Note 4 - Income Taxes

12 Months Ended

Jan. 31, 2021

Notes to Financial Statements

Income Tax Disclosure [Text Block]

4. INCOME TAXES

The provision for income taxes is computed using the asset and liability method. Under this method, deferred tax assets and liabilities are recognized for the expected future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis and operating losses and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax laws is recognized in the Consolidated Statements of Operations and Comprehensive Income (Loss) in the period that includes the enactment date.

The Company utilizes a two-step approach to recognizing and measuring uncertain income tax positions (tax contingencies). The first step is to evaluate the tax position for recognition by determining if the weight of available evidence indicates it is more likely than not that the position will be sustained on audit, including resolution of related appeals or litigation processes. The second step is to measure the tax benefit as the largest amount which is more than 50% likely of being realized upon ultimate settlement. The Company considers many factors when evaluating its tax positions and estimating its tax benefits, which may require periodic adjustments. The Company includes interest and penalties related to its tax contingencies in income tax expense.

Valuation allowances are established when necessary to reduce deferred tax assets to the amounts that are more likely than not expected to be realized based on the weight of positive and negative evidence. Future realization of deferred tax assets ultimately depends on the existence of sufficient taxable income within the carryback or carryforward periods available under the applicable tax law. The Company regularly reviews its deferred tax assets for recoverability based on historical taxable income, projected future taxable income, the expected timing of the reversals of existing temporary differences and tax planning strategies. The Company’s judgments regarding future profitability may change due to many factors, including future market conditions and the ability to successfully execute its business plans. Should there be a change in the ability to recover deferred tax assets, the tax provision would increase or decrease in the period in which the assessment is changed.

The domestic and foreign components of income (loss) before (benefit from) provision for income taxes consisted of the following:

	Years Ended January 31,
	2021		2020			2019
	(in thousands)
Domestic net income before income taxes	$	7,725	$	2,963		$	6,562
Foreign net income  (loss) before income taxes		3,096		(6,567	)		5,355
Income (loss) before income taxes	$	10,821	$	(3,604	)	$	11,917

Income tax (benefit) expense is summarized as follows:

	Years Ended January 31,
	2021			2020			2019
	(in thousands)
Current:
U.S. federal	$	997		$	471		$	(829	)
State		37			130			(13	)
Foreign		2,376			2,149			3,784
Subtotal		3,410			2,750			2,942
Deferred:
U.S. federal		3			25			79
State		6			(107	)		(30	)
Foreign		(3,663	)		9,677			(1,502	)
Subtotal		(3,654	)		9,595			(1,453	)
Total	$	(244	)	$	12,345		$	1,489

Actual income tax (benefit) expense differs from that obtained by applying the statutory federal income tax rate to income before income taxes as follows:

	Years Ended January 31,
	2021			2020			2019
	(in thousands)
Computed expected tax expense (benefit)	$	2,272		$	(757	)	$	2,503
State income taxes, net of federal income tax expense		272			(581	)		96
Incremental tax expense from foreign operations		1,708			1,256			715
Equity compensation		(958	)		(4,198	)		(2,916	)
Foreign withholding taxes		1,619			1,103			1,089
Net change in valuation allowance		(3,438	)		16,179			3,224
Net change in uncertain tax positions		125			3			(71	)
Non-deductible expenses		(41	)		218			1,149
Benefit of tax credits		(2,569	)		(1,719	)		(3,483	)
Subpart F income		611			27			101
U.S. Tax Reform (the Tax Act)		—			—			(1,312	)
Rate change impact		123			867			124
Other		32			(53	)		270
Total income tax (benefit) expense	$	(244	)	$	12,345		$	1,489

When calculating QAD’s income tax expense for fiscal 2021, the Company considered the Tax Cuts and Job Act (The Tax Act). The Company calculated an estimate for global intangible low-tax income (GILTI) in the Company’s tax expense based on the final GILTI regulations released on July 20, 2020 by the U.S. Department of Treasury. The final regulations allow taxpayers to exclude certain high-taxed income of a controlled foreign corporation from their GILTI computation on an elective basis. These regulations provide computational, definitional, and anti-avoidance rule guidance relating to the determination of a U.S. shareholder’s GILTI inclusion. In fiscal year 2021, cash taxes were not impacted by GILTI since the Company has enough net operating loss carryforward to offset this liability. In fiscal years 2020 and 2019, tax expense was not impacted by GILTI since the Company experienced losses overseas.

The Company has elected to treat the deferred taxes related to GILTI provisions as a current-period expense when incurred (the period cost method).

As of January 31, 2021, the Company continues to maintain its permanent reinvestment assertion under APB 23 for all of its foreign subsidiaries as it relates to withholding taxes, state taxes and currency translation. These permanently reinvested earnings are approximately $90 million at January 31, 2021. It is not practicable for the Company to determine the amount of the related unrecognized deferred income tax liability.

Deferred Income Taxes

Deferred income taxes reflect the net tax effect of 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,
	2021			2020
	(in thousands)
Deferred tax assets:
Allowance for doubtful accounts and sales adjustments	$	700		$	600
Accrued vacation		1,305			1,499
Tax credits		24,312			22,077
Deferred revenue		2,670			3,136
Lease liabilities		5,046			4,142
Net operating loss carryforwards		13,794			15,475
Accrued expenses - other		2,543			2,038
Other comprehensive income		3,624			1,603
Section 263(a) interest capitalization		182			190
Intellectual property		4,583			6,250
Equity compensation		4,219			3,579
Carryforward of Irish amortization		5,728			3,614
Other		718			1,767
Total deferred tax assets		69,424			65,970
Less valuation allowance		(48,571	)		(50,972	)
Less netting of unrecognized tax benefits against deferred tax assets		(968	)		(973	)
Deferred tax assets, net of valuation allowance	$	19,885		$	14,025
Deferred tax liabilities:
Depreciation and amortization		(612	)		(851	)
Acquisition accounting basis differences		(2,514	)		—
Costs to obtain and fulfill contracts		(3,081	)		(3,054	)
ASC 842 lease right of use assets		(4,756	)		(3,931	)
Other liabilities		(396	)		(355	)
Total deferred tax liabilities		(11,359	)		(8,191	)
Total net deferred tax assets	$	8,526		$	5,834

Valuation Allowance

The Company reviews its net deferred tax assets by entity at each balance sheet date to determine whether a valuation allowance is necessary based on the more-likely-than-not standard. During fiscal year 2021, management considered all available evidence, both positive and negative, to determine whether, based on the weight of that evidence, a valuation allowance was needed. Management assessed the transfer pricing methodology, the historical profits, the economics of the country in which the entity operates, the current and future customer base, the type and character of the deferred tax asset and any other current and relevant information by entity to draw its conclusion.

In fiscal year 2021, the Company continued to apply a valuation allowance against its U.S. federal and state net deferred tax assets due to a U.S. three-year cumulative loss and future earmarked investment in research and development. When the Company’s operating performance improves on a sustained basis, the conclusion regarding the need for a valuation allowance may change, resulting in the reversal of some or all of the valuation allowance in the future.

Based on the weight of evidence both positive and negative, the Company continued to maintain a full valuation allowance on the Irish principal’s net deferred tax assets in fiscal year 2021 as the negative evidence, which consisted of a three-year cumulative loss, and future earmarked investment outweighed the positive evidence.

The valuation allowance on the Company’s German and Hong Kong entities was released during fiscal 2021 after management concluded that these entities will “more-likely-than-not” be able to utilize the remaining net operating losses within the foreseeable future.

A valuation allowance has been established for select foreign jurisdictions along with U.S. federal and state net deferred tax assets. The following table discloses the Company’s valuation allowance by entity (in millions): 

Jurisdiction	January 31, 2021		January 31, 2020
U.S. federal and state	$	30.3	$	30.3
Irish principal		12.0		11.6
Brazil		6.1		5.7
Germany		-		2.6
Hong Kong		-		0.6
South Africa		0.2		0.2
Total valuation allowance	$	48.6	$	51.0

Net Operating Losses and Tax Credits

The Company has deferred tax asset net operating loss carryforwards of $13.8 million and tax credit carryforwards of $24.3 million as of January 31, 2021. The majority of the Company’s net operating loss carryforwards do not expire. The following table shows the Company’s credit carryforwards (in thousands):

Credit Carryforwards	January 31, 2021
Foreign tax credit	$	6,338
Federal R&D credit		8,336
State R&D credit		9,380
AMT credit and New hire retention		258
Total credit	$	24,312

The Company’s U.S. R&D credits, California R&D credits and U.S. foreign tax credits have been valued. The Company had $14,000 of U.S. R&D tax credits that expired in October 2020 and the remaining U.S. R&D credits will begin to expire in fiscal year 2027. The majority of the Company’s state and foreign R&D tax credits do not expire. The Company’s foreign tax credits will begin to expire in fiscal year 2028.

Unrecognized Tax Benefits

During the fiscal year ended January 31, 2021, the Company increased its reserves for uncertain tax positions by $0.1 million. Interest and penalties on accrued but unpaid taxes are classified in the Consolidated Statements of Operations and Comprehensive Income (Loss) 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 Sheets 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,
	2021			2020
	(in thousands)
Unrecognized tax benefits at beginning of the year	$	1,171		$	1,168
Decreases as a result of tax positions taken in a prior period		—			—
Increases as a result of tax positions taken in the prior period		130			143
Reduction as a result of a lapse of the statute of limitations		(5	)		(37	)
Decreases as a result of settlements with taxing authorities		—			(103	)
Unrecognized tax benefit at end of year	$	1,296		$	1,171

All of the unrecognized tax benefits included in the Consolidated Balance Sheet at January 31, 2021 would impact the effective tax rate on income (loss) from continuing operations, if recognized.

The total amount of interest recognized in the Consolidated Statement of Operations and Comprehensive Income (Loss) for unpaid taxes was $22,000 for the year ended January 31, 2021. The total amount of interest and penalties accrued in the Consolidated Balance Sheet at January 31, 2021 was $0.1 million.

Audit Status and Open Statutes

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, 2010, 2013, and 2018*

● France for fiscal years ended January 31, 2018, 2019 and 2020

During fiscal 2021, the Company closed the following audits with no adjustments:

● Germany for fiscal years ended January 31, 2015, 2016 and 2017

● Thailand for fiscal year ended January 31, 2018

● Mexico for fiscal years ended December 31, 2015, 2016, 2017 and 2018

● India for fiscal year ended March 31, 2018*

*QAD has had multiple audits of different subsidiaries in India. One of these audits for the fiscal year ended March 31, 2018 has been closed and another audit for the same year remains open.

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 general years open for audit as of January 31, 2021:

Jurisdiction	Years Open for Audit
U.S. federal	Fiscal year 2018 and beyond
California	Fiscal year 2017 and beyond
Michigan	Fiscal year 2017 and beyond
New Jersey	Fiscal year 2017 and beyond
Australia	Fiscal year 2017 and beyond
France	Fiscal year 2018 and beyond
India	Fiscal years 2010, 2013 and 2019
Ireland	Fiscal year 2017 and beyond
United Kingdom	Fiscal year 2020 and beyond
China	Calendar year 2016 and beyond
Mexico	Calendar year 2016 and beyond