NOTE 14. INCOME TAXES

For financial reporting purposes, the geographic distribution of income (loss) before income taxes includes the following components:


	Year Ended
	December 27, 2014		December 28, 2013		December 29, 2012
Domestic	$	(926)	$	(30,038)	$	(301,764)
Foreign		15,420		23,540		18,806
	$	14,494	$	(6,498)	$	(282,958)

The provision for income taxes consists of the following components:


	Year Ended
	December 27, 2014		December 28, 2013		December 29, 2012
Current:
Domestic	$	846	$	9,528	$	42,710
State		102		99		(3,630)
Foreign		14,736		13,910		11,743
	$	15,684	$	23,537	$	50,823
Deferred:
Domestic	$	5,055	$	1,361	$	2,856
State		1,482		—		(718)
Foreign		(7,809)		858		(15,660)
	$	(1,272)	$	2,219	$	(13,522)
Provision for income taxes	$	14,412	$	25,756	$	37,301

Reconciliation between the Company’s effective tax rate and the U.S. Federal statutory rate is as follows:


	Year Ended
	December 27, 2014			December 28, 2013		December 29, 2012
Income (loss) before provision for income taxes	$	14,494		$	(6,498)	$	(282,958)
Federal statutory tax rate		35%			35%		35%
Income taxes at U.S. Federal statutory rate		5,073			(2,274)		(99,035)
Tax on intercompany transactions		1,510			18,135		104,757
Change in liability for unrecognized tax benefit		10,255			6,748		938
Non-deductible intangible asset amortization and impairment of goodwill and purchased intangible assets		6,666			10,603		104,421
Non-deductible stock-based compensation		3,892			5,487		5,370
Non-deductible items and other		583			852		6,283
Utilization of stock option related loss carry-forwards recorded in equity		—			—		17,622
State taxes		132			(1,332)		(50)
True-up of prior year taxes and tax credits		12,016	(1)		(4,230)		(12,259)
Federal credits		(1,232)			(6,344)		(23,689)
Investment tax credits, net		(10,268)			(23,276)		(19,193)
Foreign and other rate differential		(2,812)			(10,208)		(6,599)
Change in valuation allowance		(6,348)	(1)		36,346		(40,311)
Other changes to deferred taxes		(5,055)			(4,751)		(954)
Provision for income taxes	$	14,412		$	25,756	$	37,301

(1)

In 2014, the amount included as true-up of prior year taxes and credits in the table above includes $12.8 million adjustments that have been offset with a change in valuation allowance.

The Company has been granted a tax holiday in Malaysia that has the effect of reducing its net income tax rate to zero in that jurisdiction. The Company’s current income tax holiday was granted based on revenue, investment and staffing criteria targets to be met by PMC International Sdn. Bhd. (Malaysia). The tax holiday was granted in 2009 by the Malaysia Investment Development Authority and is effective through 2019, subject to continued compliance with the tax holiday’s requirements. Tax savings associated with the Malaysia tax holidays were approximately $2.7 million, $3.9 million, and $7.9 million in 2014, 2013, and 2012, respectively.

The consolidated financial statements for the 2014, 2013 and 2012 include the tax effects associated with the sale of certain assets between our wholly-owned subsidiaries. GAAP requires the tax expense associated with gains on such intercompany transactions to be recognized over the estimated life of the related assets. Accordingly prepaid tax expense was recorded in the years ended December 29, 2012, December 31, 2011 and December 26, 2010. The balance in prepaid expense to be recognized in future years was $0.1 million, $5.8 million, and $19.2 million as of December 27, 2014, December 28, 2013, and December 29, 2012, respectively.

The provisions related to the income tax accounting for stock-based compensation prohibit the recognition of a deferred tax asset for an excess benefit that has not yet been realized. As a result, the Company will only recognize an excess benefit from stock-based compensation in additional paid-in-capital if an incremental tax benefit is realized after all other tax attributes currently available have been utilized. In addition, the Company continued to elect to account for the indirect benefits of stock-based compensation such as the research and development tax credit through the consolidated statement of operations.

Significant components of the Company’s deferred tax assets and liabilities are as follows:


	Year Ended
	December 27, 2014		December 28, 2013
Deferred tax assets:
Net operating loss carryforwards	$	16,609	$	30,549
Credit carryforwards		49,638		88,854
Reserves and accrued expenses		10,088		6,008
Stock-based compensation		11,643		11,688
Other		471		358
Capitalized technology & other		4,637		3,290
Capital loss		—		1,208
Depreciation and amortization		18,721		15,903
Total gross deferred tax assets	$	111,807	$	157,858
Valuation allowance		(86,948)		(92,525)
Deferred tax assets, net of valuation allowance	$	24,859	$	65,333
Deferred tax liabilities:
Deferred income tax on credits		(10,687)		(8,864)
Goodwill amortization		(52,001)		(44,946)
Federal benefits		(4,454)		(10,300)
Total deferred tax (liabilities) assets, net of valuation allowance	$	(42,283)	$	1,223

The Company determines its valuation allowance on deferred tax assets by considering both positive and negative evidence in order to ascertain whether it is more likely than not that deferred tax assets will be realized. The Company records a valuation allowance to reduce the deferred tax assets to the amount that is more likely than not to be realized. Realization of deferred tax assets is dependent upon the generation of future taxable income, if any, the timing and amount of which are uncertain. Due to the history of losses the Company has incurred, the Company believes that it is not more likely than not all or a portion of the deferred tax assets held in the U.S., Canada and Israel will be realized. The Company believes it is more likely than not that such assets will be realized to the extent presented on the balance sheet.

In 2014, the Company elected to release all of the valuation allowance related to its PMC-Sierra Israel subsidiary based on two consecutive years of positive earnings, three years of cumulative positive earnings, and the subsidiary’s forecast of continued profitability. The release of valuation allowance for the Company’s Israel subsidiary resulted in a $6.9 million benefit to the income tax provision in 2014. For the year ended December 27, 2014, the Company decreased its total valuation allowance by $5.6 million, net.

For the year ended December 28, 2013, the Company increased its valuation allowance by $37.1 million compared to the year ended December 29, 2012. The increase was primarily due to the release of reserves on federal and state R&D tax credits and the establishment of valuation allowance on foreign excess credits.

At December 27, 2014, the Company has statutory income tax losses as follows: $134.2 million of gross federal domestic loss carry-forwards, which will begin to expire 2023; and $184.1 million of U.S. state tax loss carry-forwards, $49.5 million of which will expire if not utilized in 2015. The Company has $46.3 million of gross foreign tax income loss carry-forwards which do not expire. The utilization of a portion of these loss carry-forwards may be subject to annual limitations under federal, state and foreign income tax legislation. Substantially all of the Company’s domestic loss carry-forwards relate to operations for which no tax benefit has been recorded due to the impact of stock-based compensation. The income tax benefits relating to approximately $123.9 million of the federal net operating loss carry-forwards and $112.2 million of the state net operating loss carryforwards will be credited to additional paid-in-capital when recognized.

At December 28, 2013, the Company had statutory tax credits as follows: $4.5 million of federal domestic alternative minimum tax credits which do not expire; $15.9 million of U.S. state R&D credits which do not expire; $32.5 million of foreign tax credits which will begin to expire in 2017; and $26.4 million of federal R&D credits, which will begin to expire in 2017, and $75.9 million of foreign research and experimental development credits which will begin to expire in 2029. The tax benefits relating to approximately $9.0 million of the federal credits will be credited to additional paid-in-capital when recognized.

The Company intends to reinvest its foreign earnings indefinitely. Accordingly, no U.S. income taxes have been provided for approximately $177.2 million of undistributed earnings and other outside basis differences of foreign subsidiaries. It is not practicable for the Company to determine the potential income tax impact of remitting these earnings.

A reconciliation of the beginning and ending balances of the total amounts of gross unrecognized tax benefits is as follows (in millions):


	Year Ended
	December 27, 2014		December 28, 2013		December 29, 2012
Gross unrecognized benefit at beginning of the year	$	82.1	$	91.5	$	106.0
Increase (decrease) in tax positions for prior years		1.7		(9.5)		(19.0)
Increase in tax positions for current year		6.9		4.0		4.3
Lapse in statute of limitations		—		(0.5)		(1.3)
Effect on foreign currency remeasurement (gain) loss		(5.3)		(3.4)		1.5
Ending balance	$	85.4	$	82.1	$	91.5

The total amount of unrecognized tax benefits that, if recognized, would affect the effective tax rate was $41.3 million at December 27, 2014 (2013 - $43.3 million and 2012 - $37.3 million). The Company accrues interest and penalties related to unrecognized tax benefits in its provision for income taxes. During 2014, the Company had accrued interest and penalties related to unrecognized tax benefits of $3.5 million (2013 - $3.3 million and 2012 - $3.9 million).

The Company and its subsidiaries file income tax returns in the U.S. and in various states, local and foreign jurisdictions. The tax years generally remain subject to examination by federal and most state tax authorities due to the ability to adjust net operating losses and credits. In significant foreign jurisdictions, the tax years generally remain subject to examination by their respective tax authorities.

The Company is currently under tax audit by the Canada Revenue Agency for tax years 2007 through 2009 and by the state of Minnesota for tax years 2009 through 2012. The Company anticipates tax adjustments from the audits but believes that current tax reserves are sufficient to cover any exposures. It is reasonably possible that over the next twelve-month period the Company may experience an increase or decrease in its unrecognized tax benefits. We cannot reliably determine either the magnitude or the range of any increase or decrease at this time.