INCOME TAXES

The provision for (benefit from) income taxes on income (loss) before income taxes consists of the following (in thousands):



	Fiscal
	2015			2014			2013
Currently payable:
Federal	$	(932	)	$	2,492		$	(1,796	)
State	108			92			(141		)
Foreign	32,189			26,885			27,152
	31,365			29,469			25,215
Deferred:
Federal	(4,327		)	(2,815		)	(4,022		)
State	(200		)	(111		)	(16		)
Foreign	(3,679		)	(6,430		)	(4,036		)
	(8,206		)	(9,356		)	(8,074		)
Provision for income taxes	$	23,159		$	20,113		$	17,141

The components of income (loss) before income taxes consist of (in thousands):



	Fiscal
	2015			2014		2013
United States	$	(13,293	)	$	821	$	(7,142	)
Foreign	112,861			78,398		90,638
Income before income taxes	$	99,568		$	79,219	$	83,496

The reconciliation of the income tax expense at the U.S. Federal statutory rate (35%) to actual income tax expense is as follows (in thousands):



	Fiscal
	2015			2014			2013
Federal statutory tax expense	$	34,849		$	27,727		$	29,223
Valuation allowance	635			841			534
Foreign taxes at rates less than U.S. rates, net	(10,558		)	(6,974		)	(8,219		)
Stock-based compensation	2,150			1,326			1,292
State income taxes, net of federal income tax benefit	(38		)	58			(143		)
Research and development credit	(2,979		)	(1,797		)	(4,131		)
Deferred compensation	(133		)	(778		)	(257		)
Release of unrecognized tax benefits	(39		)	(51		)	(407		)
Release of interest accrued for unrecognized tax benefits	(38		)	(289		)	(160		)
Other	(690		)	50			(591		)
Provision for income taxes	$	23,159		$	20,113		$	17,141
Effective tax rate	23.3		%	25.4		%	20.5		%

The effective tax rate on income before income taxes for fiscal 2015 of 23.3% was lower than the statutory rate of 35.0%. This was primarily due to differences related to the benefit of income subject to foreign tax rates that are lower than U.S. tax rates including South Korea and Singapore tax exemptions, the benefit of foreign tax credits and the benefit of federal research and development tax credits including renewal of the federal research and development tax credits for fiscal 2014. These amounts are partially offset by deemed dividend inclusions under the Subpart F tax rules, stock-based compensation not deductible for tax purposes and limitations on the deductibility of compensation under IRC Section 162(m).

Coherent Korea received the final approval for a High-Tech tax exemption in 2013 from the South Korean authorities and it is subject to capital contribution limitations. The impact of this tax exemption decreased South Korean income taxes by approximately $2.8 million (or $0.11 per diluted share) in fiscal 2015, $2.4 million (or $0.10 per diluted share) in fiscal 2014 and $2.1 million (or $0.09 per diluted share) in fiscal 2013. The remaining High-Tech tax exemption benefit is minimal and should be fully utilized in fiscal 2016 and Coherent Korea should be subject to South Korea income tax at that time.

Coherent Singapore had previously received a Pioneer Status tax exemption from the Singapore authorities effective from fiscal 2012 through fiscal 2017, and it may be extended if certain additional requirements are satisfied. The tax holiday is conditional upon our meeting certain revenue, business spending and employment thresholds. Although Coherent Singapore had income in fiscal 2015, 2014 and 2013, these amounts were offset by a loss carryforward from fiscal 2012 and therefore we did not realize a cumulative benefit for the Singapore tax holiday.

The significant components of deferred tax assets and liabilities were (in thousands):



	Fiscal year-end
	2015			2014
Deferred tax assets:
Reserves and accruals not currently deductible	$	31,067		$	29,060
Operating loss carryforwards and tax credits	53,386			65,643
Deferred service revenue	2,144			2,097
Inventory capitalization	1,827			1,616
Stock-based compensation	6,128			6,573
Competent authority offset to transfer pricing tax reserves	4,328			4,328
Other	2,418			—
Total gross deferred tax assets	101,298			109,317
Valuation allowance	(15,556		)	(14,403		)
Total net deferred tax assets	85,742			94,914
Deferred tax liabilities:
Gain on issuance of stock by subsidiary	20,859			20,759
Depreciation and amortization	5,117			9,579
Accumulated translation adjustment	2,229			1,357
Other	—			5,012
Total gross deferred tax liabilities	28,205			36,707
Net deferred tax assets	$	57,537		$	58,207

In determining our fiscal 2015 and 2014 tax provisions under ASC Subtopic 740, we calculated the deferred tax assets and liabilities for each separate tax entity. We then considered a number of factors including the positive and negative evidence regarding the realization of our deferred tax assets to determine whether a valuation allowance should be recognized with respect to our deferred tax assets. We determined that a valuation allowance was appropriate for a portion of the deferred tax assets of our California and certain state research and development tax credits, foreign tax attributes and foreign net operating losses at fiscal 2015 and 2014 year-ends.

During fiscal 2015, we increased our valuation allowance on deferred tax assets by $1.2 million to $15.6 million, primarily due to the reduced ability to utilize California and certain state research and development tax credits.

The net deferred tax asset is classified on the consolidated balance sheets as follows (in thousands):



	Fiscal year-end
	2015			2014
Current deferred income tax assets	$	28,118		$	27,134
Current deferred income tax liabilities	(9		)	(32		)
Non-current deferred income tax assets	32,136			37,616
Non-current deferred income tax liabilities	(2,708		)	(6,511		)
Net deferred tax assets	$	57,537		$	58,207

We have various tax attribute carryforwards which include the following:

•

Foreign gross net operating loss carryforwards are $18.0 million, of which $17.1 million have no expiration date and of which $0.9 million are scheduled to expire beginning in fiscal year 2030. A valuation allowance totaling $4.9 million has been provided against the foreign gross net operating loss carryforwards in certain jurisdictions since the recovery of the carryforwards are uncertain. California gross net operating loss carryforwards are $14.7 million and are scheduled to expire in fiscal years 2022 to 2032. The tax benefit relating to approximately $6.6 million of the state gross net operating loss carryforwards will be credited to additional paid-in-capital when recognized.

•

Federal gross capital loss carryforwards of $0.9 million are scheduled to expire in fiscal year 2020. State gross capital loss carryforwards of $1.4 million are scheduled to expire in fiscal year 2020. No valuation allowance is recorded against the federal gross capital loss and the state gross capital loss carryforwards since we anticipate that it is more likely than not we will be able to utilize the capital loss in the future.

•

Federal R&D credit carryforwards of $24.4 million are scheduled to expire in fiscal years 2024 to 2035. The tax benefit relating to approximately $0.9 million of the federal tax credit carryforwards will be credited to additional paid-in-capital when recognized. California R&D credit carryforwards of $22.2 million have no expiration date. The tax benefit relating to approximately $0.5 million of the state tax credit carryforwards will be credited to additional paid-in-capital when recognized. A valuation allowance totaling $14.0 million, before federal benefit, has been recorded against California R&D credit carryforwards since the recovery of the carryforwards are uncertain. Other states R&D credit carryforwards of $1.7 million are scheduled to expire in fiscal years 2016 to 2030. A valuation allowance totaling $0.6 million, before federal benefit, has been recorded against certain state R&D credit carryforwards since the recovery of the carryforwards is uncertain.


•	Federal foreign tax credit carryforwards of $19.0 million are scheduled to expire in fiscal years 2016 to 2023. The tax benefit relating to approximately $11.5 million of the federal foreign tax credit carryforwards will be credited to additional paid-in-capital when recognized.

We are subject to taxation and file income tax returns in the U.S. federal jurisdiction and in many state and foreign jurisdictions. For U.S. federal income tax purposes, all years prior to 2011 are closed. In our major foreign jurisdictions and our major state jurisdictions, the years prior to 2006 and 2011, respectively, are closed to examination. Earlier years in our various jurisdictions may remain open for adjustment to the extent that we have tax attribute carryforwards from those years. The various tax authorities may choose to audit tax returns for tax years beyond the statute of limitations period due to significant tax attribute carryforwards from those prior years, making adjustments only to carryforward attributes. We believe that we have provided adequate reserves for any adjustments that may be determined by the tax authorities.

A reconciliation of the change in gross unrecognized tax benefits, excluding interest and penalties, is as follows (in thousands):



	Fiscal year-end
	2015			2014			2013
Balance as of the beginning of the year	$	21,893		$	21,378		$	25,967
Tax positions related to current year:
Additions	311			346			1,008
Reductions	—			—			—
Tax positions related to prior year:
Additions	855			235			1,127
Reductions	—			—			—
Settlements	—			—			—
Lapses in statutes of limitations	(521		)	(66		)	(6,724		)
Balance as of end of year	$	22,538		$	21,893		$	21,378

As of October 3, 2015, the total amount of gross unrecognized tax benefits including gross interest and penalties was $24.3 million, of which $16.4 million, if recognized, would affect our effective tax rate. Our total gross unrecognized tax benefit was classified as long-term taxes payable in the consolidated balance sheets. We include interest and penalties related to unrecognized tax benefits within the provision for income taxes. As of October 3, 2015, the total amount of gross interest and penalties accrued was $1.8 million and it is classified as long-term taxes payable in the consolidated balance sheets. As of September 27, 2014, we had accrued $1.8 million for the gross interest and penalties and it is classified as long-term taxes payable in the consolidated balance sheets.

Management believes that it has adequately provided for any adjustments that may result from tax examinations. We regularly engage in discussions and negotiations with tax authorities regarding tax matters in various jurisdictions. It is reasonably possible that certain federal, foreign and state tax matters may be concluded in the next 12 months.

A summary of the fiscal tax years that remain subject to examination, as of October 3, 2015, for our major tax jurisdictions is:



United States—Federal	2011—forward
United States—Various States	2011—forward
Netherlands	2010—forward
Germany	2006—forward
Japan	2009—forward
United Kingdom	2014—forward