11. Income Taxes

As a company incorporated in Bermuda, the Company is principally subject to taxation in Bermuda. Under the current laws of Bermuda, tax on a company’s income is assessed at a zero percent tax rate. As a result, the Company has not recorded any income tax benefits from its losses incurred in Bermuda during each reporting period, and no net operating loss carryforwards will be available to the Company for those losses.

In August 2015, the Company entered into agreements with its wholly owned subsidiary, Kiniksa US, under which Kiniksa US provides management and research and development services to the Company for which the Company pays costs plus a service fee. On March 9, 2019, the Company entered into an agreement with Primatope to license certain intellectual property rights related to KPL-404. Kiniksa US and Primatope are subject to tax in the United States for federal and state tax purposes.

The Company has a wholly owned subsidiary in Europe, Kiniksa UK (formed in December 2018). Kiniksa UK has two wholly owned subsidiaries in Europe, Kiniksa Germany (formed in February 2019), and Kiniksa France (formed in June 2019). Each are subject to taxation in their respective countries.

Income (loss) before benefit for income taxes consisted of the following:


	Years Ended
	December 31,
	2019		2018
Bermuda	$	(168,053)	$	(105,562)
Foreign (U.S., U.K., Germany, France)		4,139		2,121
	$	(163,914)	$	(103,441)

The components of the Company’s income tax benefit for the years ended December 31, 2019 and 2018 are as follows:


	Years Ended
	December 31,
	2019		2018
Current income tax (provision):
Bermuda	$	—	$	—
U.S. federal		(567)		(547)
U.S. state		(530)		(217)
Foreign		(12)		—
Total current income tax (provision)		(1,109)		(764)
Deferred income tax benefit:
Bermuda		—		—
U.S. federal		2,397		542
U.S. state		759		436
Foreign		—		—
Total deferred income tax benefit		3,156		978
Total benefit (provision) for income taxes	$	2,047	$	214

A reconciliation of the Bermuda statutory income tax rate of 0% to the Company’s effective income tax rate is as follows:


	Years Ended
	December 31,
	2019		2018
Bermuda statutory income tax rate	—	%	—	%
Foreign (U.S.) tax rate differential	(0.5)		(1.0)
Research and development tax credits	2.2		1.5
Share-based compensation	(0.5)		0.1
Permanent differences	(0.1)		—
Change in valuation allowance	(0.1)		—
U.S. state taxes, net of federal	(0.3)		(0.4)
FDII	0.9		—
Uncertain tax positions	(0.3)		—
Effective income tax rate	1.3	%	0.2	%

Net deferred tax assets consisted of the following:


	December 31,
	2019		2018
Research and development tax credit carryforwards	$	238	$	75
Depreciation and amortization		(745)		(639)
Share-based compensation		3,746		1,000
Accrued expenses and other		1,273		829
Net operating losses		190		—
Total deferred tax assets		4,702		1,265
Valuation allowance		(330)		(49)
Net deferred tax assets	$	4,372	$	1,216

As of December 31, 2019 and 2018, the Company had federal research and development tax credit carryforwards of approximately $228 and $0 respectively, available to reduce future tax liabilities, which begin to expire in 2039. As of December 31, 2019 and 2018, the Company had state research and development tax credit carryforwards of approximately $265 and $95 respectively, available to reduce future tax liabilities, which begin to expire in 2034.

As required by ASC 740, the Company has evaluated the positive and negative evidence bearing upon its ability to realize the deferred tax assets. In order to utilize state research and development tax credits, the Company will need taxable income in the jurisdiction of where the credit was generated. The Company currently has no taxable income in certain state jurisdictions and thus management has determined that it is more likely than not that the Company will not recognize the benefits of state research and development tax credits generated in those jurisdictions, and as a result, a valuation allowance of $330 and $49 has been established at December 31, 2019 and 2018, respectively.

Utilization of the state research and development tax credits may be subject to substantial annual limitation under Section 382 of the Internal Revenue Code of 1986 due to ownership changes that could occur in the future. These ownership changes may limit the amount of carryforwards that can be utilized annually to offset future taxable income. In general, an ownership change, as defined by Section 382, results from transactions increasing the ownership of certain shareholders or public groups in the shares of a corporation by more than 50% over a three‑year period.

Changes in the valuation allowance for deferred tax assets during the years ended December 31, 2019 and 2018 were due primarily to an increase in state research and development tax credits and net operating losses from Primatope which are more likely than not to expire unutilized and were as follows:


	Years Ended
	December 31,
	2019		2018
Valuation allowance at beginning of year	$	(49)	$	(27)
Increases recorded to through the balance sheet		(200)		—
Increases recorded to income tax provision		(81)		(22)
Valuation allowance at end of year	$	(330)	$	(49)

The valuation allowance increased by $281 in 2019 primarily as a result of additional California Research and Development (“R&D”) credits and the net operating loss carryovers at Primatope which may not be realized. The remaining deferred tax assets will be fully utilized in the United States based on future income generated under the cost‑plus arrangement in place.

The Company recognizes the tax benefit from an uncertain tax position only if it is more-likely-than-not that the tax position will be sustained on examination by taxing authorities, based on the technical merits of the position. The tax benefits recognized in the financial statements from such a position are measured based on the largest benefit that has a greater than 50% likelihood of being realized upon ultimate settlement. The amount of unrecognized tax benefits is $528 and $0 as of December 31, 2019 and 2018, respectively. The net increase relates to new tax positions on Research and Development credits as a result of the R&D study performed in 2019.

A roll forward of the Company’s uncertainties in its income tax provision liability is presented below:


	Years Ended
	December 31,
	2019		2018
Gross balance at the beginning of year	$	—	$	—
Gross increases based on current period tax positions		528		—
Unrecognized tax benefits at the end of the year	$	528	$	—

The Company’s policy is to record interest and penalties related to income taxes as part of its income tax provision. The Company had recorded immaterial interest on the tax positions during the year ended December 31, 2019 and no interest or penalties for the year ended December 31, 2018.

The Company files income tax returns in the United States and certain state jurisdictions. Kiniksa US’s federal and state income tax returns are subject to tax examinations for the tax years ended December 31, 2016 and subsequent years. To the extent the Company has tax attribute carryforwards, the tax years in which the attribute was generated may still be adjusted upon examination by the Internal Revenue Service and state tax authorities to the extent utilized in a future period. There are currently no income tax examinations pending.