Note 11. Income Taxes

We account for income taxes under the asset and liability method, which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the consolidated financial statements. We perform an evaluation of the realizability of our deferred tax assets on a quarterly basis. This evaluation considers all positive and negative evidence and factors, such as the scheduled reversal of temporary differences, historical and projected future taxable income, and prudent and feasible tax planning strategies. The estimates and assumptions used by us in computing the income taxes reflected in our consolidated financial statements could differ from the actual results reflected in the income tax returns filed during the subsequent year. Adjustments are recorded based on filed returns when such returns are finalized or the related adjustments are identified.

The following is a geographical breakdown of consolidated net income (loss) before income tax:



	Year Ended September 30,
	2013			2012			2011
United States	$	14,354		$	12,392		$	(10,234	)
Foreign	(36,743		)	(16,740		)	1,603
Total income (loss) before income tax	$	(22,389	)	$	(4,348	)	$	(8,631	)

For 2013, 2012 and 2011, income tax expense consisted of the following:



	Year Ended September 30,
	2013			2012			2011
Current income taxes:
Federal	$	5,343		$	491		$	(338	)
State and local	646			613			244
Foreign	3,297			3,511			1,390
Current income tax expense	9,286			4,615			1,296
Deferred income taxes:
Federal	(3,052		)	1,276			606
State and local	(560		)	(513		)	157
Foreign	(2,741		)	(2,151		)	174
Deferred income tax expense	(6,353		)	(1,388		)	937
Income tax expense	$	2,933		$	3,227		$	2,233

Our effective tax rate reflects the inability of the Company to recognize a tax benefit associated with the losses from our Dutch licensing company, partially offset by income from the revaluation of the contingent consideration which is not subject to income taxes. A reconciliation of our effective income tax rate on income before taxes with the federal statutory rate is as follows:



	Year Ended September 30,
	2013	2012	2011
Statutory rate	35.0%	35.0%	35.0%
State and local taxes, net of federal income taxes	(1.0)	(5.5)	0.9
Research and development tax credits	7.5	11.8	23.0
Reserves for uncertainty in income taxes	(1.8)	(6.1)	(3.8)
Foreign rate differentials	(62.3)	(151.7)	3.2
Change in valuation allowance	1.8	(16.5)	(3.0)
Nondeductible expense	(7.5)	(3.6)	(18.0)
Acquisition-related contingent consideration	17.3	57.7	(56.6)
Other	(2.1)	4.7	(6.6)
Effective tax rate	(13.1)%	(74.2)%	(25.9)%

Our deferred income tax assets and liabilities reflect the net effect of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. We record deferred tax assets for the future tax benefit of net operating losses, share-based compensation, and tax credit carryforwards. Significant components of our deferred tax assets and liabilities as of September 30, 2013 and 2012, are as follows:



	September 30,
	2013			2012
Domestic deferred tax assets:
Net operating loss carryforwards	$	18,816		$	8,069
Credit carryforwards	6,290			11,167
Deferred revenue	33,290			28,196
Share-based compensation	27,320			21,347
Other compensation	3,110			4,874
Unrealized gains/losses	3,228			1,688
Deferred rent	3,793			266
Other	1,294			1,320
Total domestic deferred tax assets	97,141			76,927
Less: valuation allowance	(4		)	(145		)
Net domestic deferred tax assets	97,137			76,782

Domestic deferred tax liabilities:
Intangible assets	(9,381		)	(10,305		)
Property and equipment	(12,154		)	(13,463		)
Deferred costs	(29,258		)	(24,718		)
Convertible debt	(14,931		)	(210		)
Other	(2,219		)	(184		)
Total domestic deferred tax liabilities	(67,943		)	(48,880		)
Net domestic deferred tax asset	$	29,194		$	27,902



	September 30,
	2013			2012
Foreign deferred tax assets:
Net operating loss carryforwards	$	7,569		$	3,741
Deferred revenue	909			1,368
Share-based compensation	1,884			1,480
Compensation	554			217
Other	844			307
Total foreign deferred tax assets	11,760			7,113
Less: valuation allowance	(5,845		)	(3,073		)
Net foreign deferred tax assets	5,915			4,040

Foreign deferred tax liabilities:
Intangible assets	(4,877		)	(3,975		)
Deferred costs	(56		)	(83		)
Other	(233		)	(506		)
Total foreign deferred tax liabilities	(5,166		)	(4,564		)
Net foreign deferred tax liability	$	749		$	(524	)

The deferred tax valuation allowance increased by $2.6 million in 2013, as compared to an increase of $2.9 million for 2012. The increase in the valuation allowance for 2013 was primarily due to the deferred tax asset related to acquired foreign net operating losses offset by a release of the valuation allowance for the deferred tax assets related to foreign net operating losses we expect to realize.

To the extent that we are able to generate consistent taxable income within those operations with valuation allowances, we may reduce the valuation allowances, thereby reducing the income tax expense and increasing net income in the period the determination is made.

As a result of certain realization requirements of ASC 718, the above table of deferred tax assets and liabilities does not include certain deferred tax assets as of September 30, 2013 and 2012 that arose directly from (or the use of which was postponed by) tax deductions related to share-based compensation arrangements in excess of compensation recognized for financial reporting. Those deferred tax assets include net operating loss carryforwards (“NOL”) and research and development tax credits. Equity will be increased by $64.3 million if and when such deferred tax assets are ultimately realized. We use ASC 740 ordering for purposes of determining when excess tax benefits have been realized.

As of September 30, 2013, we had total federal net operating loss carryforwards in the amount of $211.0 million, which will expire in the years 2020 to 2031. As of September 30, 2013, we had total foreign net operating loss carryforwards in the amount of $28.8 million, most of which can be carried forward subject to various time limits. As of September 30, 2013, we had federal research and development credits in the amount of $11.2 million, which will expire in the years 2017 to 2033.

Our utilization of net operating loss carryforwards may be subject to annual limitations due to ownership change provisions of Internal Revenue Code Section 382 and similar foreign and state provisions. The annual limitations could result in the expiration of net operating losses before they can be utilized.

A provision for income taxes has not been made for the undistributed earnings of foreign subsidiaries of approximately $4.8 million as of September 30, 2013. We intend to reinvest these earnings for the foreseeable future and if these amounts were distributed to the United States, in the form of dividends or otherwise, we would be subject to additional U.S. income taxes. The unrecognized deferred tax liability for these indefinitely reinvested foreign earnings was approximately $1.8 million as of September 30, 2013.

We conduct business in the Republic of the Philippines, which grants “holidays” from income taxes for four to six year periods. These holidays expire in 2018. Without these tax “holidays,” we would have incurred aggregate income taxes of $149 in 2013 with an immaterial related earnings per share impact.

During the ordinary course of our business, there are many transactions and calculations for which the ultimate tax determination is uncertain. We establish reserves for tax-related uncertainties based on estimates of whether, and the extent to which, additional taxes will be due. These reserves are established when we believe that certain positions might be challenged despite our belief that our tax return positions are fully supportable. We adjust these reserves in light of changing facts and circumstances, such as the outcome of a tax audit. The provision for income taxes includes the impact of reserve provisions and changes to reserves that are considered appropriate.

The reconciliation of our tax contingencies is as follows:



	Year Ended September 30,
	2013			2012
Gross tax contingencies — beginning of year	$	5,115		$	4,869
Increase due to acquisition	—			—
Gross increases to tax positions in prior periods	473			640
Gross decrease to tax positions in prior periods	(141		)	(205		)
Gross increases to current period tax positions	477			227
Gross decrease due to expiration	(408		)	(416		)
Gross tax contingencies — end of year	$	5,516		$	5,115

At September 30, 2013, and 2012, the amount of unrecognized tax benefits that, if recognized, would impact the effective tax rate was $5.5 million and $4.9 million, respectively. We do not anticipate any significant changes to our unrecognized tax benefits within the next 12 months. Consistent with prior periods, we recognize interest and penalties related to unrecognized tax benefits in the provision for income taxes. The accrued interest at September 30, 2013 would not have a material impact on the effective tax rate if reversed. The provision for income taxes for each of the fiscal years ended September 30, 2013 and 2012 includes interest expense on unrecognized income tax benefits for current and prior years, which is not significant to our consolidated statements of operations.

We are subject to income taxes in the United States and numerous foreign jurisdictions. In the normal course of business, we are subject to examination by the Internal Revenue Service and various foreign jurisdictions and have different years open which are subject to audit.

Immaterial Balance Sheet Reclassification and Revision

Certain prior-year amounts have been reclassified to conform to the current year presentation. In the accompanying September 30, 2012 balance sheet, $17.4 million has been reclassified from non-current deferred tax assets to current deferred tax assets, leaving the non-current deferred taxes in a net liability position of $1.1 million.

The accompanying September 30, 2012 balance sheet has been revised from its previous presentation to present certain deferred taxes related to employee share-based payment awards as current. Previously, the company recorded such amounts as non-current tax assets. GAAP requires that deferred taxes which are to be realized within one year of the balance sheet date be recognized as current assets. This revision, which management has determined to be immaterial, had no impact on previously reported sales, operating expenses, operating cash flow or cash position.