7. Income Taxes

Pretax earnings (loss) were generated by both domestic and foreign operations as follows (in thousands):

	Years Ended December 31,
	2015			2014			2013
United States	$	(47,490	)	$	(34,885	)	$	(11,085	)
Foreign		(483	)		10,535			(8,929	)
	$	(47,973	)	$	(24,350	)	$	(20,014	)

A reconciliation of the expected statutory federal income tax provision to the actual income tax provision is summarized as follows (in thousands):

	Years Ended December 31,
	2015			2014			2013
Expected income taxes benefit at federal statutory rate	$	(16,311	)	$	(8,279	)	$	(6,804	)
State income taxes, net of federal benefit		—			(2,023	)		(634	)
Permanent items and other		19			(321	)		2
Stock-based compensation		734			396			—
Research credits		(2,674	)		(372	)		(397	)
Unrecognized tax benefits		1,070			144			159
Foreign rate differential		84			(3,391	)		2,978
Change in tax rate		3,551			—			—
Other, net		112			293			(26	)
Change in valuation allowance		13,415			13,553			4,722
Income tax (benefit) expense	$	—		$	—		$	—

Deferred income taxes are provided for temporary differences in recognizing certain income and expense items for financial and tax reporting purposes. The deferred tax assets consisted primarily of the income tax benefits from net operating loss (NOL) carryforwards, research and development credits and capitalized research and development expenses, along with other accruals and reserves. Valuation allowances of $48.3 million, $34.8 million and $21.3 million as of December 31, 2015, 2014 and 2013, respectively, have been recorded to offset deferred tax assets as realization of such assets does not meet the more-likely-than-not threshold under ASC 740, Accounting for Income Taxes.

Significant components of our deferred tax assets are summarized as follows (in thousands):

	December 31,
	2015			2014			2013
Net operating loss carryforwards	$	24,869		$	20,066		$	13,093
Capitalized research and development expenses		14,181			7,855			6,684
Research credits and other state credits		3,565			1,368			1,171
Intangible assets		4,176			4,926			28
Depreciation and amortization		(120	)		(260	)		(360	)
Reserve and accruals		1,648			891			677
Valuation allowance		(48,319	)		(34,846	)		(21,293	)
Net deferred tax assets	$	—		$	—		$	—

The consolidated financial statements in the prior years included six variable interest entities which we referred to as the Affiliates. In the fourth quarter of 2014, we dissolved all of the Affiliates and, as a result, acquired intellectual property originally developed by the Affiliates. For book purposes, as this was a transaction between consolidated entities, no intangible asset was recognized. For tax purposes, the intellectual property will be amortized over 15 years resulting in an increase to deferred tax assets as of December 31, 2014. The increase in deferred tax assets was offset by a corresponding adjustment to the valuation allowance. As a result of the dissolution, we forgave intercompany loans and recorded a corresponding tax deduction; whereas the Affiliates recognized cancellation of debt income which was offset by net operating losses.

As of December 31, 2015, we had approximately $65.4 million, $48.9 million, and $5.8 million of net operating loss carryforwards for federal, state, and foreign purposes, respectively, net of Section 382 limitations, available to offset future taxable income. The federal and state net operating loss carryforwards begin to expire in 2025 and 2016, respectively. California net operating loss carryforwards of $0.2 million and $1.4 million will expire in 2016 and 2017, respectively. California net operating loss carryforwards of $47.3 million will expire from 2028 through 2034. The foreign net operating losses carry over indefinitely. As of December 31, 2015, we had federal and state research and development credit carryforwards of approximately $1.8 million and $1.9 million, respectively, net of Section 382 limitations, which begin to expire in 2026 for federal purposes and carry over indefinitely for state purposes. We had $2.9 million of federal Orphan Drug Credits as of December 31, 2015, which will begin to expire in 2035.

In November 2015, the FASB issued ASU No. 2015-17, “Balance Sheet Classification of Deferred Taxes,” which requires all deferred tax assets and liabilities to be classified as noncurrent on the balance sheet. The new accounting guidance is effective for annual reporting periods beginning after December 15, 2016 and interim periods therein. Early adoption is permitted as of the beginning of interim or annual reporting periods. We elected to early adopt this guidance prospectively beginning in the year ended December 31, 2015 and prior periods were not retrospectively adjusted. There was no material impact on the financial statements upon adoption.

Utilization of the domestic NOL and research and development credit carryforwards may be subject to a substantial annual limitation due to ownership change limitations that may have occurred or that could occur in the future, as required by Section 382 and 383 of the Internal Revenue Code of 1986, as amended (the Code), as well as similar state and foreign provisions. These ownership changes may limit the amount of NOL and research and development credit carryforwards that can be utilized annually to offset future taxable income and tax, respectively. In general, an “ownership change” as defined by Section 382 of the Code results from a transaction or series of transactions over a three-year period resulting in an ownership change of more than 50 percentage points of the outstanding stock of a company by certain stockholders. Since the Company’s formation, we raised capital through the issuance of capital stock on several occasions which on its own or combined with the purchasing stockholders’ subsequent disposition of those shares, has resulted in such an ownership change, and could result in an ownership change in the future.

Upon the occurrence of an ownership change under Section 382 as outlined above, utilization of the NOL and research and development credit carryforwards become subject to an annual limitation under Section 382 of the Code, which is determined by first multiplying the value of our stock at the time of the ownership change by the applicable long-term, tax-exempt rate, which could be subject to additional adjustments. Any limitation may result in expiration of a portion of the NOL or research and development credit carryforwards before utilization. We completed an analysis through September 7, 2011, and had adjusted our NOL and research and development tax credit carryforwards accordingly. Ownership changes that may have occurred subsequent to September 7, 2011, and future ownership changes, including any ownership change resulting from this offering, may further limit our ability to utilize its remaining tax attributes.

We recognize a tax benefit from an uncertain tax position when it is more likely than not that the position will be sustained upon examination, including resolutions of any related appeals or litigation processes, based on the technical merits. Income tax positions must meet a more-likely-than-not recognition threshold to be recognized.

Our practice is to recognize interest and penalties related to income tax matters in income tax expense. We had no accrual for interest and penalties on our balance sheet and had not recognized interest or penalties in the consolidated statements of operations for the years ended December 31, 2015, 2014 and 2013.

Due to the existence of the valuation allowance, future changes in unrecognized tax benefits will not impact our effective tax rate.

Uncertain tax positions are evaluated based upon the facts and circumstances that exist at each reporting period. Subsequent changes in judgment based upon new information may lead to changes in recognition, derecognition, and measurement. Adjustments may result, for example, upon resolution of an issue with the taxing authorities, or expiration of a statute of limitations barring an assessment for an issue.

The activity related to our unrecognized tax benefits is summarized as follows (in thousands):

Balance as of December 31, 2012	$	774
Increase related to prior year tax positions		79
Increase related to current year tax positions		94
Balance as of December 31, 2013		947
Increase related to prior year tax positions		—
Increase related to current year tax positions		177
Other decreases		(18	)
Balance as of December 31, 2014		1,106
Increase related to prior year tax positions		2,404
Increase related to current year tax positions		1,523
Balance as of December 31, 2015		5,033

We do not anticipate that the amount of unrecognized tax benefits as of December 31, 2015 will change within the next twelve months.

We are subject to taxation in the United States, Hong Kong and state jurisdictions. Our tax years from inception are subject to examination by the United States, Hong Kong and California authorities due to the carry forward of unutilized NOLs and research and development credits.