INCOME TAXES

Tax Cuts and Jobs Act of 2017

On December 22, 2017, the Tax Cuts and Jobs Act of 2017 (the “Act”) was signed into law. The Act made broad and significantly complex changes to the U.S. corporate income tax system by, among other things; reducing the U.S. federal corporate income tax rate from 35% to 21%, transitioning U.S. international taxation to a modified territorial tax system and imposing a mandatory one-time deemed repatriation tax, payable over eight years, on accumulated undistributed foreign subsidiary earnings and profits as of December 31, 2017. Given the significant changes resulting from and complexities associated with the Act, the estimated financial impacts related to the enactment of the Act, for Fiscal 2017 and up to one year from the enactment of the Act, were provisional and subject to further analysis, interpretation and clarification of the Act. Changes in interpretations and assumptions the Company has made, resulted in changes to these estimates during Fiscal 2018. The Company completed its accounting related to the Act in the fourth quarter of Fiscal 2018. During Fiscal 2018, the Company recognized measurement period net benefits in an aggregate amount of $3.5 million during Fiscal 2018, which consisted of:


•	$6.0 million of measurement period net benefits for adjustments to deferred taxes resulting from an international tax restructuring of foreign operations completed in response to the Act;


•	$2.0 million of measurement period charges, adjusting the provisional tax amounts related to the mandatory one-time deemed repatriation tax on accumulated undistributed foreign earnings and profits; and,


•	$0.4 million of measurement period net charges, adjusting the provisional tax amounts related to the remeasurement of the Company’s ending deferred tax assets and liabilities at February 3, 2018, as well as adjusting the Company’s deferred tax liability on unremitted foreign earnings.

As a result of the Company’s initial analysis of the impact of the Act and subsequent measurement period adjustments, the Company has incurred discrete net income tax charges in an aggregate amount of $16.5 million since the enactment of the Act, which consist of:


•	$23.7 million of tax expense related to the mandatory one-time deemed repatriation tax on accumulated undistributed foreign subsidiary earnings and profits of approximately $385.8 million;


•	$5.6 million of tax benefit for the decrease in the Company’s federal deferred tax liability on unremitted foreign earnings;


•	$6.0 million of net tax benefit for adjustments to deferred taxes resulting from an international tax restructuring of foreign operations completed in response to the Act;


•	$3.5 million of tax expense related to the remeasurement of the Company’s ending deferred tax assets and liabilities at February 3, 2018, as a result of the U.S. federal corporate income tax rate reduction from 35% to 21%; and,


•	$0.8 million of tax expense at the state level related to the Company’s decision to repatriate $250 million of the Company’s undistributed foreign earnings to the U.S. in the fourth quarter of Fiscal 2018.

Components of income taxes

Income (loss) before income taxes consisted of:



(in thousands)	Fiscal 2018		Fiscal 2017			Fiscal 2016
Domestic ⁽¹⁾	$	53,858	$	(12,326	)	$	(52,041	)
Foreign	62,509		67,487			48,563
Income (loss) before income taxes	$	116,367	$	55,161		$	(3,478	)


⁽¹⁾	Includes intercompany charges to foreign affiliates for management fees, cost-sharing, royalties and interest and excludes a portion of foreign income that is currently includable on the U.S. federal income tax return.

Income tax expense (benefit) consisted of:



(in thousands)	Fiscal 2018			Fiscal 2017			Fiscal 2016
Current:
Federal	$	7,460		$	(218	)	$	(18,888	)
State	3,645			1,897			(74		)
Foreign	20,508			5,472			15,633
Total current	$	31,613		$	7,151		$	(3,329	)

Deferred:
Federal	$	5,319		$	23,620		$	(5,787	)
State	1,183			1,457			(346		)
Foreign	(556		)	12,408			(1,734		)
Total deferred	5,946			37,485			(7,867		)
Income tax expense (benefit)	$	37,559		$	44,636		$	(11,196	)

During Fiscal 2018, the Company repatriated $250 million of the Company’s foreign earnings and profits to the U.S. The Company has determined that the remaining balance of the Company’s undistributed earnings and profits from its foreign subsidiaries are considered indefinitely reinvested outside of the U.S. As a result of both the mandatory one-time deemed repatriation and the adoption of a modified territorial system under the Act, these earnings and profits could be repatriated without incurring additional federal income tax. If additional funds were to be repatriated to the U.S., the Company could incur an insignificant amount of state income taxes and foreign withholding taxes.

Reconciliation between the statutory federal income tax rate and the effective tax rate is as follows:



	Fiscal 2018		Fiscal 2017 ⁽¹⁾		Fiscal 2016 ⁽²⁾
U.S. federal corporate income tax rate	21.0	%	33.7	%	35.0	%
State income tax, net of U.S. federal income tax effect	3.6		3.5		5.0
Foreign taxation of non-U.S. operations	(1.7	)	(25.8	)	248.9
U.S. taxation of non-U.S. operations ⁽³⁾	5.1		17.3		(212.6	)
Net change in valuation allowances	0.7		1.0		(16.5	)
Audit and other adjustments to prior years’ accruals	(0.1	)	—		(0.1	)
Statutory tax rate and law changes	(0.1	)	(0.3	)	94.3
Permanent items	1.2		3.5		91.3
Credit items	(0.6	)	(4.2	)	11.7
Tax Cuts and Jobs Act of 2017	(3.0	)	36.1		—
Tax deficit recognized on share-based compensation expense⁽⁴⁾	8.3		19.2		—
Credit for increasing research activities	(1.7	)	(2.3	)	32.1
Trust-owned life insurance policies (at cash surrender value)	(0.6	)	(1.9	)	31.0
Other items, net	0.2		1.1		1.8
Total	32.3	%	80.9	%	321.9	%


⁽¹⁾	On December 22, 2017, the Act was signed into law, which reduced the U.S. federal corporate income tax rate from 35% to 21% resulting in a blended U.S. federal income tax rate of 33.7% based on the applicable tax rates before and after January 1, 2018, and the number of days in Fiscal 2017.

⁽²⁾

Given the low level of income in absolute dollars in Fiscal 2016, effective tax rate reconciling items that may have been considered de minimis in prior years in terms of absolute dollars and on a percentage basis were amplified on a percentage basis in Fiscal 2016 even as the absolute dollar value of the reconciling items were similar to prior years. Accordingly, year over year comparability may be difficult as a result of the amplifying effect of the lower levels of income.


⁽³⁾	U.S. branch operations in Canada and Puerto Rico are subject to tax at the full U.S. tax rates. As a result, income from these operations do not create reconciling items.


⁽⁴⁾	The Company incurred discrete non-cash income tax charges of $9.6 million and 10.6 million for Fiscal 2018 and Fiscal 2017, respectively, primarily related to the expiration of certain share-based compensation awards, recognized in income tax expense (benefit) due to changes in share-based compensation accounting standards adopted by the Company in Fiscal 2017.

Historically, jurisdictional location of pre-tax income (loss) represented a significant component of the Company’s effective tax rate as income tax rates outside the U.S. were generally lower than the U.S. statutory federal income tax rate. Furthermore, the impact of changes in the jurisdictional location of pre-tax income (loss) on the Company’s effective tax rate were amplified on a percentage basis at lower levels of consolidated pre-tax income (loss) in absolute dollars. As a result of the Act, the U.S. effective tax rate will be generally lower, but the effective tax rate remains dependent on jurisdictional mix. The taxation of non-U.S. operations line items in the table above excludes items related to the Company’s non-U.S. operations reported separately in the appropriate corresponding line items.

For Fiscal 2018, the impact of foreign taxation of non-U.S. operations on the Company’s effective income tax rate was primarily related to the Company’s Swiss subsidiary, along with the Company’s NCI. For Fiscal 2018, the Company’s Swiss subsidiary earned pre-tax income of $24.9 million with a jurisdictional effective tax rate of 12.9%. With respect to the NCI, the subsidiaries incurred pre-tax income of $4.3 million with no jurisdictional tax effect. The Swiss earnings are subject to U.S. tax and the effect is included in the U.S. taxation of non-U.S. operations above.

For Fiscal 2017, the impact of foreign taxation of non-U.S. operations on the Company’s effective income tax rate was primarily related to the Company’s Swiss and Hong Kong subsidiaries, along with the Company’s NCI. For Fiscal 2017, the Company’s Swiss subsidiary earned pre-tax income of $31.6 million with a jurisdictional effective tax rate of 1.2%. For Fiscal 2017, the Company’s Hong Kong subsidiary incurred pre-tax losses of $7.4 million with a jurisdictional effective tax rate of negative 3.1%. With respect to the NCI, the subsidiaries incurred pre-tax income of $3.4 million with no jurisdictional tax effect.

For Fiscal 2016, the impact of foreign taxation of non-U.S. operations on the Company’s effective income tax rate was primarily related to the Company’s Swiss and Hong Kong subsidiaries, along with the Company’s NCI. For Fiscal 2016, the Company’s Swiss subsidiary earned pre-tax income of $18.7 million with a jurisdictional effective tax rate of negative 11.0%. For Fiscal 2016, the Company’s Hong Kong subsidiary incurred pre-tax losses of $12.6 million with a jurisdictional effective tax rate of negative 4.5%. With respect to the NCI, the subsidiaries incurred pre-tax income of $3.8 million with no jurisdictional tax effect.

Components of deferred income tax assets and liabilities

The effect of temporary differences which gives rise to deferred income tax assets (liabilities) were as follows:



(in thousands)	February 2, 2019			February 3, 2018
Deferred income tax assets:
Intangibles, foreign step-up in basis ⁽¹⁾	$	52,615		$	—
Rent	27,299			29,594
Deferred compensation	22,341			31,567
Accrued expenses and reserves	12,767			13,790
Net operating losses (NOL), tax credit and other carryforwards	8,195			5,256
Investments in subsidiaries	1,988			—
Other	1,012			1,100
Valuation allowances	(5,402		)	(3,508		)
Total deferred income tax assets	$	120,815		$	77,799

Deferred income tax liabilities:
U.S. offset to foreign step-up in basis ⁽¹⁾	$	(52,615	)	$	—
Inventory	(6,937		)	(5,206		)
Property, equipment and intangibles	(4,769		)	(2,923		)
Store supplies	(2,998		)	(3,261		)
Prepaid expenses	(2,564		)	(1,698		)
Investments in subsidiaries	—			(2,937		)
Other	(660		)	(1,532		)
Total deferred income tax liabilities	(70,543		)	(17,557		)
Net deferred income tax assets ⁽²⁾	$	50,272		$	60,242

⁽¹⁾

In conjunction with the adoption of ASU 2016-16, Intra-Entity Transfers of Assets Other Than Inventory, which was effective at the beginning of Fiscal 2018 for the Company, Swiss deferred tax assets and U.S. deferred tax liabilities associated with prior year restructurings were recorded as an error correction during the fourth quarter of Fiscal 2018. Recognizing the impact of adoption at the beginning of Fiscal 2018 would have resulted in an increase to both deferred tax assets and deferred tax liabilities of $53.5 million, $53.3 million, and $52.6 million as of May 5, 2018, August 4, 2018 and November 3, 2018, respectively. Based on quantitative and qualitative assessments, such amounts are not considered material to the prior periods. This correction did not have an impact to the Consolidated Statements of Operations and Comprehensive Income (Loss) or the Consolidated Statements of Cash Flows. The deferred tax asset relates to a step-up in basis associated with the intra-entity transfer of intangible assets to Switzerland which are being amortized for Swiss local tax purposes. As this subsidiary’s income is also taxable in the U.S., a corresponding U.S. deferred tax liability was recognized to reflect lower resulting foreign tax credits due to the amortization of the Swiss step-up in basis.


⁽²⁾	This table does not reflect deferred taxes classified within accumulated other comprehensive loss. As of February 2, 2019, accumulated other comprehensive loss included deferred tax liabilities of $0.3 million. As of February 3, 2018, accumulated other comprehensive loss included deferred tax assets of $1.2 million.

As of February 2, 2019, the Company had deferred tax assets related to foreign and state NOL and credit carryforwards of $6.7 million and $1.5 million, respectively, that could be utilized to reduce future years’ tax liabilities. If not utilized, a portion of the foreign NOL carryovers will begin to expire in 2020 and a portion of state NOL will begin to expire in 2022. Some foreign NOLs have an indefinite carryforward period.

The Company believes it is more likely than not that NOLs and credit carryforwards will reduce future years’ tax liabilities in various states and certain foreign jurisdictions less any associated valuation allowance. All valuation allowances have been reflected through the Consolidated Statements of Operations and Comprehensive Income (Loss). No other valuation allowances have been provided for deferred tax assets because management believes that it is more likely than not that the full amount of the net deferred tax assets will be realized in the future. While the Company does not expect material adjustments to the total amount of valuation allowances within the next 12 months, changes in assumptions may occur based on the information then currently available. In such case, the Company will record an adjustment in the period in which a determination is made.

Other

The amount of uncertain tax positions as of February 2, 2019, February 3, 2018 and January 28, 2017, which would impact the Company’s effective tax rate if recognized and a reconciliation of the beginning and ending amounts of uncertain tax positions, excluding accrued interest and penalties, are as follows:



(in thousands)	Fiscal 2018			Fiscal 2017			Fiscal 2016
Uncertain tax positions, beginning of the year	$	1,113		$	1,239		$	2,455
Gross addition for tax positions of the current year	151			148			67
Gross (reduction) addition for tax positions of prior years	(3		)	(1		)	19
Reductions of tax positions of prior years for:
Lapses of applicable statutes of limitations	(218		)	(157		)	(1,211		)
Settlements during the period	(16		)	(116		)	(40		)
Changes in judgment / excess reserve	(549		)	—			(51		)
Uncertain tax positions, end of year	$	478		$	1,113		$	1,239

The Internal Revenue Service (“IRS”) is currently conducting an examination of the Company’s U.S. federal income tax returns for Fiscal 2018 and Fiscal 2017 as part of the IRS’ Compliance Assurance Process program. The IRS examinations for Fiscal 2016 and prior years have been completed. State and foreign income tax returns are generally subject to examination for a period of three to five years after the filing of the respective income tax return. The Company has various state and foreign income tax returns in the process of examination, administrative appeals or litigation. The outcome of these examinations is not expected to have a material impact on the Company’s consolidated financial statements. The Company believes that some of these audits will conclude within the next 12 months and that it is reasonably possible the amount of uncertain income tax positions, including interest, may change by an immaterial amount due to settlements of audits and expiration of statutes of limitations.

The Company does not expect material adjustments to the total amount of uncertain tax positions within the next 12 months, but the outcome of tax matters is uncertain and unforeseen results can occur.