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Note 9 - Income Taxes

6 Months Ended

Jul. 31, 2020

9.	INCOME TAXES

In determining the quarterly provision for income taxes, the Company calculated income tax expense based on actual quarterly results in each of the second quarters of fiscal years 2021 and 2020. These results were adjusted for discrete items recorded during the period. Actual quarterly results were used in fiscal 2021 and 2020 since they provided a more reliable estimate of quarterly tax expense.

The Company recorded income tax expense of $0.4 million and $9.9 million in the second quarter of fiscal 2021 and 2020, respectively. The Company’s effective tax rate was 88% during the second quarter of fiscal 2021 compared to (292%) for the same period in the prior year. The change in the effective tax rate was primarily due to a pre-tax profit of $0.5 million in the second quarter of fiscal 2021 as compared to a pre-tax loss of $3.4 million in addition to a $10 million valuation allowance that was placed on the net deferred tax assets of the Company’s wholly-owned Irish subsidiary in the second quarter of fiscal 2020. 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 $1.4 million and $10.6 million for the first six months of fiscal 2021 and 2020, respectively. The Company’s effective tax rate was 132% during the first six months of fiscal 2021 compared to (180%) for the same period in the prior year. The change in the effective tax rate was primarily due to a pre-tax profit of $1.1 million in the first six months of fiscal 2021 compared to a $5.9 million pre-tax loss in addition to a $10 million valuation allowance that was placed on the Company’s wholly-owned Irish subsidiary’s net deferred tax assets in fiscal 2020.

On March 27, 2020, in response to the COVID-19 pandemic, the Coronavirus Aid, Relief, and Economic Security (CARES) Act was signed into law. The CARES Act provides additional economic stimulus to address the impact of the COVID-19 pandemic. In the first six months of fiscal year 2021, the Company’s income tax provision was not significantly impacted by the CARES Act. The Company will continue to closely monitor the impact of the COVID-19 pandemic, as well as any effects that may result from future legislation.

In July 2020, the U.S. Department of Treasury issued final tax regulations related to foreign-derived intangible income and global intangible low-taxed income (GILTI) provisions. Also in July 2020, the U.S. Department of Treasury released final tax regulations that provide certain U.S. taxpayers with an annual election to exclude foreign income that is subject to a high effective tax rate from their GILTI inclusions. The Company is currently assessing the impact of these new regulations to its condensed consolidated financial statements.

When calculating QAD’s income tax expense for the first six months of fiscal 2021, the Company considered the U.S. Tax Cuts and Job Act that was signed into law in December 2017. The Company calculated an estimate for 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 addition, the technical change in depreciation on qualified improvement property enacted in the CARES Act was also considered in the GILTI calculation. In the first six months of fiscal 2021, cash taxes were not impacted by GILTI since the Company has experienced losses in foreign jurisdictions.

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

At July 31, 2020 and 2019, the gross amount of unrecognized tax benefits was $1.3 million including interest and penalties. The unrecognized tax benefits for the first six months of fiscal 2021 and fiscal 2020 were reduced by $1 million with an accompanying reduction of 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, 2020 and 2019, the Company 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 at each balance sheet date to determine whether a valuation allowance is necessary based on the more-likely-than-not standard. During the first six months of fiscal year 2021 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 assessed the transfer pricing methodology, the historical profits, the economics of the country including the impact of COVID-19 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.

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

Jurisdiction	July 31, 2020		January 31, 2020
U.S. federal and state	$	32.1	$	30.3
Ireland		11.9		11.6
Brazil		6.2		5.7
Germany		2.8		2.6
Hong Kong		0.6		0.6
South Africa		0.2		0.2
Total valuation allowance	$	53.8	$	51.0

At July 31, 2020 and January 31, 2020, the worldwide valuation allowance attributable to deferred tax assets was $53.8 million and $51.0 million, respectively.

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 2018
	●	Thailand for fiscal year ended January 31, 2018
	●	Mexico for calendar years ended December 31, 2015, 2016, 2017 and 2018

During the fiscal year 2021, the Company closed the following audits with no adjustment:

●

Germany for fiscal years ended January 31, 2015, 2016 and 2017

- Definition

The entire disclosure for income taxes. Disclosures may include net deferred tax liability or asset recognized in an enterprise's statement of financial position, net change during the year in the total valuation allowance, approximate tax effect of each type of temporary difference and carryforward that gives rise to a significant portion of deferred tax liabilities and deferred tax assets, utilization of a tax carryback, and tax uncertainties information.

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