10.

INCOME TAXES

In determining the quarterly provision for income taxes, the Company calculated income tax expense based on actual quarterly results in the

second

quarter of fiscal year

2020,

compared to the prior year where the Company calculated income tax expense based on the estimated annual tax rate. Results were adjusted for discrete items recorded during the period. Actual quarterly results are being used in fiscal

2020

since they provide a more reliable estimate of quarterly tax expense given the Company has recorded net losses during the

first

half of fiscal

2020

and expects to record a net loss for the full fiscal year.

The Company recorded income tax expense of

$9.9

million and

$1.5

million in the

second

quarter of fiscal

2020

and

2019,

respectively. The Company’s effective tax rate was (

292%

) during the

second

quarter of fiscal

2020

compared to

57%

for the same period in the prior year. The change in the effective tax rate was primarily due to a valuation allowance that was placed on the net deferred tax assets of the Company’s wholly-owned Irish subsidiary (the “Irish Principal”) and a taxable loss in the

second

quarter of fiscal

2020

compared to taxable profits for the same period of fiscal

2019.

The placement of a valuation allowance resulted in an accounting adjustment of

$10

million to income tax expense.

The Company recorded income tax expense of

$10.6

million and

$2.7

million for the

first

six

months of fiscal

2020

and

2019,

respectively. The Company’s effective tax rate was (

180%

) during the

first

six

months of fiscal

2020

compared to

51%

for the same period in the prior year. The change in the effective tax rate was primarily due to a valuation allowance that was placed on the Company’s Irish Principal’s net deferred tax assets and a taxable loss for the

first

six

months of fiscal

2020

compared to taxable profits for the same period of fiscal

2019.

The placement of a valuation allowance resulted in an accounting adjustment of

$10

million to income tax expense.

When calculating QAD’s income tax expense for the

first

six

months of fiscal

2020

and fiscal

2019,

the Company considered the U.S. Tax Cuts and Jobs Act (“Tax Act”) enacted

December 22, 2017.

The Company calculated an estimate for global intangible low-tax income (“GILTI”) in the Company’s tax expense based on the final GILTI regulations released on

June 14, 2019

by the U.S. Department of Treasury. These regulations provide computational, definitional, and anti-avoidance rule guidance relating to the determination of a U.S. shareholder’s GILTI inclusion. In the

second

quarter of fiscal

2020,

cash taxes were

not

impacted by GILTI since the Company is experiencing losses overseas.

The Company has elected to treat the deferred taxes related to GILTI provisions as a current-period expense when incurred (the “period cost method”).

The gross amount of unrecognized tax benefits was

$1.3

million at

July 31, 2019,

including interest and penalties. The unrecognized tax benefits were reduced by

million with an offset to deferred tax assets, as a result of the netting required under ASU

2013

11.

The entire amount of unrecognized tax benefits, if recognized, will impact the Company’s effective tax rate. This liability is classified as long-term unless the liability is expected to conclude within

twelve

months of the reporting date.

The Company’s policy is to recognize interest and penalties, if any, related to unrecognized tax benefits as a component of income tax expense. As of

July 31, 2019,

the Company has accrued approximately

$0.1

million of interest and penalty expense relating to unrecognized tax benefits.

The Company reviews its net deferred tax assets by entity on a quarterly basis to determine whether a valuation allowance is necessary based on the more-likely-than-

not

standard. During the

second

quarter of fiscal year

2020

management considered all available evidence, both positive and negative, to determine whether, based on the weight of that evidence, a valuation allowance was needed. Management assesses the transfer pricing methodology, the historical profits, the economics of the country in which the entity operates, the current and future customer base, the type and character of the deferred tax asset and any other current and relevant information by entity to draw its conclusion.

●

For the Irish Principal, the positive evidence was outweighed by the Irish

three

-year cumulative loss, a fiscal

2020

projected loss, and future earmarked investment necessary to transition the business to cloud. Management concluded that the weight of this negative evidence warranted placing a valuation allowance on the Irish Principal’s net deferred tax assets. A full valuation allowance of

$10

million was placed on the Irish Principal’s net deferred tax assets during the

second

quarter of fiscal

2020.

●

A valuation allowance was also placed on South Africa’s net deferred tax assets. The Company plans to liquidate this entity and does

not

anticipate utilizing its net operating losses.

●

The valuation allowance on Belgium has been released as management concluded that it is “more likely than

not”

that Belgium will utilize its net deferred tax assets within the foreseeable future.

A valuation allowance has been established for select foreign jurisdictions along with U.S. federal and state deferred tax assets. The following table discloses the Company’s valuation allowance by entity (in millions):

Jurisdiction	July 31, 2019		January 31, 2019
U.S. federal and state	$	26.8	$	24.7
Irish Principal		9.9		-
Brazil		5.4		5.2
Germany		2.7		2.9
Hong Kong		1.2		1.2
South Africa		0.2		-
Belgium		-		0.9
Total valuation allowance	$	46.2	$	34.9

The Company files U.S. federal, state, and foreign tax returns that are subject to audit by various tax authorities. The Company is currently under audit in:

	●	India for fiscal years ended March 31, 2010, 2013 and 2014
	●	Netherlands for fiscal year ended January 31, 2016
	●	Germany for fiscal years ended January 31, 2015, 2016 and 2017
	●	Switzerland for fiscal years ended January 31, 2014, 2015, 2016, 2017 and 2018

●

Thailand for fiscal year ended

January 31, 2017

During the fiscal year

2020,

the Company closed the following audits with an immaterial adjustment:

●

Tennessee for fiscal year ended

January 31, 2014,

2015,

2016

and

2017