Income Taxes

The provision (benefit) for taxes consists of the following:



	Fiscal Year Ended
(in thousands)	January 31, 2016			January 25, 2015			January 26, 2014
Current tax provision
Federal	$	—		$	749		$	3,769
State	—			—			554
Foreign	8,709			7,810			14,962
Subtotal	8,709			8,559			19,285
Deferred tax provision (benefit)
Federal	6,679			508			23,938
State	(96		)	(100		)	(1,293		)
Foreign	(6,410		)	(419		)	(5,945		)
Subtotal	173			(11		)	16,700
Provision for taxes	$	8,882		$	8,548		$	35,985

The provision (benefit) for taxes reconciles to the amount computed by applying the statutory federal rate to income before taxes as follows:



	Fiscal Year Ended
(in thousands)	January 31, 2016			January 25, 2015			January 26, 2014
Federal income tax at statutory rate	$	7,133		$	12,775		$	(44,968	)
State income taxes, net of federal benefit	(7		)	(100		)	(1,260		)
Foreign taxes at rates less than federal rates	(62		)	(11,960		)	(8,378		)
Tax credits generated	(3,598		)	(5,302		)	(5,523		)
Changes in valuation allowance	1,847			14,284			52,942
Goodwill impairment	—			—			40,840
Changes in uncertain tax positions	1,009			(5,167		)	893
Deemed dividends	276			2,513			726
Equity compensation	2,529			2,200			1,173
Permanent differences	28			(93		)	2,895
Deferred tax provision - indefinite life intangibles	5,670			—			—
Triune earn-out	(5,670		)	—			—
Revaluation of deferred tax assets and liabilities	334			(432		)	(12		)
Other	(607		)	(170		)	(3,343		)
Provision for taxes	$	8,882		$	8,548		$	35,985

The Company receives an income tax benefit from tax rate differentials due to its presence in foreign jurisdictions such as Switzerland and Canada where statutory rates are lower than US federal tax rates. This income tax benefit is reflected in the line item “Foreign taxes at rates less than federal rates.”

The Company, via its Swiss subsidiary, Semtech International AG, receives an income tax benefit in Switzerland because only a portion of its total earnings are subject to taxation in Switzerland. Specifically, in the third quarter of fiscal year 2014, the Company received a new Swiss tax ruling (“New Swiss Ruling”), with an effective date retroactive to the beginning of fiscal year 2014, which allows the Company to compute Swiss income tax using an allocated portion of its total pre-tax earnings that are attributable to the sourcing of production activities. This New Swiss Ruling superseded a Swiss tax ruling that was in effect during fiscal years 2012 and 2013 (“Previous Swiss Ruling”). The Previous Swiss Ruling required the Company to allocate each element of revenue and expense to activities sourced to Switzerland or outside Switzerland based on an analysis of where certain activities were being performed.

In the next twelve months, the Company intends to revisit its existing Swiss tax ruling and begin discussions with local authorities as a result of changes in Swiss tax law that are expected to occur within the next twelve months. The impact of these changes are not expected to have a material impact on our effective tax rate.

On November 20, 2015, the FASB issued Accounting Standards Update ("ASU") No. 2015-17, Balance Sheet Classification of Deferred Taxes, requiring all deferred tax assets and liabilities, and any related valuation allowance, to be classified as non-current on the balance sheet. The classification change for all deferred taxes as non-current simplifies entities’ processes as it eliminates the need to separately identify the net current and net non-current deferred tax asset or liability in each jurisdiction and allocate valuation allowances. The company elected to prospectively adopt the accounting standard in the beginning of our fourth quarter of fiscal 2016. Prior periods in our Consolidated Financial Statements were not retrospectively adjusted.

The deferred tax assets and deferred tax liabilities are classified in the consolidated balance sheets as follows:



(in thousands)	January 31, 2016			January 25, 2015
Deferred tax assets
Current	$	—		$	2,478
Non-current	7,354			106
Subtotal	7,354			2,584
Deferred tax liabilities
Current	—			(1,444		)
Non-current	(6,802		)	(2,477		)
Subtotal	(6,802		)	(3,921		)
Net deferred tax assets (liabilities)	$	552		$	(1,337	)

The components of the net deferred income tax assets and liabilities at January 31, 2016 and January 25, 2015 are as follows:



(in thousands)	January 31, 2016			January 25, 2015
Current deferred tax asset:
Deferred revenue	$	—		$	3,052
Inventory reserve	—			3,156
Payroll and related accruals	—			2,306
Bad debt reserve	—			927
Accrued service fees	—			608
Other deferred assets	—			1,191
Valuation allowance	—			(8,637		)
Total current deferred tax asset	—			2,603
Non-current deferred tax asset:
Deferred revenue	4,295			—
Inventory reserve	2,931			—
Bad debt reserve	521			—
Accrued service fees	238			—
Research and development charges	584			1,323
Research credit carryforward	32,605			40,819
NOL carryforward	38,979			29,144
Payroll and related accruals	8,773			7,148
Stock-based compensation	5,006			6,176
Other deferred assets	6,281			5,054
Valuation allowance	(77,383		)	(66,899		)
Total non-current deferred tax asset	22,830			22,765
Current deferred tax liabilities:
Inventory reserve - foreign	—			(826		)
Bad debt reserve - foreign	—			(256		)
Other current deferred tax liabilities	—			(373		)
Total current deferred tax liabilities	—			(1,455		)
Non-current deferred tax liabilities:
Inventory reserve - foreign	(515		)	—
Depreciation and amortization - foreign	(194		)	—
Purchase accounting deferred tax liabilities	(16,895		)	(20,917		)
Depreciation and amortization	(3,324		)	(2,956		)
Other non-current deferred tax liabilities	(1,350		)	(1,377		)
Total non-current deferred tax liabilities	(22,278		)	(25,250		)
Net deferred tax assets (liabilities)	$	552		$	(1,337	)

As of January 31, 2016, the Company had federal and state net operating loss carryforwards of $114.7 million and $97.4 million, respectively, which, subject to certain limitations, are available to offset future taxable income through fiscal year 2036. A portion of these losses were generated by Sierra Monolithics Inc. (“SMI”) prior to the Company’s purchase of SMI in fiscal year 2010 and therefore are subject to change of control provisions which limit the amount of acquired tax attributes that can be utilized in a given tax year. The Company does not expect these changes in control limitations to significantly impact its ability to utilize these attributes.

Included in the Company’s net operating loss carryforward deferred tax asset is approximately $8.4 million of deferred tax assets attributable to excess equity deductions related to stock awards that are not included on the Company’s consolidated balance sheet. The portion of the Company’s deferred tax asset related to such excess tax benefits is excluded from the Company's recognized deferred tax asset, even if the facts and circumstances indicate that it is more likely than not that the deferred tax asset can be realized. The credit to paid-in-capital will be recorded when the benefit is reflected in the Company's taxes payable.

As of January 31, 2016, the Company had gross federal and state research credits available of approximately $13.3 million and $13.9 million, respectively, which are available to offset taxable income. These credits will expire between fiscal years 2021 through 2036. As of January 31, 2016, the Company had federal Alternative Minimum Tax credits available of approximately $1.3 million. The Company also had gross Canadian research credits available of approximately $24.7 million. These credits will expire between fiscal years 2029 and 2036.

As of January 31, 2016, the Company has a full valuation allowance against its U.S. deferred tax assets of approximately $77.4 million. The Company assessed whether a valuation allowance should be recorded against all of its deferred tax assets (“DTAs”) based on the consideration of all available evidence, using a “more likely than not” realization standard. The four sources of taxable income that must be considered in determining whether DTAs will be realized are, (1) future reversals of existing taxable temporary differences (i.e., offset of gross deferred tax assets against gross deferred tax liabilities); (2) taxable income in prior carryback years, if carryback is permitted under the tax law; (3) tax planning strategies and (4) future taxable income exclusive of reversing temporary differences and carryforwards.

In assessing whether a valuation allowance is required, significant weight is given to evidence that can be objectively verified. The Company evaluated its DTAs each reporting period, including an assessment of the cumulative income or loss generated by jurisdiction over the most recent three-year period, to determine if a valuation allowance was required. A significant negative factor in the assessment was the Company’s three-year cumulative loss history as of January 31, 2016 and January 25, 2015 in the U.S.

After a review of the four sources of taxable income described above, the Company determined that the U.S. was in a three-year cumulative loss position as of January 31, 2016 and January 25, 2015. A three-year cumulative loss is considered to be a significant negative factor and the Company concluded that it is not more likely than not that its DTAs in the U.S. at January 31, 2016 and January 25, 2015 will be realized. As a result, the Company recorded a full valuation allowance on its DTAs in the U.S., with a corresponding charge to the income tax provision of approximately $9.1 million as of January 31, 2016. During the fourth quarter of fiscal year 2016, the Company assessed current facts and circumstances and whether a valuation allowance would be appropriate for its Canadian deferred tax assets, and concluded that sufficient positive evidence exists to conclude that it is more likely than not that these deferred tax assets will be realized. The Company is forecasting pretax income growth for its Canadian operations over the next five years, and correspondingly estimated Canadian based taxes over the next five years. The amount of anticipated taxes owed in this period was compared to the Company’s net deferred tax assets to conclude that the Company would be able to utilize its deferred tax assets without any concerns related to expiration. As a result, valuation allowances on the Canadian deferred tax assets were released, with a corresponding benefit to the income tax provision of approximately $7.2 million. The net charge to the income tax provision is approximately $1.8 million in fiscal 2016. Changes in the valuation allowance for the three years ended January 31, 2016 are summarized in the table below:



	Fiscal Year Ended
(in thousands)	January 31, 2016			January 25, 2015		January 26, 2014
Beginning balance	$	75,536		$	61,251	$	8,320
Additions	9,055			14,285		52,931
Releases	(7,208		)	—		—
Ending balance	$	77,383		$	75,536	$	61,251

As of January 31, 2016, the Company had approximately $516.8 million of unremitted earnings related to the Company’s wholly owned foreign subsidiaries for which income taxes have not been provided.

Uncertain Tax Positions

The Company uses a two-step approach to recognize and measure uncertain tax positions (“UTP”). The first step is to evaluate the tax position for recognition by determining if the weight of available evidence indicates that it is more likely than not that the position will be sustained on audit, including resolution of related appeals or litigation processes, if any. The second step is to measure the tax benefit as the largest amount that is more than 50% likely of being realized upon ultimate settlement.

A reconciliation of the beginning and ending amount of unrecognized tax benefits (net of federal impact of state items) is as follows:



	Fiscal Year Ended
(in thousands)	January 31, 2016			January 25, 2015
Beginning balance	$	7,774		$	12,348
Additions based on tax positions related to the current year	1,425			466
Reductions for tax positions of prior years, net	(767		)	(3,970		)
Reductions for settlements with tax authorities, net	—			(1,070		)
Ending balance	$	8,432		$	7,774

Included in the balance of unrecognized tax benefits at January 31, 2016 and January 25, 2015, are $8.4 million and $7.8 million, respectively, of net tax benefits (after federal impact of state items) that, if recognized, would impact the effective tax rate.

The liability for UTP is reflected on the consolidated balance sheets as follows:



	Fiscal Year Ended
(in thousands)	January 31, 2016		January 25, 2015
Deferred tax assets - non-current	$	7,162	$	7,522
Accrued liabilities	—		—
Other long-term liabilities	1,270		252
Total accrued taxes	$	8,432	$	7,774

The Company’s policy is to include net interest and penalties related to unrecognized tax benefits within the provision for taxes on the consolidated statements of operations. Since the Company has sufficient net operating losses and R&D credit carryforwards, there would be no cash tax liability, and therefore no additional penalties or interest accrued during fiscal year 2016. The Company had approximately $0.3 million of net interest and penalties accrued at January 31, 2016 and January 25, 2015.

Tax years prior to 2012 (the Company’s fiscal year 2013) are generally not subject to examination by the Internal Revenue Service (“IRS”) except for items involving tax attributes that have been carried forward to tax years whose statute of limitations remains open. The Company is currently under IRS audit for fiscal years 2012 and 2013 and expects to close those audits within the next twelve months. The Company's positions are expected to be sufficient to address matters that may arise under examination. For state returns, the Company is generally not subject to income tax examinations for years prior to 2011 (the Company’s fiscal year 2012). The Company has a significant tax presence in Switzerland for which Swiss tax filings have been examined through fiscal year 2014. The Company is also subject to routine examinations by various foreign tax jurisdictions in which it operates.