13. INCOME TAXES

Currently, we file a consolidated U.S. federal income tax return. The effective income tax rate from continuing operations varies from the federal statutory rate of 35 percent as follows (in thousands):

	Year Ended July 31,

	2013			2012			2011
Federal income tax expense (benefit) at statutory rate	$	4,177		$	(8,936	)	$	(38,750	)
State income taxes, net of federal benefit		858			(2,767	)		(4,250	)
Tax on repatriation of foreign earnings		3,954			5,950			14,099
Foreign tax rate changes and differential(a)		577			225			(1,274	)
Change in valuation allowance		(6,977	)		2,285			44,406
Depreciation and amortization adjustment(b)		—			—			(8,512	)
Other		(665	)		4,608			(4,162	)

Income tax expense	$	1,924		$	1,365		$	1,557

Effective income tax rate		16.1	%		(5.3	)%		(1.4	)%

(a): For the past three years, Canada has reduced both its federal statutory and provincial tax rates. In fiscal year 2012, Puerto Rico reduced its federal statutory tax rate. Foreign tax rate differential represents the difference between the statutory tax rate in the U.S. and the statutory tax rates in Canada and Puerto Rico.
(b): The $8.5 million adjustment in fiscal year 2011 was fully offset with a valuation allowance, resulting in no impact to the consolidated statement of operations.

The provision for income taxes from continuing operations consists of the following (in thousands):

	Year Ended July 31,

	2013			2012			2011
Current income tax expense (benefit):
Federal	$	232		$	349		$	(9,628	)
Foreign		1,131			664			5,003
State		(604	)		(1,206	)		910

Total current income tax expense (benefit)		759			(193	)		(3,715	)

Deferred income tax expense:
Federal		102			(166	)		5,114
Foreign		986			1,675			159
State		77			49			(1	)

Total deferred income tax expense		1,165			1,558			5,272

	$	1,924		$	1,365		$	1,557

Deferred tax assets and liabilities are determined based on the estimated future tax effects of the difference between the financial statement and tax basis of asset and liability balances using statutory tax rates. Tax effects of temporary differences that give rise to significant components of the deferred tax assets and deferred tax liabilities at July 31, 2013 and 2012, respectively, are as follows (in thousands):

	Year Ended July 31,

	2013			2012
Assets:
Accrued liabilities	$	78,754		$	84,515
Inventory reserves		7,220			7,083
Deferred income		14,033			—
Net operating loss carryforward		100,407			120,277
Stock-based compensation		7,067			7,160
Investments in subsidiaries		3,177			1,752
Foreign tax credits		13,978			12,609
Property and equipment		9,355			9,326
Other		2,854			5,986

Total deferred tax assets		236,845			248,708
Valuation allowances		(92,149	)		(98,995	)

Total deferred tax assets, net	$	144,696		$	149,713

Liabilities:
Merchandise inventories, principally due to LIFO reserve	$	(129,273	)	$	(119,256	)
Undistributed earnings		—			(13,973	)
Goodwill		(13,869	)		(13,941	)
Other		(3,963	)		(3,853	)

Total deferred tax liabilities		(147,105	)		(151,023	)

Deferred tax liabilities, net	$	(2,409	)	$	(1,310	)

Deferred tax assets and liabilities in the accompanying consolidated balance sheets are as follows (in thousands):

	Year Ended July 31,

	2013			2012
Other current assets	$	3,495		$	4,150
Deferred tax asset		107,110			96,929
Deferred tax liability		(107,016	)		(96,662	)
Other liabilities		(5,998	)		(5,727	)

Deferred tax liabilities, net	$	(2,409	)	$	(1,310	)

We are required to assess the available positive and negative evidence to estimate if sufficient future income will be generated to utilize deferred tax assets. A significant piece of negative evidence that we consider is cumulative losses (generally defined as losses before income taxes) incurred over the most recent three-year period. Such evidence limits our ability to consider other subjective evidence such as our projections for future growth. As of July 31, 2013 and 2012, cumulative losses were incurred over the applicable three-year period.

Our valuation allowances totaled $92.1 million and $99.0 million as of July 31, 2013 and 2012, respectively. The valuation allowances were established due to the uncertainty of our ability to utilize certain federal, state and foreign net operating loss carryforwards in the future. The amount of the deferred tax asset considered realizable could be adjusted if negative evidence, such as three-year cumulative losses, no longer exists and additional consideration is given to our growth projections.

Deferred tax assets associated with foreign tax credits totaled $14.0 million and $12.6 million as of July 31, 2013 and 2012, respectively. The net operating loss carryforwards, including foreign tax credits, expire from fiscal year 2014 to fiscal year 2033. These carryforwards may be subject to limitations under Section 382 of the Internal Revenue Code if significant ownership changes occur in the future.

In fiscal year 2011, we recorded income tax benefits totaling $4.6 million related to tax refunds associated with net operating loss carrybacks pursuant to the Worker, Homeownership and Business Assistance Act of 2009 (the "Business Assistance Act"). The Business Assistance Act was enacted in November 2009 and includes provisions that extend the time period in which net operating loss carrybacks can be utilized from two to five years, with certain limitations.

Income tax refunds, net of taxes paid, during fiscal years 2013, 2012 and 2011 totaled $2.2 million, $0.8 million and $1.0 million, respectively.

Uncertain Tax Positions

We operate in a number of tax jurisdictions and are subject to examination of our income tax returns by tax authorities in those jurisdictions who may challenge any item on these returns. Because the tax matters challenged by tax authorities are typically complex, the ultimate outcome of these challenges is uncertain. In accordance with ASC 740, Income Taxes, we recognize the benefits of uncertain tax positions in our financial statements only after determining that it is more likely than not that the uncertain tax positions will be sustained.

The total amount of unrecognized tax benefits as of July 31, 2013 was $3.5 million, of which $2.5 million would favorably impact the effective tax rate if resolved in our favor. Over the next twelve months, management does not anticipate that the amount of unrecognized tax benefits will be materially reduced due to our tax position being sustained upon audit or as a result of the expiration of the statute of limitations for specific jurisdictions.

A reconciliation of the fiscal year 2013 beginning and ending balance of unrecognized tax benefits is as follows (in thousands):

	Unrecognized Tax Benefits

Balance at July 31, 2012	$	3,631
Additions based on tax positions related to prior years		555
Settlements with tax authorities		(341	)
Expiration of statute of limitations		(331	)

Balance at July 31, 2013	$	3,514

We recognize accrued interest and penalties related to unrecognized tax benefits in our income tax expense. We had $1.5 million, $1.9 million and $2.6 million of interest and penalties accrued at July 31, 2013, 2012 and 2011, respectively. There was no material interest expense in fiscal years 2013, 2012 and 2011.