Income Taxes

12 Months Ended

Dec. 31, 2021

Income Tax Disclosure [Abstract]

Income Tax Disclosure

Income Taxes

Income Tax Expense

For the years ended December 31, 2021 and 2020, the Company recorded income tax expense of $18.4 million and $5.0 million, respectively, which reflects an effective tax rate of (37.0)% and (12.0)%, respectively. The Company's income tax expense in 2021 was primarily driven by U.S. Federal and state taxes, change in valuation allowance on Federal & state deferred tax assets and German net operating losses and interest carryforwards, and non-deductible German share-based compensation arrangements. The Company's income tax expense in 2020 was primarily driven by U.S. Federal and state taxes, valuation allowance on German net operating losses and interest carryforwards, and non-deductible German share-based compensation arrangements.

The components of the income (loss) before income taxes are as follows:

	Year Ended December 31,
(in thousands)	2021		2020
Germany	$	(5,852)	$	224
Foreign	(43,905)		(41,843)
Total	$	(49,757)	$	(41,619)

The components of the income tax expense are as follows:

	Years Ended December 31,
(in thousands)	2021		2020
Current tax expense:
Germany	2,260		1,298
Foreign	797		161
Total current tax expense	$	3,057	$	1,459
Deferred tax expense:
Germany	239		3,144
Foreign	15,102		386
Total deferred tax expense	$	15,341	$	3,530
Income tax expense	$	18,398	$	4,989

The statutory income tax rate of the Company is determined by the tax rate of Spark Networks SE, consisting of the German corporate income tax of 15.8% including solidarity surcharge, as well as the trade tax of 14.4%.

Reported income tax expense differed from the amounts computed by applying the combined German corporate and trade income tax rate of 30.2% in both 2021 and 2020 to income (loss) before income taxes as a result of the following:

	Year Ended December 31,
(in thousands)	2021		2020
Income tax (benefit) at statutory rate	$	(15,014)	$	(12,558)
Foreign tax rate differential	10,538		4,214
Impairment of goodwill	4,575		9,808
Change in valuation allowance	16,659		2,496
Share-based payment arrangements	832		1,458
Unrecognized tax benefits	255		461
Tax credits	340		(737)
Other	213		(153)
Income tax expense	$	18,398	$	4,989

Components of Deferred Tax Assets and Liabilities

Significant components of deferred tax assets (liabilities) are as follows:

	Years Ended December 31,
(in thousands)	2021		2020
Deferred tax assets:
Property and equipment	$	49	$	85
Intangible assets	401		467
Accrued employee compensation and benefits	26		48
Deferred revenue	737		531
Lease liabilities	1,289		1,453
Interest expense carryforwards	4,567		2,985
Other	1,753		965
Tax credit carryforwards	9,323		9,789
Tax loss carryforwards	38,018		44,611
Total deferred tax assets	56,163		60,934
Less: valuation allowance	(40,233)		(18,336)
Deferred tax assets, net of valuation allowance	15,930		42,598
Deferred tax liabilities:
Intangible assets	(7,013)		(13,918)
Right-of-use assets	(1,006)		(1,339)
Property and equipment	(356)		(2,636)
Other	(1,009)		(2,176)
Total deferred tax liabilities	(9,384)		(20,069)
Net deferred tax assets	$	6,546	$	22,529

At December 31, 2021, the Company had German and foreign net operating losses of approximately $111.4 million and $155.0 million, respectively. At December 31, 2020, the Company had German and foreign net operating losses of approximately $143.6 million and $169.2 million, respectively. The foreign net operating loss carryforward is made up of U.S. Federal and state and Israeli losses. The U.S. Federal net operating loss carryforward will expire beginning December 31, 2025 through December 31, 2037. The U.S. state net operating loss carryforward will expire beginning December 31, 2030 through December 31, 2040. The German and Israel net operating losses have an unlimited carryforward period. Of the total U.S. Federal net operating loss carryforward, $18.7 million will carry forward indefinitely.

The U.S. Internal Revenue Code ("IRC") of 1986, as amended, imposes substantial restrictions on the utilization of carryforwards in the event of an “ownership change” of a corporation. Accordingly, a company’s ability to use net operating losses may be limited as prescribed under Internal Revenue Code Section 382 (“IRC Section 382”). Events which may cause limitations in the amount of the net operating losses that the Company may use in any one year include, but are not limited to, a cumulative ownership change of more than 50% over a three-year period. Due to the effects of historical equity issuances, the Company has determined that the future utilization of a portion of its net operating losses is limited annually pursuant to IRC Section 382. Furthermore, under current German tax laws, certain substantial changes in the Group’s ownership and business may further limit the amount of German net operating loss carryforwards, which could otherwise be utilized annually to offset future taxable income.

At December 31, 2021 and 2020, the Company has U.S. Federal and state tax credit carryforwards of approximately $13.7 million and $14.4 million, respectively, which primarily relate to Research and Development ("R&D") tax credits. These tax credits will expire beginning December 31, 2027 through December 31, 2039 for U.S. Federal purposes and December 31, 2022 through December 31, 2028 for U.S. state purposes. The U.S. state R&D tax credits of $6.4 million have an unlimited carryforward period.

Periodically, the Company considers both positive and negative evidence related to the likelihood of realization of its deferred tax assets to determine, based on the weight of available evidence, whether it is more likely-than-not that some or all of the deferred tax assets will not be realized. As of December 31, 2021, the Company's valuation allowance on its U.S. Federal and state deferred tax assets was $23.8 million primarily related to net operating loss and tax credit carryforwards and $2.5 million

related to Israel net deferred tax assets, primarily made up of cumulative loss carryforwards. As of December 31, 2020, the Company's valuation allowance on its U.S. Federal and state deferred tax assets was $4.0 million related to California net operating losses and California Enterprise Zone credits and $2.5 million related to Israel net deferred tax assets, primarily made up of cumulative loss carryforwards. As of December 31, 2021, the Company has a valuation allowance on all of its Federal, state, and Israel deferred tax assets with the exception of $1.1 million which could be offset against deferred tax payables. The Company has determined, after evaluating all positive and negative historical and prospective evidence, that it is more-likely-than-not that these U.S. assets will not be realized. The U.S. valuation allowance increased by $19.8 million during 2021 which was primarily due to establishing an additional valuation allowance on certain Federal deferred tax assets along with all additional state net operating losses and credits that were not offset by a valuation allowance at the end of December 31, 2020. The change was as a result of increases in U.S. deferred tax assets for which there existed uncertainty about our future ability to fully utilize the assets.

In addition, as of December 31, 2021 and 2020, management determined that a valuation allowance of $13.9 million and $11.8 million, respectively, was required for certain German deferred tax assets that are not more-likely-than-not to be realized due to the negative evidence which outweighed the positive evidence. For the remaining German deferred tax assets without a valuation allowance, management believes it is more-likely-than-not that the Company will generate sufficient taxable income in the appropriate future periods to realize the benefit. The $2.1 million increase in the valuation allowance during 2021 is primarily driven by an increase in German interest carryforwards.

The Company has determined that its offshore earnings will be indefinitely reinvested outside of Germany. As a result, the Company has not recorded a deferred tax liability related to undistributed earnings of foreign subsidiaries as of December 31, 2021 and December 31, 2020. The Company will continue to evaluate its reinvestment policy on a quarterly basis and will adjust its deferred tax liability accordingly to the extent there is a change and adjustment is required. As of December 31, 2021, the amount of undistributed earnings was $76.1 million. Upon distribution of these earnings, we would be subject primarily to German income taxes and foreign withholding taxes. Assuming the indefinitely reinvested earnings were repatriated under the laws and rates applicable at December 31, 2021, the incremental taxes are estimated to be $4.9 million.

In assessing whether unrecognized tax benefits should be recognized in its financial statements, the Company first determines whether it is more-likely-than-not that a tax position will be sustained upon examination, including resolution of any related appeals or litigation processes, based on the technical merits of the position. In evaluating whether a tax position has met the more-likely-than-not recognition threshold, the Company presumes that the position will be examined by the appropriate taxing authority that would have full knowledge of all relevant information. For tax positions that meet the more-likely-than-not recognition threshold, the Company measures the amount of benefit recognized in the financial statements at the largest amount of benefit that is greater than 50% likely of being realized upon settlement. For each reporting period, management applies a consistent methodology to measure unrecognized tax benefits, and all unrecognized tax benefits are reviewed periodically and adjusted as circumstances warrant.

A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows:

	Year Ended December 31,
(in thousands)	2021		2020
Balance at the beginning of the year	$	4,593	$	3,747
Increases for current year tax positions	242		614
Increases (decreases) for prior year tax positions	(104)		232
Statute of limitation expirations	—		—
Settlements with taxing authorities	—		—
Balance at the end of the year	$	4,731	$	4,593

As of December 31, 2021 and 2020, the Company has $4.7 million and $4.6 million of unrecognized tax benefits, respectively. As of December 31, 2021 and 2020, the Company has recognized $0.7 million and $0.4 million of interest and penalties respectively. The Company recognized an increase to interest and penalties of $0.3 million. Of the $4.7 million of unrecognized tax benefits as of December 31, 2021, $1.3 million would impact the effective tax rate if recognized. The Company’s policy is to classify interest and penalties on uncertain tax positions as a component of income tax expense.

The Company is subject to income taxes in Germany and multiple other foreign jurisdictions. The Company remains subject to examination in Germany for the 2016 through 2020 tax years. U.S. Federal income tax returns of the Company are subject to IRS examination for the 2018 through 2020 tax years. U.S. state income tax returns are subject to examination for the 2017

through 2020 tax years. The Company is subject to examination in Israel for the 2016 through 2020 tax years and in France for the 2018 through 2020 tax years.

As a matter of course, the Company may be audited by Germany, U.S. Federal and state, Israel, France, the U.K. and other foreign tax authorities within which it operates. From time to time, these audits result in proposed assessments. The Company was notified during 2020 that the Israeli tax authorities were auditing Spark Networks Ltd. for the tax years 2016-2019. There is minimal activity in the entity and, while we do not expect adverse findings, any potential finding would result in a reduction of the net operating loss carryforward which has a full valuation allowance against it. The Company was notified that the German tax authorities are auditing Spark SE for the tax years 2017-2018, as well as Spark GmbH for the tax years 2016-2018.

Based on the current status of Germany, U.S. Federal, state, local and other foreign audits, the Company does not expect the amount of unrecognized tax benefits to significantly decrease in the next 12 months as a result of settlements of tax audits and/or the expiration of statutes of limitations.