NOTE 6 — INCOME TAXES:

Income Tax Issues Concerning Overseas Income

On April 15, 2013 and June 5, 2013, Emerson received correspondence from the IRS including a (i) Form 5701 and Form 886-A regarding Adjusted Sales Income (collectively referred to as “NOPA 1”) and (ii) Form 5701 and Form 886-A regarding Adjusted Subpart F-Foreign Base Company Sales Income (collectively referred to as “NOPA 2”).

With respect to NOPA 1, the IRS is (i) challenging the position of the Company with respect to the way the Company’s controlled foreign corporation in Macao (the “Macao CFC”) recorded its product sales during Fiscal 2010 and Fiscal 2011 and (ii) asserting that an upward adjustment to the Company’s Fiscal 2010 and Fiscal 2011 taxable income of $4,981,520 and $5,680,182, respectively, is required.

With respect to NOPA 2, the IRS is challenging the position of the Company with respect to the fact that the Company considered the service fee paid by the Company to the Macao CFC to be non-taxable in the U.S. The IRS has taken the position that the service fee paid to the Macao CFC by the Company constitutes foreign base company sales income (“FBCSI”). The IRS asserts that the service fee earned by the Macao CFC in connection with its sales of products to the Company should be taxable to the Company as FBCSI. As a result, the IRS determined that an upward adjustment to the Company’s Fiscal 2010 and Fiscal 2011 taxable income of $1,553,984 and $1,143,162, respectively, is required.

The Company has evaluated the determinations made by the IRS as set forth in each of NOPA 1 and NOPA 2 in order to decide (a) how it will proceed and (b) the potential impact on the Company’s financial condition and operations. Furthermore, although NOPA 1 and NOPA 2 represent potential adjustments to Fiscal 2010 and Fiscal 2011 only, the Company believes it is likely that the IRS will take the position that the same type of adjustments should be made for each of the Company’s subsequent fiscal years. The assessment and payment of such additional taxes, penalties and interest would have a material adverse effect on the Company’s financial condition and results of operations.

With respect to NOPA 1, the Company is appealing the proposed adjustment with the IRS. In the event that the Company is not successful in its appeal, the Company estimates that it could be liable for a maximum in taxes, penalties and interest of approximately $13.3 million pertaining to NOPA 1, in the aggregate, for its Fiscal 2010, Fiscal 2011, Fiscal 2012 and Fiscal 2013 periods. However, because the Company’s current assessment is that its appeal of NOPA 1 is more likely than not to be successful, the Company has not recorded any liability to its March 31, 2013 balance sheet related to NOPA 1.

With respect to NOPA 2, the Company agrees in principle with the IRS’ position that the service fee paid to the Macao CFC by the Company would be treated as FBCSI and taxable to the Company but the Company does not agree with the adjustment to the Company’s taxable income as calculated by the IRS. However, the Company has estimated as approximately $1.1 million the amount of taxes, penalties and interest for which it would be liable for its Fiscal 2010, Fiscal 2011, Fiscal 2012 and Fiscal 2013 periods using the adjustments to taxable income as proposed by the IRS, and recorded such amount as a liability to its March 31, 2013 balance sheet.

The Company’s provision for income taxes for Fiscal 2013 and Fiscal 2012 were as follows:


	2013		2012
	(In thousands)
Current:
Federal	$	1,353	$	266
Foreign, state and other		215		579
Prior year federal and state with penalty & interest		881		234
Deferred:
Federal		947		1089
Foreign, state and other		270		308

Provision for income taxes	$	3,666	$	2,476

The Company files a consolidated federal return and certain state and local income tax returns.

The difference between the effective rate reflected in the provision for income taxes and the amounts determined by applying the statutory federal rate of 34% to earnings before income taxes for Fiscal March 2013 and Fiscal 2012 is analyzed below:


	2013			2012
	(In thousands)
Statutory provision	$	3,283		$	4,458
Foreign subsidiary		(2,626	)		(1,677	)
State taxes		366			736
Permanent differences		716			6
Prior year taxes		897			34
True up AMT Credit		898			—
True up to prior year taxes		56			—
Valuation allowance					(1,081	)
Other, net		76			—

Total income tax	$	3,666		$	2,476

As of March 31, 2013 and March 31, 2012, the significant components of the Company’s deferred tax assets and liabilities were as follows:


	2013			2012
	(In thousands)
Deferred tax assets:
Current:
Accounts receivable reserves	$	881		$	1,445
Inventory reserves		401			368
Accruals		237			214
Stock warrants		166			166
Non-current:
Property, plant, and equipment		1,169			699
Net operating loss and credit carryforwards		107			1,235
Stock compensation		79			79

Gross deferred tax assets		3,040			4,206

Valuation allowances		(234	)		(234	)

Total deferred tax assets		2,806			3,972
Deferred tax liabilities:
Non-current:
Capital lease expense		194			177

Total Deferred Tax Liabilities		194			177

Net deferred tax assets	$	2,612		$	3,795

The Company has no U.S. federal net operating loss carryforwards (“NOLs”) as of March 31, 2013.

The amounts of state NOLs available by year as of March 31, 2013 are as follows (in millions $):


Loss Year (Fiscal)	Included in DTA		Expiration Year (Fiscal)
2008		1.3		2018

The tax benefits related to these state net operating loss carryforwards and future deductible temporary differences are recorded to the extent management believes it is more likely than not that such benefits will be realized.

Income of foreign subsidiaries before taxes was $7,787,000 and $4,908,000 for the years ended March 31, 2013 and 2012, respectively.

No provision was made for U.S. or additional foreign taxes on undistributed earnings of foreign subsidiaries. Such earnings have been and will be reinvested but could become subject to additional tax if they were remitted as dividends, or were loaned to the Company or a domestic affiliate, or if the Company should sell its stock in the foreign subsidiaries. It is not practicable to determine the amount of additional tax, if any, that might be payable on undistributed foreign earnings.

A reconciliation of the Company’s changes in uncertain tax positions from April 1, 2012 to March 31, 2013 is as follows:


	In 000’s
Total amount of unrecognized tax benefits as of April 1, 2012	$	121
Gross increases in unrecognized tax benefits as a result of tax positions taken during a prior period		—
Gross decreases in unrecognized tax benefits as a result of tax positions taken during a prior period		—
Gross increases in unrecognized tax benefits as a result of tax positions taken during the current period		—
Gross decreases in unrecognized tax benefits as a result of tax positions taken during the current period		—
Decreases in unrecognized tax benefits relating to settlements with taxing authorities		—
Reductions to unrecognized tax benefits as a result of lapse of statute of limitations		—

Total amount of unrecognized tax benefits as of March 31, 2013	$	121

The effective tax rate on the Company’s income before income taxes for fiscal 2013 differs from the federal statutory rate primarily as a result of difference in tax rate between U.S. and foreign jurisdictions, state income taxes, and change in net operating loss carryforwards. The effective tax rate on the Company’s income before income taxes for fiscal 2012 differs from the federal statutory rate primarily as a result of difference in tax rate between U.S. and foreign jurisdictions, state income taxes and change in net operating loss carryforwards.

The Company is subject to examination and assessment by tax authorities in numerous jurisdictions. A summary of the Company’s open tax years is as follows as of March 31, 2013:


Jurisdiction	Open Tax Years
U.S. Federal		2009-2012
U.S. States		2008-2012
Foreign		2006-2012

Based on the outcome of tax examinations or due to the expiration of statutes of limitations, it is reasonably possible that the unrecognized tax benefits related to uncertain tax positions taken in previously filed returns may be different from the liabilities that have been recorded for these unrecognized tax benefits. As a result, the Company may be subject to additional tax expense.