Income Taxes

12 Months Ended

Mar. 31, 2020

Income Taxes

Income Taxes

(17) Income Taxes

The income before income tax expense shown below is based on the geographic location to which such income is attributed for each of the fiscal years ended March 31, 2020, 2019 and 2018:

	Year Ended March 31,
	2020		2019		2018
United States	$	25,528	$	9,454	$	(31,526)
Foreign		23,133		28,710		73,362
Total	$	48,661	$	38,164	$	41,836

The provision for income taxes for each of the fiscal years ended March 31, 2020, 2019 and 2018 consisted of the following:

	March 31,
	2020		2019		2018
Current provision:
Federal	$	(736)	$	672	$	18,747
State		995		447		(108)
Foreign		(2,133)		21,124		24,195
Total current provision	$	(1,874)	$	22,243	$	42,834
Deferred (benefit) provision:
Federal	$	(3,135)	$	(315)	$	(1,289)
State		1,692		1,105		(2,726)
Foreign		3,626		(2,560)		(5,931)
Total deferred (benefit) provision	$	2,183	$	(1,770)	$	(9,946)
Total provision for income taxes	$	309	$	20,473	$	32,888

The items which gave rise to differences between the income taxes in the statements of income and the income taxes computed at the U.S. statutory rate 21.0%, 21.0% and 30.7% for the year ended March 31, 2020, 2019 and 2018 respectively are summarized as follows:

	Year Ended March 31,
	2020		2019		2018
Tax on income before income tax expense at U.S. statutory rate	$	10,124	$	8,014	$	12,865
U.S. state and local taxes (benefit), net of U.S. federal income tax effects		2,478		1,459		(2,800)
Benefit from foreign subsidiaries’ tax holidays		(126)		(5,778)		(7,727)
Foreign rate difference		7,668		11,795		(2,215)
Tax rate change		(1,917)		431		9,915
Nondeductible business costs		539		1,032		2,721
Repatriated foreign earnings		—		—		—
Deemed repatriated foreign earnings		—		(1,628)		17,834
GILTI and BEAT tax		3,367		3,763		—
Excess stock-based compensation benefits		(1,024)		(3,388)		(1,674)
Nondeductible interest		—		6,213		6,500
Other adjustments		4,118		(1,157)		(342)
Tax credit carry forwards		(15,565)		548		(1,360)
Income Tax Refundable		(16,940)		—		—
Valuation Allowance		7,587		(831)		(829)
Income tax expense	$	309	$	20,473	$	32,888

Deferred tax assets (liabilities) at March 31, 2020 and 2019 were as follows:

	Year Ended March 31,
	2020		2019
Deferred revenue	$	1,458	$	898
Bad debt reserve		525		662
Tax credit carry forwards		15,401		591
Accrued expenses and reserves		23,116		14,087
Operating lease liabilities		20,428		—
Share-based compensation expense		1,929		4,911
Unrealized losses		4,630		583
Intangible assets		—		3,324
Net operating loss		8,637		14,777
Total gross deferred tax assets	$	76,124	$	39,833
Valuation allowance		(9,644)		(2,492)
Total deferred tax assets	$	66,480	$	37,341
Depreciable assets		(6,497)		(7,351)
Intangible assets		(13,236)		—
Operating lease right-of-use assets		(18,829)		—
Acquisition and other liabilities		(2,961)		(8,890)
Goodwill		(10,799)		(8,154)
Total deferred tax liabilities	$	(52,322)	$	(24,395)
Net deferred tax assets/(liabilities)	$	14,158	$	12,946

The ultimate realization of deferred tax assets is dependent upon management’s assessment of the Company’s ability to generate sufficient taxable income to realize the deferred tax assets during the periods in which the temporary

differences become deductible. Management considers the historical level of taxable income, projections for future taxable income, and tax planning strategies in making this assessment. The Company has deferred tax assets in the United States, the United Kingdom and India, that are subject to realizability constraints for which a partial valuation allowance recoded. The Company assessed the available positive and negative evidence to estimate if sufficient future taxable income will be generated to realize the existing deferred tax assets. The Company recorded an increase to the valuation allowance totaling $7,152 during the fiscal year ended March 31, 2020 related to provisions of foreign tax credits and net operating losses in the United Kingdom and capital losses in India, for which realization does not meet more likely than not requirements.

The Company has determined for all other deferred assets that it is more likely than not that the results of future operations will generate sufficient taxable income to realize the deferred tax assets. We continue to monitor all positive and negative evidence related to this asset. Net losses in the United Kingdom have decreased during the fiscal year ended March 31, 2020 compared with the fiscal year ended March 31, 2019. A valuation allowance is required if, based on available evidence, it is more likely than not that all or some portion of the asset will not be realized due to the inability of the Company to generate sufficient taxable income in a specific jurisdiction. The Company has $28,218 and $673 of net deferred tax assets in the United States and the United Kingdom, respectively, at March 31, 2020. The Company has recorded a valuation allowance against certain NOLs in the United Kingdom as management has concluded it is more likely than not these will not be able to be utilized due to separate return limitations.

At March 31, 2020, the Company has $15,401 of US foreign tax credits which begin to expire in March 2024 and for which a partial valuation allowance has been recorded. The Company also has $4,246 of net operating losses, as of March 31, 2020, which begin to expire in the next five years and $4,391 of capital loss carryover which begins to expire in 2026. The Company has determined that it is more likely than not that the results of future operations will generate sufficient taxable income to realize $14,393 of these deferred tax assets for which a valuation allowance is not provided.

During the fiscal year ended March 31, 2020, the Company recorded $3,778 of net income tax benefit directly in other comprehensive income (loss) related to the unrealized gain (loss) on available-for-sale debt securities, the unrealized gain/loss on effective cash flow hedges and the foreign currency loss on certain long-term intercompany balances. During the fiscal year ended March 31, 2020, the Company recognized $1,024 of net income tax benefit related to a windfall in the tax benefits of share-based compensation which was recorded as an income tax benefit in the consolidated statement of income (loss) pursuant to ASU 2016-09.

During the fiscal year ended March 31, 2020, the Company merged Polaris Consulting and Software Limited (“Polaris”) with into Virtusa Consulting Services Private Limited (“Virtusa India”). The merger of Polaris into Virtusa India is considered an entity liquidation for US income tax purposes. The earnings of this entity will be subject to US taxation as well as local taxation with a corresponding foreign tax credit or deduction, at the election of the Company. The election resulted in a deferred tax charge of $2,879 during fiscal year ended March 31, 2020. The election also makes available to the Company the benefits of future foreign tax credits. The Company’s income tax provision for the fiscal year ended March 31, 2020 includes the expected impact of GILTI and executive compensation limitations of the Tax Cuts and Jobs Act (the “Tax Act”) impacting the operating results for the Company’s fiscal year ended March 31, 2020. The Company’s aggregate income tax rate in foreign jurisdictions is comparable to its income tax rate in the United States, as a result of the Tax Act, other than in Singapore and Sri Lanka in which the Company has tax holiday benefits and eligible tax exemptions respectively.

The Company’s effective tax rate for the fiscal year ended March 31, 2020 was significantly impacted by the merger of Polaris India into Virtusa India.  The merger makes available to the Company tax deductions for interest on debt used to purchase the group as well as amortization of intangible assets. Under local Indian law, the merger was retroactive to April 1, 2018 resulting in amended tax return filing in India for the year ended March 31, 2019.  The Company recorded an income tax benefit of $11,377 reflecting an expected refund of previously paid tax. The Company also recorded certain foreign tax credits totaling $14,324, which are expected to be available to reduce future federal income tax.  

During the fiscal year ended March 31, 2019, the Company elected to treat several foreign entities as disregarded entities. The earnings of these subsidiaries will be subject to US taxation as well as local taxation with a corresponding foreign tax credit or deduction, at the election of the Company. The GILTI provisions and executive compensation limitations enacted in the Tax Act, enacted on December 22, 2017 by the U.S. government continue to impact the results. The Company’s reported effective tax rate is also impacted by jurisdictional mix of profits and losses in which the Company operates, foreign statutory tax rates in effect, unusual or infrequent discrete items requiring a provision and certain exemptions or tax holidays applicable to the Company.

The Coronavirus Aid, Relief, and Economic Security (CARES) Act provided for NOLs arising in tax years beginning after December 31, 2017, and before January 1, 2021, may be carried back to each of the five tax years preceding the tax year of such loss.  Net operating losses have an unlimited carry forward period, although there are annual limitations on their use suspended for certain years as result of CARES Act.  The Company intends to file an immediate carry back claim in the United States. The income tax expense for the fiscal year ended March 31, 2020 included the impact of the carryback claim for $1,524 benefit, net of valuation allowance.

At March 31, 2020, the remaining deemed repatriation balance is $13,461, of which $1,282 is included in income tax payable and $12,179 is included in long-term liabilities in the consolidated balance sheet. The Company has elected to pay the deemed repatriation tax on unremitted earnings in eight installments through the fiscal year 2025. In July 2019, the Company paid approximately $1,137 representing the second yearly installment out of the eight yearly installments.

The U.S. Tax Act subjects a U.S. shareholder to GILTI earned by certain foreign subsidiaries. The FASB Staff Q&A, Topic 740, No. 5, Accounting for Global Intangible Low-Taxed Income, states that an entity can make an accounting policy election to either recognize deferred taxes for temporary basis differences expected to reverse as GILTI in future years or provide for the tax expense related to GILTI in the year the tax is incurred. The Company has elected to provide for GILTI in the year incurred. The Company’s results for the fiscal year ended March 31, 2020 and 2019 include the expected impact of GILTI.

The Company’s Indian subsidiaries operate several development centers in areas designated as a special economic zone, or SEZ, under the SEZ Act of 2005. In particular, the Company was approved as an SEZ Co-developer and has built a campus on a 6.3 acre parcel of land in Hyderabad, India that has been designated as an SEZ. As an SEZ Co-developer, the Company is entitled to certain tax benefits for any consecutive period of 10 years during the 15-year period starting in fiscal year 2008. The Company has elected to claim SEZ co-developer income tax benefits starting in the fiscal year ended March 31, 2013. Beginning April 1, 2019, the Company adopted the new tax ordinance of the income tax act of 1961 requiring the surrender of unexpired tax holidays.  The Company had units at various stages of tax holiday benefit with many nearing expiration.

On September 20, 2019, the Indian government issued Ordinance 2019 making certain amendments in the Income-tax Act 1961, which substantially reduces tax rates. The effective rate of tax on India-based companies was reduced from 34.9% to 25.17%, effective for fiscal years beginning April 1, 2019. The Company adopted the new ordinance for the fiscal year beginning April 1, 2019. The new rates require the surrendering of any tax holidays and other attributes of which the Company historically was taking advantage of and favorably impacting our tax rate.

In addition, the Company’s Sri Lankan subsidiary, Virtusa (Private) Limited, is operating under a 12-year income tax holiday arrangement that expired on March 31, 2019 and required Virtusa (Private) Limited to retain certain job creation and investment criteria through the expiration of the holiday period. During the fiscal year ended March 31, 2020, the Company believes it had fulfilled its hiring and investment commitments and is eligible for tax holiday through March 2019. Beginning April 1, 2019, the Company is taking advantage of certain exemptions offered to IT service providers. The India and Sri Lanka income tax holidays reduced the overall tax provision and increased both net income and diluted

earnings per share in the fiscal years ended March 31, 2020, 2019 and 2018 by $126, $5,778 and $7,727, respectively, and by $0.00, $0.19 and $0.26, respectively.

The Company has been under income tax examination in India, the U.K., Singapore and the United States. The Indian taxing authorities issued an assessment order with respect to their examination of the various tax returns for the fiscal years ended March 31, 2006 to March 31, 2017 of the Company’s Indian subsidiary, Virtusa (India) Private Ltd, and Polaris Consulting & Services Limited (Polaris India) now merged with and into Virtusa Consulting Services Private Limited (collectively referred to as “Virtusa India”). At issue were several matters, the most significant of which was the redetermination of the arm’s-length profit which should be recorded by Virtusa India on the intercompany transactions with its affiliates. These matters are currently at different level of appeals beginning with the fiscal year ended March 31, 2006. In the United Kingdom, the Company is currently under examination for transfer pricing and research benefits for the years ended March 31, 2014 to March 31, 2018. In Singapore, the Inland Revenue Authority is confirming the appropriateness of the Company’s deductions for the year ended March 31, 2017. In the United States, the Internal Revenue Service has concluded an examination of fiscal years ended March 31, 2015 and March 31, 2017. During the fiscal year ended March 31, 2020, the Company settled with the Internal Revenue Service employment tax matters for several years. The impact of these settlements with the Internal Revenue Service was not material to the consolidated statements of income and consolidated statements of cash flows.

Undistributed Earnings of Foreign Subsidiaries

A substantial amount of the Company’s income before provision for income tax is from operations earned in its Indian and Sri Lankan subsidiaries and is subject to tax holiday. The Company intends to use accumulated and future earnings of foreign subsidiaries to expand operations outside the United States and, accordingly, undistributed income is considered indefinitely reinvested. The Company does not provide for U.S. income taxes on foreign currency translation or applicable withholding tax until a distribution is declared. At March 31, 2020, the Company had approximately $194,789 of cash, cash equivalents, short-term and long-term investments that would otherwise be available for potential distribution, if not indefinitely reinvested. If required, such cash and investments could be repatriated to the United States. Due to the various methods by which such earnings could be repatriated in the future, the amount of taxes attributable to the undistributed earnings is not practicably determinable.

Each fiscal year, unrecognized tax benefits may be adjusted upon the closing of the statute of limitations for income tax returns filed in various jurisdictions. The total amount of unrecognized tax benefits that would reduce income tax expense and the effective income tax rate, if recognized, is $6,627, $6,744 and $7,544 as of March 31, 2020, 2019 and 2018, respectively. Although it would be difficult to anticipate the final outcome on timing of resolution of any particular uncertain tax position, the Company anticipates that $10 of unrecognized tax benefits will reverse during the twelve- month period ending March 31, 2021 due to settlement or expiration of statute of limitations on open tax years. All of these benefits are expected to have an impact on the effective tax rate as they are realized.

The following summarizes the activity related to the gross unrecognized tax benefits:

	March 31,
	2020		2019		2018
Balance at beginning of the fiscal year	$	6,744	$	7,544	$	7,612
Foreign currency translation related to prior year tax positions		(467)		(472)		105
Decreases related to prior year tax positions		—		(770)		(332)
Decreases related to prior year tax positions due to settlements or lapse in applicable statute of limitations		(324)		(206)		(335)
Increases related to prior year tax positions		674		648		494
Balance at end of the fiscal year	$	6,627	$	6,744	$	7,544

The Company continues to classify accrued interest and penalties related to unrecognized tax benefits in income tax expense. During the fiscal years ended March 31, 2020 and 2019, the Company expensed accrued interest and penalties of $194 and $311, respectively, through income tax expense consistent with its prior positions, to reflect interest and penalties on certain unrecognized tax benefits as part of income tax. The total accrued interest and penalties, including foreign currency translation relating to certain foreign and domestic tax matters at March 31, 2020 and 2019, were $1,586 and $1,572, respectively. During the fiscal year ended March 31, 2020, the Company’s unrecognized tax benefits decreased by $117. The decrease in the unrecognized tax benefits during the fiscal year ended March 31, 2020 was predominantly due to foreign currency movements and the settlement of a prior period position offset by increases for United Kingdom audit matters and incremental interest accrued on existing uncertain tax positions. The net movement in unrecognized tax benefits for the fiscal year ended March 31, 2020 was as follows: $599 expense recorded to income tax expense, $249 for cash settlements and $467 to other comprehensive income (loss) for foreign currency impact. The Company has recorded unrecognized tax benefits in long-term liabilities if settlement is not expected in the next year.