INCOME TAXES

Income Taxes

As of December 31, 2017, the Company had a domestic federal net operating loss carryforward ("NOL"), of approximately $94.0 million and a domestic research and development tax credit carryforward of approximately $0.4 million. Our federal NOL is expected to expire as follows if unused: $88.0 million in 2018 through 2022, $5.5 million in 2024 and 2025 and $0.5 million in 2027 and later. The Tax Cuts and Jobs Act repealed the corporate alternative minimum tax credit and made refundable all carryforward amounts in years 2018-2021. As a result, the alternative minimum tax credit of $0.5 million has been reclassified from a deferred tax asset to a non-current federal income tax asset.

The Company is subject to income taxes in the US federal jurisdiction, and various foreign, state and local jurisdictions. Tax regulations within each jurisdiction are subject to the interpretation of the related tax laws and regulations and require significant judgment to apply. In the United States, the tax years 2014 - 2016 remain open to examination by the Internal Revenue Service and the tax years 2013 - 2016 remain open for various state taxing authorities.

Cash paid for income taxes for the years ended December 31, 2017, 2016, and 2015 was $213 thousand, $357 thousand and $55 thousand, respectively.

The components of income before income taxes were as follows (in thousands):



	Year Ended December 31,
	2017		2016		2015
Domestic	$	18,188	$	16,375	$	8,325
Foreign	181		129		102
	$	18,369	$	16,504	$	8,427

Temporary differences that give rise to the components of net deferred tax assets are as follows (in thousands):



	December 31,
	2017			2016
Inventory	$	1,321		$	1,172
Accrued compensation	103			114
Stock options	914			811
Research and development	442			438
Alternative minimum tax credit	—			543
Deferred revenue	2,002			2,934
Property and equipment	2,531			2,750
Net operating loss carryforwards – domestic	22,627			34,706
Foreign tax credit carryforward	54			—
Capital leases	(3,757		)	(2,833		)
Unremitted earnings for controlled foreign corporations	(50		)	—
Other	194			34
	26,381			40,669
Valuation allowance	(14,504		)	(19,547		)
Total net deferred tax assets	$	11,877		$	21,122

The components of the income tax expense are as follows (in thousands):



	Year Ended December 31,
	2017			2016		2015
Current income tax expense:
Federal	$	—		$	197	$	1,492
State	6			179		65
Foreign	43			31		24
Total current expense	$	49		$	407	$	1,581
Deferred income tax expense (benefit):
Federal	$	9,736		$	3,545	$	1,043
State	(872		)	387		284
Foreign	—			—		—
Total deferred expense	8,864			3,932		1,327
Total income tax expense	$	8,913		$	4,339	$	2,908

The Company's income tax expense (benefit) relating to income (loss) for the periods presented differs from the amounts that would result from applying the federal statutory rate to that income (loss) as follows:



	Year Ended December 31,
	2017		2016		2015
Statutory federal tax rate	34	%	34	%	34	%
State income taxes, net of federal benefit	(5	)%	2	%	3	%
Non-controlling interest in Heska Imaging US, LLC	1	%	(3	)%	(1	)%
Non-temporary stock option benefit	(30	)%	(7	)%	(1	)%
Other permanent differences	1	%	(1	)%	—	%
Change in tax rate	32	%	—	%	(1	)%
Change in valuation allowance	16	%	—	%	(14	)%
Other	—	%	1	%	15	%
Effective income tax rate	49	%	26	%	35	%

In 2017, we had total income tax expense of $8.91 million, including $8.86 million in domestic deferred income tax expense, a non-cash expense, and $0.05 million in current income tax expense. In 2016, we had total income tax expense of $4.3 million, including $3.9 million in domestic deferred income tax expense, a non-cash expense, and $0.4 million in current income tax expense. In 2015, we had total income tax expense of $2.9 million, including $1.3 million in domestic deferred income tax expense, a non-cash expense, and $1.6 million in current income tax expense. The overall increase in tax expense in 2017 from 2016 was due to the re-measurement of our deferred tax assets (including the valuation allowance) due to the US Tax Cuts and Jobs Act, offset by the reduction of tax expense from stock based compensation deductions. Income tax expense increased in 2016 from 2015 as a result of higher income before taxes in 2016.

ASC 740 provides detailed guidance for the financial statement recognition, measurement and disclosure of uncertain tax positions recognized in the financial statements. Tax positions must meet a "more-likely-than-not" recognition threshold before a benefit is recognized in the financial statements. As of December 31, 2017, the Company has not recorded a liability for uncertain tax positions. The Company would recognize interest and penalties related to uncertain tax positions in income tax (benefit)/expense. No interest and penalties related to uncertain tax positions were accrued at December 31, 2017.

US Tax Reform

On December 22, 2017, the tax legislation commonly known as the US Tax Cuts and Jobs Act was signed into law (the “Act”). This enactment resulted in a number of significant changes to US federal income tax law for US corporations. Most notably, the statutory US federal corporate income tax rate was changed from 35% to 21% for corporations. In addition to the change in the corporate income tax rate, the Act further introduced a number of other changes including a one-time transition tax via a mandatory deemed repatriation of post-1986 undistributed foreign earnings and profits; the introduction of a tax on global intangible low-taxed income (“GILTI”) for tax years beginning after December 31, 2017; the further limitation of the deductibility of share-based compensation of certain highly compensated employees; and the repeal of the corporate alternative minimum tax; amongst other things.

Shortly after enactment, the Security and Exchange Commission ("SEC") issued SAB 118, which provides guidance on accounting for the new legislation. Under SAB 118, an entity should recognize amounts for which accounting can be completed. Where accounting under ASC 740 is incomplete relative to certain income tax effects of tax reform, the entity should recognize provisional amounts and adjust such amounts as more information becomes available and disclose this information in its financial statements. The measurement period under SAB 118 is one year from date of enactment (with the approach being similar to business combinations).

Heska has determined the estimated tax impact of the Act by using the most reliable data available in accordance with SAB 118. Specifically, at the time the estimated tax reform impact was performed, only the Final Bill itself and Notice 2018-07 had been released to provide guidance. Therefore, reasonable approaches and considerations were performed in estimating the overall tax reform impact. Further refinement will be made to this estimation as the IRS provides further guidance prior to the filing of the Company’s 2017 income tax returns. The ultimate impact of the Act may differ from this year-end estimate due to changes in interpretations and assumptions, guidance that may be issued by various US authorities and standard setting bodies, and actions the Company may take as a result of the new provisions. The Company will refine these estimates during the one year measurement period in accordance with SAB 118.

The items below outline the 2017 financial statement considerations associated with the most material provisions of the Act impacting the Company. This list is not intended to be inclusive of all provisions included in the Act nor all impacts to the Company as a result of the Act.

•

The Act reduces the US corporate income tax rate to 21% for tax years beginning after December 31, 2017. The Company’s deferred tax balances were re-measured at 21% as of December 31, 2017. The total impact of the US tax rate decrease resulted in a one-time tax expense of $5.9 million (i.e., the write down of deferred tax asset balances and the valuation allowance.). The large amount of federal NOLs, offset against the valuation allowance thereon, were included in this re-measurement, acting as a significant driver in the large adjustment.

•

The Act imposes a one-time transition tax associated with the deemed mandatory repatriation of accumulated, and previously undistributed, foreign earnings. The Company has considered estimates of earnings and profits (E&P) as prepared and maintained for US income tax reporting and performed other procedures consistent with current guidance, in arriving at the current transition tax estimate of $38 thousand. The Company will pay this tax liability in the year it is initially assessed and will not elect to pay over the optional eight-year period.

•

GILTI (Global Intangible and Low Taxed Income) is not expected to apply to the Company as it has been historically subject to full inclusions of Subpart F income, which is excluded from “tested income” for GILTI purposes. This will be monitored going forward to ensure proper inclusion if necessary. If indeed levied, the Company will likely elect to treat such GILTI inclusion as a period expense, not a deferred tax liability.


•	Corporate AMT is repealed for tax years beginning after December 31, 2017. For this reason, the remaining AMT credit carryforward has been re-classified in the tax provision from a deferred tax asset to a long term receivable. This change reflects the Act’s provision that AMT credits become refundable over time beginning in 2018.

We previously considered the earnings in our non-US subsidiaries to be indefinitely reinvested and, accordingly, recorded no deferred income taxes for the year ended December 31, 2016. As of December 31, 2017, Heska is no longer asserting indefinite reinvestment under the exception noted in ASC 740-30-25-3, which states that the presumption that all undistributed earnings will be transferred to the parent entity may be overcome, and no income taxes shall be accrued by the parent entity. Prior to the Transition Tax, we had an excess of the amount for financial reporting over the tax basis in our foreign subsidiaries. While the Transition Tax resulted in the reduction of the excess of the amount for financial reporting over the tax basis in our foreign subsidiaries and subjected undistributed foreign earnings to an estimated $.02 million of tax which has been provisionally recorded, an actual repatriation from our non-US subsidiaries could still be subject to additional foreign withholding taxes and US state taxes. As such, for those investments from which we were able to make a reasonable estimate of the tax effects of such repatriation, we have recorded a provisional estimate for withholding and state taxes as a deferred tax liability of $.05 million. We will record the tax effects of any change in our prior assertion with respect to these investments, and disclose any unrecognized deferred tax liability for temporary differences related to our foreign investments, if practicable, in the period that we are first able to make a reasonable estimate, no later than December 2018.