5. Income Taxes

12 Months Ended

Dec. 31, 2012

Income Tax Disclosure [Text Block]

5. INCOME TAXES

The Company is subject to U.S. federal and state income taxes. The Company’s subsidiaries incorporated in the PRC are subject to PRC enterprise income taxes. The provision for income taxes from continuing operations consisted of the following:

	2012		2011			2010
	US$		US$			US$
Current:
Federal		222,374		—			(271,969	)
State		979		900			4,241
PRC		28,154		4,800,239			1,878,181
		251,507		4,801,139			1,610,453
Deferred:
Federal		165,463		5,515,443			—
State		—		—			—
PRC		3,645,999		(306,155	)		(1,890,175	)
Total provision for income tax		4,062,969		10,010,427			(279,722	)

The provision for income taxes is attributable to:

	2012		2011		2010
	US$		US$		US$
Continuing operations		4,062,969		10,010,427		(279,722	)
Discontinued operations		—		—		—
Total provision for income tax		4,062,969		10,010,427		(279,722	)

The following is a reconciliation of the difference between the actual provision for income taxes and the provision computed by applying the federal statutory rate on income from continuing operations before income taxes:

	2012			2011			2010
Tax at federal statutory rate		34	%		34	%		34	%
Permanent differences		(1.68	%)		11.49	%		(33.31	%)
Effect of income tax rate differences in PRC		(9.35	%)		(10.47	%)		(29.96	%)
Effect of tax holidays and preferential tax rates in PRC		(11.19	%)		(14.07	%)		67.61	%
Change in deferred tax		15.10	%		10.38	%		(25.03	%)
(Decrease) increase in unrecognized tax benefit		(11.01	%)		37.01	%		(14.73	%)
Others		0.22	%		0.03	%		9.03	%
		16.09	%		68.37	%		7.61	%

The following presents the aggregate dollar and per share effects of the Company’s tax holidays:

	2012			2011			2010
	US$			US$			US$
Aggregate dollar effect of tax holiday		(2,825,735	)		(2,059,344	)		(859,790	)
Per share effect-basic		0.14			0.09			0.04
Per share effect-diluted		0.14			0.09			0.04

Deferred tax assets and liabilities are recognized for the expected future tax consequences of differences between the carrying amounts of assets and liabilities and their respective tax bases using enacted tax rates in effect for the year in which the differences are expected to reverse. Deferred taxes as of December 31, 2012 and 2011 comprised the following:

	2012			2011
	US$			US$
Current deferred tax assets:
Accrued liabilities and reserves		3,896,232			158,199
Provision for doubtful accounts		1,723,800			1,360,000
Net current deferred tax assets before valuation allowance:		5,620,032			1,518,199
Less: Valuation allowance		(2,194,434	)		(1,518,199	)
Current deferred tax assets, net:		3,425,598			—
Non-current deferred tax assets
Stock option expense		56,930			40,100
Net operating loss carry forwards		4,278,078			10,071,000
Accrued liabilities and reserves		—			2,873,346
Depreciation and amortization		392,513			354,799
Non-current deferred tax assets before valuation allowance		4,727,521			13,339,245
Less: Valuation allowance		(2,079,633	)		(3,441,652	)
Non-current deferred tax assets, net:		2,647,888			9,897,593
Non-current deferred tax liabilities:
Intangible assets acquired		(79,246	)		(91,892	)
Non-current deferred tax assets, net:		2,568,642			9,805,701
Total deferred tax assets, net		5,994,240			9,805,701

The Company has recorded a valuation allowance against all of its U.S. federal and state and PRC deferred tax assets at December 31, 2012 and 2011, except for Feihe Dairy and Gannan Feihe. In accordance with authoritative guidance regarding accounting for income taxes, based on all available evidence, including the Company’s historical results and the uncertainty of predicting its future income, the valuation allowance reduces the Company’s deferred tax assets to an amount that is more likely than not to be realized.

For U.S. federal income tax purposes, the Company has net operating loss (“NOL”) carry forwards of approximately $4.4 million and $2.6 million, as of December 31, 2012 and 2011, respectively. The Company also has approximately $11.1 million and $36.8 million of NOL carry forwards for PRC enterprise income tax purposes, as of December 31, 2012 and 2011, respectively. As of December 31, 2012 and 2011, valuation allowances were approximately $4.3 million and $5.0 million, respectively, which were provided against deferred tax assets of the Company and certain subsidiaries due to the uncertainty of realization. The NOL carry forwards for the Company and its subsidiaries as of December 31, 2012 will expire on various dates between 2015 and 2032.

On March 16, 2007, the PRC National People’s Congress passed the PRC Enterprise Income Tax Law (“EIT Law”) which became effective on January 1, 2008. The EIT Law applies a uniform 25% enterprise income tax rate to both foreign invested enterprises and domestic enterprises. The EIT Law provides a five-year transition period from its effective date for those enterprises which were established before the promulgation date of the EIT Law and which were entitled to a preferential tax treatment such as a reduced tax rate or a tax holiday. On December 26, 2007, the PRC State Council issued the Notice of the State Council Concerning Implementation of Transitional Rules for Enterprise Income Tax Incentives (“Circular 39”). Based on Circular 39, certain specifically listed categories of enterprises which enjoyed a preferential tax rate are eligible for a graduated rate increase to 25% over the 5-year period beginning from January 1, 2008.

Pursuant the former PRC Enterprise Income Tax Law, a manufacturing enterprise that had operated for at least 10 years was eligible to receive certain preferential tax treatments. Moreover, a foreign invested manufacturing enterprise (“FIME”), starting from its first profitable calendar year after offset of accumulated tax losses, was entitled to a two-year exemption from enterprise income tax followed by a three year 50% reduction in its enterprise income tax rate.

Under the current tax regime in China, foreign invested enterprises established prior to the promulgation of the EIT Law have been offered a transitional policy and a grand-fathering of certain preferential tax treatments. Thus, an enterprise that is entitled to preferential treatment in the form of enterprise income tax reduction or exemption prior to January 1, 2008 would continue to enjoy such preferential treatment until the expiration of the period.

Since Gannan Feihe, Shanxi Feihe and Langfang Feihe are considered FIMEs established prior to the promulgation of the EIT law, they have enjoyed 100% tax holidays for 2008 and 2009 and 50% tax holidays for 2010, 2011 and 2012. All other PRC subsidiaries are subject to the statutory tax rate of 25% in 2010, 2011 and 2012.

The tax subsidies granted by the local government for the Company’s PRC subsidiaries may be modified or challenged by the central government or the tax authority. The Company may lose or receive a significantly lesser amount of the tax subsidy from the local government, which would adversely affect the financial statements.

Undistributed earnings of the Company’s PRC subsidiaries amounted to approximately $164 million as of December 31, 2012. Those earnings are considered to be permanently reinvested and accordingly, no deferred tax expense is recorded for U.S. federal and state income tax or applicable withholding taxes. The PRC tax authorities have clarified that dividend distributions made out of pre-January 1, 2008 retained earnings will not be subject to withholding taxes.

Uncertainties exist with respect to how the current income tax law in the PRC applies to the Group’s overall operations, and more specifically with regard to tax residency status. The EIT Law includes a provision specifying that legal entities organized outside of the PRC will be considered residents for Chinese income tax purposes if the place of effective management or control is within the PRC. The implementation rules to the EIT Law provide that non-resident legal entities will be considered China residents if substantial and overall management and control over the manufacturing and business operations, personnel, accounting, properties, and related matters occurs within the PRC. If the PRC tax authorities subsequently determine that the Company and its subsidiaries registered outside the PRC should be deemed a resident enterprise, the Company and its subsidiaries registered outside the PRC will be subject to the PRC income tax at a rate of 25%. As of the balance sheet date, the determination on tax residency of status of the Company is unclear because of the limited guidance issued by the PRC tax authorities. However, the Company believes that no material tax liability will occur for respective tax years if the Company is considered to be a PRC tax resident by the PRC tax authorities.

The Company records interest and penalties related to unrecognized tax benefits in income tax expense.  The Company had cumulatively accrued approximately $1.9 million, $1.9 million, and $1.6 million for estimated interest and penalties related to uncertain tax positions as of December 31, 2012, 2011 and 2010, respectively.  For the years ended December 31, 2012, 2011 and 2010, the Company recorded estimated interest and penalties of approximately $0.04 million, $0.2 million and $0.6 million, respectively.

A reconciliation of January 1, 2010 through December 31, 2012 amount of unrecognized tax benefits and interest and penalties is as follows:

	Gross UTB			Surcharge		Net UTB
	US$			US$		US$
Balance as of January 1, 2010		3,687,082			1,060,001		4,747,083
Increase in surcharge in current year		—			574,843		574,843
Decrease in unrecognized tax benefits taken in current year		(259,590	)		—		(259,590	)
Balance as of December 31, 2010		3,427,492			1,634,844		5,062,336
Increase in surcharge in current year		—			221,238		221,238
Increase in unrecognized tax benefits taken in current year		9,523,194			—		9,523,194
Balance as of December 31, 2011		12,950,686			1,856,082		14,806,768
Increase in surcharge in current year		—			40,973		40,973
Decrease in unrecognized tax benefits taken in current year		(2,821,178	)		—		(2,821,178	)
Balance as of December 31, 2012		10,129,508			1,897,055		12,026,563

The Company and its subsidiaries are subject to taxation in the U.S. and the PRC. Our U.S. federal and state income tax returns are generally not subject to examination by the tax authorities for tax years before 2007. With a few exceptions, the tax years 2007-2012 remain open to examination by tax authorities in the PRC.