10.

INCOME TAXES

Income Tax Expense and Effective Income Tax Rate

Total income tax expense was allocated as follows:


(dollars in thousands)	2018		2017			2016
income from operations	$	5,740		7,339			10,963
shareholders’ equity, related to the tax benefit arising from stock based compensation		—		(657	)		(841	)

	$	5,740		6,682			10,122

Income tax expense attributable to income from operations consists of:


(dollars in thousands)	2018			2017			2016
current
federal	$	(1,367	)		109			—
state		9			13			6
2017 Tax Cuts and Jobs Act		4,854			—			—
foreign		4,726			5,981			6,765
foreign – reversal of uncertain tax position		—			(3,431	)		—

		8,222			2,672			6,771

deferred
federal		4,295			404			(1,205	)
state		112			54			305
2017 Tax Cuts and Jobs Act (1)		(6,903	)		—			—
undistributed earnings – foreign subsidiaries		(195	)		(101	)		(1,129	)
U.S. operating loss carryforwards		—			3,630			5,467
foreign		93			734			1,086
valuation allowance (1)		116			(54	)		(332	)

		(2,482	)		4,667			4,192

	$	5,740			7,339			10,963

(1)	The income tax benefit of $6,903 includes a charge of $4,550 for the establishment of a valuation allowance against U.S. foreign tax credits that are more-likely-than not to be realized as a result of the 2017 Tax Cuts and Jobs Act.

Income (loss) before income taxes related to our foreign and U.S. operations consists of:


(dollars in thousands)	2018		2017			2016
Foreign
China	$	11,036		13,650			14,130
Canada		5,985		4,918			3,647
Poland		—		(19	)		(62	)
Cayman Islands		339		154			—

Total Foreign		17,360		18,703			17,715

United States		9,523		10,993			10,183

	$	26,883		29,696			27,898

The following schedule summarizes the principal differences between the income tax expense at the federal income tax rate and the effective income tax rate reflected in the consolidated financial statements:


	2018			2017			2016
federal income tax rate		30.4	%		34.0	%		34.0	%
tax effects of the 2017 Tax Cuts and Jobs Act		(7.6	)		—			—
tax effects of Chinese foreign exchange (losses) gains		(2.8	)		1.6			4.4
reversal of foreign uncertain income tax position		—			(11.6	)		—
tax effects of stock-based compensation		(1.8	)		—			—
undistributed earnings from foreign subsidiaries		3.7			—			—
other		(0.5	)		0.7			0.9

		21.4	%		24.7	%		39.3	%

Deferred Income Taxes—Overall

The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and liabilities consist of the following:


(dollars in thousands)	2018			2017
deferred tax assets:
accounts receivable	$	316			447
inventories		2,217			2,196
compensation		3,438			6,222
liabilities and other		117			890
foreign income tax credits – U.S.		5,720			44,917
alternative minimum tax credit – U.S.		—			1,428
property, plant and equipment (1)		226			245
loss carryforwards – U.S.		2,513			3,842
loss carryforwards – foreign		76			73
unrecognized tax benefits – U.S.		—			(3,842	)
valuation allowances		(5,204	)		(536	)

total deferred tax assets		9,419			55,882

deferred tax liabilities:
undistributed earnings on foreign subsidiaries		(4,256	)		(43,978	)
unrecognized tax benefits – U.S.		(380	)		(7,936	)
property, plant and equipment (2)		(4,352	)		(5,546	)
goodwill		(1,046	)		(1,478	)
other		(77	)		(118	)

total deferred tax liabilities		(10,111	)		(59,056	)

Net deferred liabilities	$	(692	)		(3,174	)

(1)	Pertains to the company’s operations located in China.

(2)	Pertains to the company’s operations located in the U.S. and Canada.

Federal and state net operating loss carryforwards were approximately $11.5 million with related future tax benefits of $2.5 million at April 29, 2018. These carryforwards principally expire in fiscal years 2027 through fiscal 2035. Our U.S. foreign income tax credits of $5.7 million will expire 10 years from when the associated earnings and profits from our foreign subsidiaries are repatriated to the U.S.

2017 Tax Cuts and Jobs Act

On December 22, 2017 (the “Enactment Date”), the Tax Cuts and Jobs Act (H.R.1) (the “Tax Act”) was signed into law. The Tax Act contains significant changes to corporate taxation, including (i) the reduction of the corporate income tax rate to 21%, (ii) the acceleration of expensing certain business assets, (iii) a one-time mandatory repatriation tax (the “Transition Tax”) related to the transition of U.S. international tax from a worldwide tax system to a territorial tax system, (iv) limitations on the use of foreign tax credits to reduce the U.S. income tax liability, (v) the repeal of the domestic production activities deduction, (vi) additional limitations on the deductibility of interest expense and executive compensation, and (vii) the creation of new minimum taxes such as the base erosion anti-abuse tax (“BEAT”) and Global Intangible Low Taxed Income (“GILTI”) tax.

The corporate income tax rate reduction is effective as of January 1, 2018. Since we have a fiscal year rather than a calendar year, we are subject to IRS rules relating to transitional income tax rates. As a result, our fiscal 2018 federal statutory rate is a blended income tax rate of 30.4%. For fiscal 2019 and beyond, we will utilize the enacted U.S. federal corporate income tax rate of 21%.

The key impacts of the Tax Act on our financial statements for fiscal 2018 were the re-measurement of our U.S. deferred income tax balances to the new U.S. federal corporate income tax rate and the determination of the income tax effects of the Transition Tax on our accumulated earnings and profits associated with our foreign subsidiaries. While we have not yet completed our assessment of the effects of the Tax Act, we were able to determine reasonable estimates for the impacts of the key items specified above, and thus we reported provisional amounts for these items under guidance provided by SEC Staff Accounting Bulletin No. 118 (“SAB 118”). Our estimates may change and revisions to these estimates will be recorded during the measurement period allowed by SAB 118, which is not to extend beyond one year from the Enactment Date.

The provisional estimates related to our U.S. deferred income tax balances and Transition Tax may change due to a variety of factors that include, (i) actual versus estimates of accumulated earnings and profits associated with our foreign subsidiaries, (ii) utilization of our foreign income tax credits, (iii) anticipated guidance from the U.S. Department of Treasury about implementing the Tax Act and (iv) potential guidance from the Securities and Exchange Commission and Financial Accounting Standards Board related to the Tax Act.

In order to determine the effects of the new U.S. federal corporate income tax rate on our U.S. deferred income tax balances, ASC Topic 740 “Income Taxes” (ASC Topic 740), requires the re-measurement of our U.S. deferred income tax balances as of the Enactment Date of the Tax Act, based on income tax rates at which our U.S. deferred income tax balances are expected to reverse in the future. The provisional amount determined for the re-measurement of our U.S. net deferred income taxes was an income tax charge of $2.2 million during fiscal 2018.

The Transition tax is based on our total post-1986 foreign earnings and profits (“E&P”) that were previously deferred from U.S. income tax and applicable income tax rates associated with E&P held in cash and other specified assets (the “aggregate foreign cash position”). Also, E&P was not permanently reinvested prior to the Tax Act. The provisional amount determined for the income tax effects of the Transition Tax was an income tax benefit of $4.3 million during fiscal 2018. This $4.3 million income tax benefit relates to an income tax benefit of $18.0 million for the release of deferred income tax liabilities related to E&P, an income tax benefit of $11.7 million that relates to the reduction in our U.S. Federal income tax rate pursuant to the Tax Act on the effective settlement on an IRS exam related to E&P, partially offset by an income tax charge for the write-off and the establishment of a valuation allowance against our unused foreign tax credits totaling $25.4 million. The Transition Tax may be paid over a period of eight years at the election of the taxpayer and we intend to make this election.

In addition to the above mentioned key impacts of the Tax Act on fiscal 2018, the Tax Act also establishes new tax laws that will be effective for our fiscal 2019 which include the creation of new minimum taxes such as the BEAT and GILTI taxes. We have not yet made a policy election with respect to the accounting treatment of these taxes. We can either account for these taxes as expensed when incurred or factor such amounts in the measurement of our U.S. deferred income taxes. We are currently evaluating our selection of an accounting policy, which will depend, in part, on analyzing our facts to determine what the impact is expected to be under each method.

Deferred Income Taxes – Valuation Allowance

Summary

In accordance with ASC Topic 740, we evaluate our deferred income taxes to determine if a valuation allowance is required. ASC Topic 740 requires that companies assess whether a valuation allowance should be established based on the consideration of all available evidence using a “more likely than not” standard with significant weight being given to evidence that can be objectively verified. Since the company operates in multiple jurisdictions, we assess the need for a valuation allowance on a jurisdiction-by-jurisdiction basis, taking into account the effects of local tax law.

Based on our assessments at April 29, 2018 and April 30, 2017, valuation allowances against our deferred income taxes pertain to the following jurisdictions:


(dollars in thousands)	April 29, 2018		April 30, 2017
U.S. foreign income tax credits	$	4,550		—
U.S. state loss carryforwards and credits		578		464
Polish loss carryforwards		76		72

	$	5,204		536

A summary of the change in the valuation allowances against our deferred income taxes follows:


(dollars in thousands)	2018		2017			2016
beginning balance	$	536		590			922
establishment of valuation allowance (1)		4,550		—			—
change in estimate (2)		118		(54	)		(332	)

ending balance	$	5,204		536			590

(1)	The establishment of this valuation allowance pertains to U.S. foreign tax credits that are more-likely-than not to be realized as a result of the Tax Act.

(2)	Amounts pertain to a change in estimate of the recoverability of certain deferred income tax assets as of the end of the respective prior fiscal year.

Deferred Income Taxes – Undistributed Earnings from Foreign Subsidiaries

In accordance with ASC Topic 740, we assess whether the undistributed earnings from our foreign subsidiaries will be reinvested indefinitely or eventually distributed to our U.S. parent company. ASC Topic 740 requires that a deferred tax liability should be recorded for undistributed earnings from foreign subsidiaries that will not be reinvested indefinitely. Also, we assess the recognition of U.S. foreign income tax credits associated with foreign withholding and income tax payments and whether it is more-likely-than-not that our foreign income tax credits will not be realized. If it is determined that any foreign income tax credits need to be recognized or it is more-likely-than-not our foreign income tax credits will not be realized, an adjustment to our provision for income taxes will be recognized at that time.

During the fiscal 2018, the Tax Act imposed a Transition Tax on our undistributed E&P associated with our foreign subsidiaries. The Tax Act required us to determine E&P as of November 2, 2017 and December 31, 2017 (the “Measurement Dates”), in which the greater E&P amount of the Measurement Dates is subject to the Transition Tax. As a result, we had provisional estimates of E&P prior to participation exemption totaling $156.7 million subject to the Transition Tax and provisional estimates totaling $42.2 million for foreign tax credits that could be used to reduce the Transition Tax subject to certain limitations as defined in the Tax Act.

For fiscal 2019 and beyond, the Tax Act allows a U.S. corporation a 100% dividend received deduction for E&P received from a 10% owned foreign corporation. Therefore, a deferred tax liability will only be required for withholding taxes that are incurred by our foreign subsidiaries at the time E&P is distributed. As a result, at April 29, 2018, we recorded a deferred tax liability of $4.3 million for withholding taxes on undistributed E&P from our foreign subsidiaries.

Uncertainty in Income Taxes

Overall

In accordance with ASC Topic 740, an unrecognized income tax benefit for an uncertain income tax position can be recognized in the first interim period if the more-likely-than-not recognition threshold is met by the reporting period, or is effectively settled through examination, negotiation, or litigation, or the statute of limitations for the relevant taxing authority to examine and challenge the tax position has expired. If it is determined that any of the above conditions occur regarding our uncertain income tax positions, an adjustment to our unrecognized income tax benefit will be recorded at that time.

The following table sets forth the change in the company’s unrecognized income tax benefit:


(dollars in thousands)	2018			2017			2016
beginning balance	$	12,245			14,897			14,141
increases from prior period tax positions		350			854			454
decreases from prior period tax positions (1)		(11,751	)		(3,506	)		(77	)
increases from current period tax positions		—			—			379

ending balance	$	844			12,245			14,897

(1)

The $11.8 million reduction in our unrecognized income tax benefits during fiscal 2018 is mostly associated with the reduction in our U.S. Federal income tax rate pursuant to the Tax Act on the effective settlement on an IRS exam. The $3.5 million reduction in our unrecognized income tax benefits during fiscal 2017 is due to a lapse of applicable statute of limitations in a foreign jurisdiction.

At April 29, 2018, we had $844,000 of total gross unrecognized tax benefits, of which $465,000 would favorably affect the income tax rate in future periods. At April 30, 2017, we had $12.2 million of total gross unrecognized tax benefits, of which $467,000 would favorably affect the income tax rate in future periods.

At April 29, 2018, we had $844,000 of total gross unrecognized tax benefits, of which $379,000 and $465,000 were classified as net non-current deferred income taxes and income taxes payable-long-term, respectively, in the accompanying Consolidated Balance Sheets. At April 30, 2017 we had $12.2 million of total gross unrecognized tax benefits, of which $11.8 million and $467,000 were classified as net non-current deferred income taxes and income taxes payable- long-term, respectively, in the accompanying Consolidated Balance Sheets.

We elected to classify interest and penalties as part of income tax expense. At April 29, 2018 and April 30, 2017, the gross amount of interest and penalties due to unrecognized tax benefits was $40,000 and $50,000, respectively.

Our gross unrecognized income tax benefit of $844,000 at April 29, 2018, relates to income tax positions for which significant change is currently not expected within the next year. This amount primarily relates to double taxation under applicable income tax treaties with foreign tax jurisdictions. United States federal income tax returns filed by us remain subject to examination for income tax years 2017 and subsequent. Canadian federal income tax returns filed by us remain subject to examination for income tax years 2014 and subsequent. Canadian provincial (Quebec) income tax returns filed by us remain subject to examination for income tax years 2016 and subsequent. Income tax returns associated with our operations located in China are subject to examination for income tax year 2013 and subsequent.

Income Tax Exams

During the third quarter of fiscal 2017, Revenue Quebec commenced an examination of our Canadian provincial (Quebec) income tax returns for fiscal years 2013 through 2015. This examination was completed during the fourth quarter of fiscal 2018 with final adjustments totaling $4,000.

During the fourth quarter of fiscal 2016, the Internal Revenue Service commenced and examination of our U.S. Federal income tax returns for fiscal years 2014 through 2016. This examination was effectively settled during the fourth quarter of fiscal 2018 with no adjustment.

Income Taxes Paid

Income tax payments, net of income tax refunds, were $4.0 million, $5.5 million, and $6.7 million during fiscal years 2018, 2017, and 2016, respectively.