Note 9 – Income Taxes

Income (loss) before the provision (benefit) for income taxes consists of the following:


	2019		2018
Domestic	$	(513,000)	$	(67,000)
Foreign		303,000		49,000
Total	$	(210,000)	$	(18,000)

The provision (benefit) for income taxes in the accompanying consolidated financial statements consists of the following:


	2019		2018
Current
Federal	$	(74,000)	$	124,000
State		14,000		15,000
Foreign		(40,000)		(32,000)
Total current	$	(100,000)	$	107,000

Deferred
Federal	$	169,000	$	(183,000)
State		120,000		(1,508,000)
Foreign		(7,000)		(24,000)
Total deferred		282,000		(1,715,000)
Total provision (benefit)	$	182,000	$	(1,608,000)

A reconciliation of the federal statutory rate to the Company’s effective tax rate is as follows:


	2019		2018
Federal statutory rate	21.00	%	24.28	%

State rate, net of federal benefit	(36.16)	%	(9.29)	%
Permanent differences	(45.18)		**
Change in valuation allowance	(66.33)		**
Foreign rate differential and other	27.80		**
Federal impact under TCJA	34.29		**
Tax credits genereated in foreign jurisdictions	60.23		**
Non-deductible related de-registration costs	(82.62)		**
Effective tax rate	(86.97)	%	8703.64	%

**These values are not meaningful. Please see the subsequent paragraphs of this note for more detailed explanations.

Net deferred tax assets (liabilities) consisted of the following at September 30, 2019:


Deferred tax assets	Domestic		Foreign		Worldwide
Credits	$	3,501,000	$	—	$	3,501,000
NOLs		2,974,000		24,000		2,998,000
Stock compensation		202,000		—		202,000
Accruals		310,000		—		310,000
Other		126,000		—		126,000
Gross deferred tax assets		7,113,000		24,000		7,137,000

Valuation allowance		(1,916,000)		—		(1,916,000)
Net deferred tax assets		5,197,000		24,000		5,221,000
Deferred tax liabilities
Depreciation		(1,194,000)		(157,000)		(1,351,000)
Intangibles		41,000		(52,000)		(11,000)
Other		—		—		—
Gross deferred tax liabilities		(1,153,000)		(209,000)		(1,362,000)

Net deferred tax asset (liability)	$	4,044,000	$	(185,000)	$	3,859,000

Net deferred tax assets (liabilities) consisted of the following at September 30, 2018:


Deferred tax assets	Domestic		Foreign		Worldwide
Credits	$	3,530,000	$	—	$	3,530,000
NOLs		3,235,000		25,000		3,260,000
Stock compensation		203,000		—		203,000
Accruals		209,000		—		209,000
Other		109,000		—		109,000
Gross deferred tax assets		7,286,000		25,000		7,311,000

Valuation allowance		(1,777,000)		—		(1,777,000)
Net deferred tax assets		5,509,000		25,000		5,534,000
Deferred tax liabilities
Depreciation		(1,168,000)		(164,000)		(1,332,000)
Intangibles		(7,000)		(66,000)		(73,000)
Gross deferred tax liabilities		(1,175,000)		(230,000)		(1,405,000)

Net deferred tax asset (liability)	$	4,334,000	$	(205,000)	$	4,129,000

In assessing the ability to realize the net deferred tax assets, management considers various factors including taxable income in carryback years, future reversals of existing taxable temporary differences, tax planning strategies and projections of future taxable income, to determine whether it is more likely than not that some portion or all of the net deferred tax assets will not be realized.

As a result of the conversion of the Xcede convertible notes and accrued interest to preferred stock in November 2016 (see Note 3), the Company’s ownership percentage in Xcede decreased to less than 80%. Xcede, therefore, is no longer included in Dynasil’s federal consolidated tax return and files a separate federal return. Xcede will continue to be included in the Dynasil consolidated state tax filings pursuant to the respective state tax requirements.

As a result of Xcede’s de-consolidation from the Company’s federal tax returns, the Company is no longer able to offset taxable income with Xcede’s current or cumulative net operating losses. Upon review of relevant criteria for the new Dynasil federal consolidated group, it was determined that it is more likely than not that the federal, deferred tax assets of the new Dynasil federal consolidated group will be realized based upon positive earnings history and expected future profits of the group. As a result, the federal deferred tax asset valuation allowance associated with the Dynasil federal consolidated group was reversed resulting in an income tax benefit in the amount of $2.7 million during the twelve months ended September 30, 2017. Going forward, as the Company records income, it will be able to utilize the NOLs (net operating losses) within its deferred tax assets.

As a result of Xcede’s decision to halt clinical trial preparations and curtail operations to a minimal level while the Board of Directors of Xcede evaluates alternative avenues to develop the Xcede Patch, following the July 2018 notice of termination from Cook Biotech Inc. (“CBI”) claiming that the results of a recent animal study showed that it is not commercially reasonable, in CBI’s assessment, to continue to the next development phase of the Xcede Patch, the Company has concluded that it is more likely than not that the deferred tax assets associated with the Company’s unitary state filings will be realized based on future profit for the group and thus has reversed the related valuation allowance on the Company’s NOLs of approximately $0.6 million. In addition, the Company conducted a research and experimentation study which released the tax valuation allowance and increased deferred tax assets by $0.6 million. The reversal resulted in an income tax benefit of approximately $1.2 million recorded during the year ended September 30, 2018.

The valuation allowance will continue to be addressed independently for the Company and Xcede, instead of on a consolidated basis. The net change in the valuation allowances for the years ending September 30, 2019 and 2018 was $0.1 million and ($0.6) million, respectively.

On December 22, 2017, the 2017 Tax Act was signed into law. The 2017 Tax Act, which was effective on December 22, 2017, significantly revised the U.S. tax code by, among other changes, lowering the corporate income tax rate from 35% to 21%, requiring a one-time transition tax on accumulated foreign earnings of certain foreign subsidiaries that were previously tax deferred and creating new taxes on certain foreign sourced earnings. As of September 30, 2019, the Company has completed its accounting for the tax effects of the 2017 Tax Act.

The Company re-measured certain U.S. deferred tax assets and liabilities based on the rates at which they are expected to reverse in the future, which is generally 21%, and recorded an income tax expense of $0.7 million related to such re-measurement in 2018.

The one-time transition tax is based on the total unremitted earnings of the Company’s foreign subsidiary, Hilger, which has previously been deferred from U.S. income taxes. The Company recorded an estimated provision for its one-time transition liability of its foreign subsidiary resulting in additional income tax expense of $0.2 million in 2018 and an income tax benefit of $0.07 million in 2019.

As of September 30, 2019 and 2018, the Company has federal net operating losses of $8.5 million and $9.0 million, respectively. Included in the balance as of September 30, 2019 are federal operating losses of $1.2 million that have an indefinite carryforward period. As of September 30, 2019 and 2018, the Company has state net operating losses of $17.0 million and $19.3 million, respectively. The federal and state net operating losses begin expiring in 2033 and 2026, respectively. At September 30, 2019 and 2018, the Company has foreign net operating loss carryforwards of approximately $144,000 and $147,000, respectively which can be carried forward indefinitely.

As of September 30, 2019 and 2018, the Company has federal research credits of $2.9 million and $2.9 million, respectively. The $2.9 million primarily resulted from a benefit in the second quarter of 2018 related to R&E tax credits for the years ended 2013 through 2016. The federal credits begin expiring in fiscal year 2030. As of September 30, 2019 and 2018, the Company has state research credits of $815,000 and $852,000, respectively. The state credits begin expiring in fiscal year 2027.

As of September 30, 2019 and 2018, the Company has no unrecorded liabilities for uncertain tax positions. Interest and penalty charges, if any, related to uncertain tax positions would be classified as income tax expense in the accompanying consolidated statement of operations. As of September 30, 2019 and 2018, the Company has no accrued interest or penalties related to uncertain tax positions.

The Company is subject to taxation in the United States, various states, and the United Kingdom. At September 30, 2018, domestic tax years from fiscal 2012 through fiscal 2018 remain open to examination by the United States taxing authorities and tax years 2016 through 2019 remain open in the United Kingdom.