12. VAT Tax Issue in Brazil

Please see footnote 10 of the Company’s Annual Report on Form 10-K for the year ended January 31, 2013 for a more detailed discussion.

The Bahia state tax auditors filed several claims for VAT taxes. The claims assert that the state VAT taxes are owed to the state of domicile of the ultimate importer/user and disregarded the fact that the VAT taxes had already been paid to the neighboring state.

The Company has changed its strategy regarding the large VAT tax claim as a result of the current cash flow needs in Brazil. At such time when a switch to a formal judicial proceeding is required, the Company intends to negotiate a guarantee with the court whereby the Company would either pledge its inventory as collateral for the judicial deposit or alternately would agree to deposit into an escrow account with the court system a monthly judicial deposit of a negotiated percentage of its future sales in Brazil. The Company believes it is probable it would be able to negotiate such an arrangement. The Company would then be able to avail itself of a later amnesty. Any amounts paid into the escrow would be available at such time to be applied to the amnesty payment. The Company believes it is more likely than not that it will have the cash from operations or the borrowing capacity at such time to fund such amnesty payment but no assurances can be given.

Such arrangement would result in a judicial tax claim filed against the Company for 20% greater than the total claim, or approximately US $6.7 million (R15.0 million).

Once this arrangement is completed, the formal judicial process could take from 5 to 10 years. The Company believes there is a strong likelihood that another amnesty would be offered by the state prior to such completion.

The Company has accepted amnesty for a smaller claim which will result in 8 monthly payments of about US $19,000 (R42,000) which reflects abatement of 80% of penalty and interest. An accrual of US $153,000 has been charged to expense and included in Other Accrual Expenses on the Balance Sheet as of October 31, 2013.

In December 2013, the company has just learned of a different VAT tax claimed by the State of Sao Paulo for a tax in the amount of approximately US $45,000 and total claim including interest and penalty totaling approximately US $200,000.

Management needs more time to evaluate this claim but intends to defend until the next amnesty if loss is probable and will defend totally if loss is remote. Given the lack of materiality management will make a more definite judgment in the year-end report.

A table summarizing all five different VAT claims and their status is listed below:

Principle		Interest		Penalty		Total		Approximate for Totals		Loss Possibility	Strategy		Collateral
R$		R$		R$		R$		US $

	305,897		310,182		181,089		797,168		362,000	Remote		To wait Judicial Process		New Land
	573,457		754,401		344,074		1,671,932		760,000	Remote		To wait Judicial Process		Plant
	6,209,836		3,142,429		3,511,156		12,863,422		5,847,000	Probable		To wait Judicial Process and offer Judicial Deposit (approx. 3% net sales)		-
	402,071		528,891		241,242		1,172,204		533,000	Remote		To wait Judicial Process		New Land
	285,009		78,135		171,005		534,149		243,000	Loss Agreed		*Accept State Amnesty (8 installments, approx. BRL 42K)		-
	7,776,270		4,814,038		4,448,567		17,038,875		7,745,000			*After State Amnesty Accepted

	PRINCIPAL		INTEREST		PENALTY		TOTAL			State Requirements

		285,009		15,626		34,200		334,835			8 Installments
Total		285,009		15,626		34,200		334,835	152,000