610			303			229
Foreign		(348	)		63			(348	)
Subtotal		14,826			(590	)		(905	)
Equity adjustment		89			1,253			251
Total	$	19,276		$	1,624		$	2,639

Actual income tax expense differs from that obtained by applying the statutory federal income tax rate of

34%

to income before income taxes as follows:

	Years Ended January 31,
	2017			2016			2015
	(in thousands)
Computed expected tax expense	$	1,301		$	3,582		$	5,299
State income taxes, net of federal income tax expense		(54	)		252			253
Incremental tax expense (benefit) from foreign operations		137			(2,548	)		(5,220	)
Non-deductible equity compensation		(29	)		254			258
Foreign withholding taxes		676			968			1,256
Net change in valuation allowance		16,861			2,564			1,657
Net change in contingency reserve		198			(379	)		(594	)
Non-deductible expenses		660			621			742
Benefit of tax credits		(1,243	)		(3,186	)		(1,345	)
Subpart F income		345			254			283
Rate change impact		19			193			54
Benefit from liquidation utilized		—			(1,321	)		—
Other		405			370			(4	)
	$	19,276		$	1,624		$	2,639

Consolidated U.S. (loss) before income taxes was

$(3.8)

million,

$(7.8)

million, and

$(2.4)

million, for the fiscal years ended

January

31,

2017,

2016

and

2015,

respectively. The corresponding income before income taxes for foreign operations was

$7.6

million,

$18.4

million, and

$18.0

million for the fiscal years ended

January

31,

2017,

2016

and

2015,

respectively.

The Company files U.S. federal, state, and foreign tax returns that are subject to audit by various tax authorities. The Company is currently under audit in:

●

India for fiscal years ended

March

31,

1998,

1999,

2010,

2013,

2014,

2015

and

2016

●

State of Iowa for fiscal year

2014

●

China for calendar years

2013,

2014,

2015

and

2016

U.S. income and foreign withholding taxes have not been recorded on permanently reinvested earnings of our foreign subsidiaries. These permanently reinvested earnings are approximately

$83.2

million at

January

31,

2017.

It is not practicable for the Company to determine the amount of the related unrecognized deferred income tax liability. Such earnings would become taxable upon the sale or liquidation of these subsidiaries or upon the remittance of dividends.

Deferred income taxes reflect the net effects of the temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes.

Significant components of the Company’s deferred tax assets and liabilities are as follows:

	January 31,
	2017			2016
	(in thousands)
Deferred tax assets:
Allowance for doubtful accounts and sales adjustments	$	356		$	486
Accrued vacation		2,033			1,900
Tax credits		13,116			11,025
Deferred revenue		3,465			3,520
Net operating loss carry forwards		10,255			7,965
Accrued expenses - other		1,695			1,557
Other comprehensive income		—			1,483
Section 263(a) interest capitalization		322			333
Equity compensation		5,399			4,631
Other		2,039			2,111
Total deferred tax assets		38,680			35,011
Less valuation allowance		(29,868	)		(13,480	)
Less netting of unrecognized tax benefits against deferred tax assets		(954	)		(1,042	)
Deferred tax assets, net of valuation allowance	$	7,858		$	20,489
Deferred tax liabilities:
Depreciation and amortization		(630	)		(249	)
Other comprehensive income		(1,009	)		—
Other		(53	)		(118	)
Total deferred tax liabilities		(1,692	)		(367	)
Total net deferred tax assets	$	6,166		$	20,122

The Company reviews its net deferred tax assets by jurisdiction on a quarterly basis to determine whether a valuation allowance is necessary based on the more-likely-than-not standard. During the

fourth

quarter of the fiscal year ended

January

31,

2017

management considered all available positive and negative evidence to determine whether, based on the weight of that evidence, a valuation allowance was needed. Management assessed historic, current and future financial projections by jurisdiction to draw its conclusion. For the U.S. federal jurisdiction, the positive evidence was outweighed by the U.S.

three

-year cumulative loss, a fiscal

2018

projected loss, and future earmarked investment necessary to transition the business to cloud. Management concluded that the weight of this negative evidence warranted placing a full valuation allowance on all its U.S. federal net deferred tax assets. The majority of QAD’s state deferred tax assets are California research and development tax credits. This jurisdiction was analyzed separately because QAD’s California return is filed on a worldwide basis. A significant decrease in current and forecast income both within and outside the US, along with a recent significant drop in the California apportionment percentage, led management to conclude that a full valuation allowance on QAD’s state deferred tax assets was also necessary. In total, a full valuation allowance of

$16.3

million was placed against QAD’s U.S. federal and state net deferred tax assets. If and when the Company’s operating performance improves on a sustained basis, the conclusion regarding the need for a valuation allowance could change, resulting in the reversal of some or all of the valuation allowance in the future. At

January

31,

2017

and

2016,

the valuation allowance attributable to deferred tax assets was

$29.9

million and

$13.5

million, respectively.

The Company has gross net operating loss carryforwards of

$35.5

million and tax credit carryforwards of

$16.4

million as of

January

31,

2017.

The majority of the Company’s net operating loss carryforwards do not expire, the remaining begin to expire in fiscal year

2035.

The majority of the Company’s tax credits carryforwards do not expire, the remaining begin to expire in fiscal year

2019.

During the fiscal year ended

January

31,

2017,

the Company increased its reserves for uncertain tax positions by

$0.2

million. Interest and penalties on accrued but unpaid taxes are classified in the Consolidated Statements of Operations and Comprehensive (Loss) Income as income tax expense. The liability for unrecognized tax benefits that

may

be recognized in the next

twelve

months is classified as short-term in the Company’s Consolidated Balance Sheet while the remainder is classified as long-term.

The following table reconciles the gross amounts of unrecognized tax benefits at the beginning and end of the period:

	Years Ended January 31,
	2017			2016
	(in thousands)
Unrecognized tax benefits at beginning of the year	$	1,545		$	1,924
Decreases as a result of tax positions taken in a prior period		(79	)		(17	)
Increases as a result of tax positions taken in the current period		365			15
Reduction as a result of a lapse of the statute of limitations		(88	)		(288	)
Decreases as a result of tax settlements		—			(89	)
Unrecognized tax benefit at end of year	$	1,743		$	1,545

All of the unrecognized tax benefits included in the balance sheet at

January

31,

2017

would impact the effective tax rate on income from continuing operations, if recognized.

The total amount of interest recognized in the Consolidated Statement of Operations and Comprehensive (Loss) Income for unpaid taxes was

$69,000

for the year ended

January

31,

2017.

The total amount of interest and penalties recognized in the Consolidated Balance Sheet at

January

31,

2017

was

$0.3

million.

The Company files U.S. federal, state, and foreign income tax returns in jurisdictions with varying statute of limitations. The years that

may

be subject to examination will vary by jurisdiction. Below is a list of our material jurisdictions and the years open for audit as of fiscal

2017:

Jurisdiction	Years Open for Audit
U.S. Federal	FY14 and beyond
California	FY13 and beyond
Michigan	FY13 and beyond
New Jersey	FY13 and beyond
Australia	FY13 and beyond
France	FY14 and beyond
India	FY98, FY99, FY10, FY13 and beyond
Ireland	FY13 and beyond
United Kingdom	FY16 and beyond