Income Taxes

Our income (loss) before income taxes consisted of the following:



	Year ended September 30,
	2015			2014		2013
	(in thousands)
Domestic	$	(110,867	)	$	17,038	$	6,112
Foreign	137,392			169,074		120,122
Total income before income taxes	$	26,525		$	186,112	$	126,234

Our (benefit) provision for income taxes consisted of the following:



	Year ended September 30,
	2015			2014			2013
	(in thousands)
Current:
Federal	$	3,907		$	12,792		$	7,081
State	599			2,062			1,512
Foreign	23,823			31,010			13,586
	28,329			45,864			22,179
Deferred:
Federal	(20,809		)	(13,200		)	(38,224		)
State	(566		)	(2,085		)	(4,718		)
Foreign	(27,986		)	(4,661		)	3,228
	(49,361		)	(19,946		)	(39,714		)
Total provision (benefit) for income taxes	$	(21,032	)	$	25,918		$	(17,535	)

The reconciliation between the statutory federal income tax rate and our effective income tax rate is shown below:



	Year ended September 30,
	2015		2014		2013
Statutory federal income tax rate	35	%	35	%	35	%
Change in valuation allowance	63	%	(11	)%	(32	)%
State income taxes, net of federal tax benefit	7	%	1	%	1	%
Federal and state research and development credits	(8	)%	—	%	(1	)%
Resolution of uncertain tax positions	(11	)%	—	%	(1	)%
Foreign rate differences	(213	)%	(19	)%	(26	)%
Foreign withholding tax	14	%	3	%	5	%
U.S. permanent items	34	%	4	%	5	%
Other, net	—	%	1	%	—	%
Effective income tax rate	(79	)%	14	%	(14	)%

In 2015, our effective tax rate was a benefit of 79% on pre-tax income of $26.5 million. Our effective tax rate was lower than the 35% statutory federal income tax rate due, in large part, to our corporate structure in which our foreign taxes are at an effective tax rate lower than the U.S. A significant amount of our foreign earnings is generated by our subsidiaries organized in Ireland. In 2015, 2014 and 2013, the foreign rate differential predominantly relates to these Irish earnings. Our foreign rate differential in 2015 includes a rate benefit from a business realignment completed on September 30, 2014 in which intellectual property was transferred between two wholly-owned foreign subsidiaries. The realignment allows us to more efficiently manage the distribution of our products to European customers. In 2015, this realignment resulted in a tax benefit of approximately $24.0 million. U.S. permanent items include the tax effect of a $14.5 million expense related to a pending legal settlement. Other factors impacting the effective tax rate include: the release of a valuation allowance totaling $18.7 million relating to the U.S. pension plan termination, foreign withholding taxes of $3.8 million, a tax benefit of $3.1 million relating to the reassessment of our reserve requirements and a benefit of $1.4 million in conjunction with the reorganization of our Atego U.S. subsidiaries. Additionally, our provision reflects a $2.1 million tax benefit related to a retroactive extension of the U.S. research and development tax credit enacted in the first quarter of 2015. This benefit was offset by a corresponding provision to increase our U.S. valuation allowance.

In 2014, our effective tax rate was a provision of 14% on pre-tax income of $186.1 million. Our effective tax rate was lower than the 35% statutory federal income tax rate due, in large part, to the reversal of a portion of the valuation allowance against U.S. deferred tax assets. We recorded benefits resulting from 2014 acquisitions as described below. Other factors impacting the effective tax rate include: our corporate structure in which our foreign taxes are at an effective tax rate lower than the U.S. rate, foreign withholding taxes of $5.1 million and the establishment of a valuation allowance totaling $3.5 million in two foreign subsidiaries.

In 2013, our effective tax rate was a benefit of 14% on pre-tax income of $126.2 million. Our effective tax rate was lower than the 35% statutory federal income tax rate due, in large part, to the reversal of a portion of the valuation allowance against deferred tax assets (primarily the U.S.). We recorded benefits resulting from 2013 acquisitions as described below, and a benefit of $7.9 million related to the release of a valuation allowance as a result of a pension gain recorded in accumulated other comprehensive income in equity. Additionally, our 2013 tax provision reflects a $2.0 million provision related to a research and development (R&D) cost sharing prepayment by a foreign subsidiary to the U.S. A similar prepayment was made in 2012 resulting in a $7.8 million provision in that year. This impact is included in foreign rate differences in our effective tax rate reconciliation above. This impact was offset by a corresponding increase in our valuation allowance in the U.S. Other factors impacting the rate include: our corporate structure in which our foreign taxes are at an effective tax rate lower than the U.S. rate, foreign withholding taxes of $6.0 million and non-cash tax benefits of $5.3 million, included in foreign rate differences, recorded as a result of the conclusion of tax audits in several foreign jurisdictions.

Acquisitions in 2014 and 2013 were accounted for as business combinations. Assets acquired, including the fair value of acquired tangible assets, intangible assets and assumed liabilities were recorded, and we recorded net deferred tax liabilities of $21.6 million and $38.7 million in 2014 and 2013, respectively, primarily related to the tax effect of the acquired intangible assets that are not deductible for income tax purposes. These deferred tax liabilities reduced our net deferred tax asset balance and resulted in a tax benefit of $18.1 million and $36.7 million in 2014 and 2013, respectively, to decrease our valuation allowance in jurisdictions where we have recorded a valuation allowance (primarily the U.S.). As these decreases in the valuation allowance are not part of the accounting for business combinations (the fair value of the assets acquired and liabilities assumed), they were recorded as an income tax benefit.

At September 30, 2015 and 2014, income taxes payable and income tax accruals recorded in accrued income taxes, other current liabilities, and other liabilities on the accompanying Consolidated Balance Sheets were $14.7 million ($4.0 million in accrued income taxes, $2.2 million in other current liabilities and $8.5 million in other liabilities) and $17.7 million ($9.3 million in accrued income taxes, $1.3 million in other current liabilities and $7.1 million in other liabilities), respectively. At September 30, 2015 and 2014, prepaid taxes recorded in prepaid expenses on the accompanying Consolidated Balance Sheets were $8.2 million and $6.3 million, respectively. We made net income tax payments of $30.1 million, $25.5 million and $35.4 million in 2015, 2014 and 2013, respectively.

The significant temporary differences that created deferred tax assets and liabilities are shown below:



	September 30,
	2015			2014
	(in thousands)
Deferred tax assets:
Net operating loss carryforwards	$	71,533		$	57,677
Foreign tax credits	15,962			9,022
Capitalized research and development expense	31,690			41,720
Pension benefits	11,009			39,063
Deferred revenue	71,399			67,433
Stock-based compensation	16,777			18,828
Other reserves not currently deductible	21,940			24,273
Amortization of intangible assets	62,227			9,302
Other tax credits	37,270			30,982
Depreciation	3,465			3,157
Capital loss carryforward	8,040			7,964
Other	10,116			7,118
Gross deferred tax assets	361,428			316,539
Valuation allowance	(198,168		)	(177,541		)
Total deferred tax assets	163,260			138,998
Deferred tax liabilities:
Acquired intangible assets not deductible	(124,401		)	(110,003		)
Pension prepayments	(395		)	(20,263		)
Deferred revenue	(3,110		)	(1,446		)
Other	(3,598		)	(4,484		)
Total deferred tax liabilities	(131,504		)	(136,196		)
Net deferred tax assets	$	31,756		$	2,802

We have concluded, based on the weight of available evidence, that a full valuation allowance continues to be required against our U.S. net deferred tax assets as they are not more likely than not to be realized in the future. We will continue to reassess whether a valuation allowance is required each financial reporting period.

For U.S. tax return purposes, net operating loss (NOL) carryforwards and tax credits are generally available to be carried forward to future years, subject to certain limitations. At September 30, 2015, we had U.S. federal NOL carryforwards of $159.7 million that expire in 2018 to 2035. These include NOL carryforwards from acquisitions of $81 million. The utilization of these NOL carryforwards is limited as a result of the change in ownership rules under Internal Revenue Code Section 382. NOL's totaling $38.8 million relate to windfall tax benefits that have not been recognized, the impact of which will be recorded in APIC when realized.

As of September 30, 2015, we had Federal R&D credit carryforwards of $18.5 million, which expire beginning in 2021 and ending in 2035, and Massachusetts R&D credit carryforwards of $25.7 million, which expire beginning in 2016 and ending in 2030. We also had foreign tax credits of $16.0 million, which expire beginning in 2023 and ending in 2025. A full valuation allowance is recorded against these carryforwards.

We also have NOL carryforwards in non-U.S. jurisdictions totaling $117.7 million, the majority of which do not expire. We also have non-U.S. tax credit carryforwards of $7.2 million that expire beginning in 2025 and ending in 2034. There are limitations imposed on the utilization of such NOLs that could restrict the recognition of any tax benefits.

As of September 30, 2015, we have a valuation allowance of $166.5 million against net deferred tax assets in the U.S. and a remaining valuation allowance of $31.7 million against net deferred tax assets in certain foreign jurisdictions. The valuation allowance recorded against net deferred tax assets of certain foreign jurisdictions is established primarily for our net operating loss carryforwards, the majority of which do not expire. There are limitations imposed on the utilization of such net operating losses that could restrict the recognition of any tax benefits.

The changes to the valuation allowance were primarily due to:



	Year ended September 30,
	2015			2014			2013
	(in millions)
Valuation allowance beginning of year	$	177.5		$	156.5		$	170.4
Net release of valuation allowance (1)	(18.7		)	(18.1		)	(44.6		)
Net increase/decrease in deferred tax assets for foreign jurisdictions with a full valuation allowance	(1.9		)	(5.2		)	1.9
Establish valuation allowance for acquired businesses	—			21.5			12.1
Establish valuation allowance in foreign jurisdictions	—			3.5			—
Adjust deferred tax asset and valuation allowance	41.3			19.3			16.7
Valuation allowance end of year	$	198.2		$	177.5		$	156.5


(1)	In 2014 and 2013, this is attributable to recognition of deferred tax liabilities recorded in connection with accounting for acquisitions and in 2015 and 2013 a reduction in deferred tax assets associated with our U.S. pension plan, both of which are described above.

Our policy is to record estimated interest and penalties related to the underpayment of income taxes as a component of our income tax provision. In 2015 and 2014, we recorded interest expense of $0.1 million and $0.3 million, respectively. In 2013, we recorded a net benefit of $1.2 million. In 2015, 2014 and 2013, we had no tax penalty expense in our income tax provision. As of September 30, 2015 and 2014, we had accrued $1.5 million and $1.4 million, respectively, of net estimated interest expense related to income tax accruals. We had $0.1 million of accrued tax penalties as of September 30, 2013, and no accrued tax penalties as of September 30, 2015 or 2014.



	Year ended September 30,
Unrecognized tax benefits	2015			2014			2013
	(in millions)
Unrecognized tax benefit beginning of year	$	15.0		$	13.7		$	19.1
Tax positions related to current year:
Additions	1.3			2.2			1.0
Tax positions related to prior years:
Additions	0.8			0.3			1.8
Reductions	(3.0		)	(0.1		)	(6.3		)
Settlements	—			(0.6		)	(0.7		)
Statute expirations	—			(0.5		)	(1.2		)
Unrecognized tax benefit end of year	$	14.1		$	15.0		$	13.7

If all of our unrecognized tax benefits as of September 30, 2015 were to become recognizable in the future, we would record a benefit to the income tax provision of $12.5 million (which would be partially offset by an increase in the U.S. valuation allowance of $4.5 million) and a credit to additional paid-in capital (APIC) of $1.6 million. Although we believe our tax estimates are appropriate, the final determination of tax audits and any related litigation could result in favorable or unfavorable changes in our estimates. We anticipate the settlement of tax audits may be finalized within the next twelve months and could result in a decrease in our unrecognized tax benefits of up to $4 million.

In the normal course of business, PTC and its subsidiaries are examined by various taxing authorities, including the IRS in the United States. As of September 30, 2015, we remained subject to examination in the following major tax jurisdictions for the tax years indicated:



Major Tax Jurisdiction		Open Years
United States		2011 through 2015
Germany		2011 through 2015
France		2013 through 2015
Japan		2009 through 2015
Ireland		2011 through 2015

We incurred expenses related to stock-based compensation in 2015, 2014 and 2013 of $50.2 million, $50.9 million and $48.8 million, respectively. Accounting for the tax effects of stock-based awards requires that we establish a deferred tax asset as the compensation is recognized for financial reporting prior to recognizing the tax deductions. The tax benefit recognized in the Consolidated Statements of Operations related to stock-based compensation totaled $0.7 million, $0.7 million and $2.7 million in 2015, 2014 and 2013, respectively. Upon the settlement of the stock-based awards (i.e., exercise, vesting, forfeiture or cancellation), the actual tax deduction is compared with the cumulative financial reporting compensation cost and any excess tax deduction is considered a windfall tax benefit and is tracked in a “windfall tax benefit pool” to offset any future tax deduction shortfalls and will be recorded as increases to APIC in the period when the tax deduction reduces income taxes payable. In 2015, 2014 and 2013, we recorded windfall tax benefits of $0.0 million, $10.4 million and $0.3 million to APIC, respectively. We follow the with-and-without approach for the direct effects of windfall tax deductions to determine the timing of the recognition of benefits for windfall tax deductions. We follow the direct method for indirect effects. As of September 30, 2015, the tax effect of windfall tax deductions which had not yet reduced taxes payable was $30.1 million.

We have not provided for U.S. income taxes or foreign withholding taxes on foreign unrepatriated earnings as it is our current intention to permanently reinvest these earnings outside the U.S. unless it can be done with no significant tax cost, with the exception of a newly formed foreign holding company. There was no impact to this assertion in the current year. In the future, we expect to incur annual deferred tax expense of $11 million. If we decide to change this assertion in the future to repatriate any additional non-U.S. earnings, we may be required to establish a deferred tax liability on such earnings. The cumulative amount of undistributed earnings of our subsidiaries for which U.S. income taxes have not been provided totaled approximately $1,915 million and $613 million as of September 30, 2015 and 2014, respectively. The amount of unrecognized deferred tax liability on the undistributed earnings cannot be practicably determined at this time.