NOTE 9 – INCOME TAXES

Income from continuing operations before provision for income taxes and loss of unconsolidated affiliates includes the following components (in thousands):



	Years Ended August 31,
	2016		2015		2014
United States	$	25,533	$	41,694	$	34,927
Foreign		105,707		94,902		99,322
Income from continuing operations before provision for income taxes and loss of unconsolidated affiliates	$	131,240	$	136,596	$	134,249

Significant components of the income tax provision are as follows (in thousands):



	Years Ended August 31,
	2016		2015		2014
Current:
U.S.	$	9,269	$	10,918	$	11,921
Foreign		30,705		33,676		29,120
Total	$	39,974	$	44,594	$	41,041
Deferred:
U.S.	$	832	$	3,941	$	613
Foreign		(82)		(3,100)		(381)
Valuation allowance charge (release)		2,125		2,131		99
Total	$	2,875	$	2,972	$	331
Provision for income taxes	$	42,849	$	47,566	$	41,372

The reconciliation of income tax computed at the Federal statutory tax rate to the provision for income taxes is as follows (in percentages):



	Years Ended August 31,
	2016		2015		2014
Federal tax provision at statutory rates	35.0	%	35.0	%	35.0	%
State taxes, net of federal benefit	0.2		0.4		0.3
Differences in foreign tax rates	(5.6)		(4.2)		(5.2)
Permanent items and other adjustments	2.0		2.3		0.8
Increase (decrease) in foreign valuation allowance	1.0		1.3		(0.1)
Provision for income taxes	32.6	%	34.8	%	30.8	%

Significant components of the Company’s deferred tax assets as of August 31, 2016 and 2015 are shown below (in thousands):



	August 31,
	2016		2015
Deferred tax assets:
U.S. net operating loss carryforward	$	3,226	$	4,611
Foreign tax credits		185		—
Deferred compensation		1,706		1,563
U.S. timing differences and alternative minimum tax credits		2,846		2,438
Foreign net operating losses		13,414		9,493
Foreign timing differences:
Accrued expenses and other timing differences		3,807		5,385
Depreciation and amortization		8,923		6,855
Deferred income		3,606		3,474
Gross deferred tax assets		37,713		33,819
U.S. deferred tax liabilities (depreciation and other timing differences)		(3,944)		(3,761)
Foreign deferred tax liabilities netted against deferred tax assets		(8,848)		(4,677)
U.S. valuation allowance		(652)		(652)
Foreign valuation allowance		(12,011)		(9,884)
Net deferred tax assets	$	12,258	$	14,845

As of August 31, 2016 and 2015, the Company had net deferred tax liabilities of $1.8 million at the end of each period, $1.8 million arising from timing differences in certain subsidiaries.

For fiscal year 2016, the effective tax rate was 32.6%. The decrease in the effective rate versus the prior year was primarily attributable to an intercompany transaction between PriceSmart, Inc. and its Colombian subsidiary in support of PriceSmart’s ongoing market development and growth in Colombia. This intercompany transaction resulted in a favorable impact on the effective tax rate of 3% due to reductions to taxable income in the U.S. and a resulting increase in taxable income in our Colombia subsidiary. This income did not generate income tax expense in Colombia, because the additional taxable income in Colombia was fully offset by the reversal of valuation allowances on accumulated net losses in that subsidiary. We expect a similar favorable impact to the consolidated Company’s effective tax rate over the next several quarters. Additionally, in comparison to the prior year, there was an offsetting unfavorable impact of 1.5% due to the establishment of a valuation allowance against the deferred tax assets of the Company’s Barbados subsidiary.

For fiscal year 2016, management concluded that a valuation allowance continues to be necessary for certain U.S. and foreign deferred tax assets, primarily because of the existence of negative objective evidence, such as the fact that certain subsidiaries are in a cumulative loss position for the past three years, and the determination that certain net operating loss carryforward periods are not sufficient to realize the related deferred tax assets. The Company factored into its analysis the inherent risk of forecasting revenue and expenses over an extended period of time and also considered the potential risks associated with its business. Additionally, regarding the Company’s Barbados subsidiary, while the Company forecasts profitability for the immediate and foreseeable future, due to the existence of negative objective evidence from recent years, the establishment of a valuation allowance of approximately $2.0 million was necessary in order to reduce deferred tax assets to amounts expected to be realized. The Company had net foreign deferred tax assets of $8.9 million and $10.6 million as of August 31, 2016 and 2015, respectively.

The Company has U.S. federal and state tax NOLs at August 31, 2016 of approximately $7.4 million and $7.4 million, respectively. The federal and state NOLs generally expire during periods ranging from 2016 through 2027, unless previously utilized. In calculating the tax provision and assessing the likelihood that the Company will be able to utilize the deferred tax assets, the Company considered and weighed all of the evidence, both positive and negative, and both objective and subjective. The Company factored in the inherent risk of forecasting revenue and expenses over an extended period of time and considered the potential risks associated with its business. Using the Company's U.S. income from continuing operations and projections of future taxable income in the U.S., the Company was able to determine that there was sufficient positive evidence to support the conclusion that it was more likely than not that the Company would be able to realize substantially all of its U.S. NOLs by generating sufficient taxable income during the carry-forward period. However, the Company maintains a valuation allowance on substantially all of its state NOLs due to the adoption of single sale factor apportionment in California, which significantly reduces taxable income in this state.

The Company has determined that due to a deemed change of ownership (as defined in Section 382 of the Internal Revenue Code) in October 2004, there will be annual limitations in the amount of U.S. taxable income of approximately $3.5 million that may be offset by NOLs. The Company does not believe this will impact the recoverability of these NOLs.

The Company does not provide for income taxes which would be payable if undistributed earnings of its foreign subsidiaries were remitted to the U.S., because the Company considers these earnings to be permanently reinvested as management has no plans to repatriate undistributed earnings and profits of foreign affiliates. As of August 31, 2016 and 2015, the undistributed earnings of these foreign subsidiaries are approximately $472.5 million and $405.2 million, respectively. Upon distribution of those earnings in the form of dividends or otherwise, the Company would be subject to both U.S. income taxes and withholding taxes payable to the foreign countries, but would also be able to offset unrecognized foreign tax credits. Determination of the amount of unrecognized deferred U.S. income tax liability is not practicable because of the complexities associated with its hypothetical calculation.

The Company accrues for the estimated additional amount of taxes for uncertain income tax positions if the likelihood of sustaining the tax position does not meet the more likely than not standard for recognition of tax benefits.

A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows (in thousands):



	Years Ended August 31,
	2016		2015		2014
Balance at beginning of fiscal year	$	8,159	$	8,786	$	9,373
Additions based on tax positions related to the current year		—		—		964
Settlements		—		—		(1,093)
Expiration of the statute of limitations for the assessment of taxes		(405)		(627)		(458)
Balance at end of fiscal year	$	7,754	$	8,159	$	8,786

As of August 31, 2016, the liability for income taxes associated with uncertain tax benefits was $7.8 million and can be reduced by $7.2 million of tax benefits associated with timing adjustments which are recorded as deferred tax assets and liabilities. The net amount of $600,000, if recognized, would favorably affect the Company's financial statements and favorably affect the Company's effective income tax rate.

The Company expects changes in the amount of unrecognized tax benefits in the next 12 months as the result of a lapse in various statutes of limitations. The lapse of statutes of limitations in the 12-month period ending August 31, 2017 could result in a total income tax benefit amounting up to $129,000.

The Company recognizes interest and/or penalties related to income tax matters in income tax expense. As of August 31, 2016 and 2015, the Company had accrued $370,000 and $619,000, respectively, for the payment of interest and penalties (before income tax benefit).

The Company has various appeals pending before tax courts in its subsidiaries' jurisdictions. Any possible settlement could increase or decrease earnings but is not expected to be significant. Audit outcomes and the timing of audit settlements are subject to significant uncertainty. During the first quarter of fiscal year 2015, one of the Company’s subsidiaries received provisional assessments claiming $2.5 million of taxes, penalties and interest related to withholding taxes on certain charges for services rendered by the Company. In addition, this subsidiary received provisional assessments totaling $5.1 million for lack of deductibility of the underlying service charges due to the lack of withholding. Based on a review of the Company's tax advisers' interpretation of local law, rulings and jurisprudence (including Supreme Court precedents with respect to the deductibility assessment), the Company expects to prevail in both instances and has not recorded a provision for these assessments. In another country in which the Company has warehouse clubs, beginning in fiscal year 2015, a new minimum income tax mechanism took effect, which requires the Company to pay taxes based on a percentage of sales rather than income. As a result, the Company is making income tax payments substantially in excess of those it would expect to pay based on taxable income. The current rules (which the Company has challenged in court) do not clearly allow the Company to obtain a refund or to offset this excess income tax against other taxes. As of August 31, 2016, the Company had deferred tax assets of approximately $1.9 million in this country. Also, the Company had an income tax receivable balance of $2.5 million as of August 31, 2016 related to excess payments from fiscal years 2015 and 2016. The Company has not placed any type of allowance on the recoverability of these tax receivables or deferred tax assets, because the Company believes that it is more likely than not that it will succeed in its refund request and/or court challenge on this matter.

The Company and its subsidiaries file income tax returns in the U.S. federal jurisdiction and various state and foreign jurisdictions. The Company is generally no longer subject to income tax examinations by tax authorities in its major jurisdictions except for the fiscal years subject to audit as set forth in the table below:



Tax Jurisdiction		Fiscal Years Subject to Audit
U.S. federal		2000 to 2005, 2007, 2013 to the present
California (U.S.) (state return)		2005, 2007 and 2012 to the present
Florida(U.S.) (state return)		2007 and 2013 to the present
Aruba		2012 to the present
Barbados		2010 to the present
Costa Rica		2011 to the present
Colombia		2011 to the present
Dominican Republic		2011 to the present
El Salvador		2009 to 2010 and 2013 to the present
Guatemala		2009, 2012 to the present
Honduras		2012 to the present
Jamaica		2010 to the present
Mexico		2011 to the present
Nicaragua		2012 to the present
Panama		2013 to the present
Trinidad		2010 to the present
U.S. Virgin Islands		2001 to the present
Spain		2013 to the present

Generally for U.S. federal and U.S. Virgin Islands tax reporting purposes, the statute of limitations is three years from the date of filing of the income tax return. If and to the extent the tax year resulted in a taxable loss, the statute is extended to three years from the filing date of the income tax return in which the carryforward tax loss was used to offset taxable income in the carryforward year. Given the historical losses in these jurisdictions and the Section 382 change in control limitations on the use of the tax loss carryforwards, there is uncertainty and significant variation as to when a tax year is no longer subject to audit.