NOTE 6. INCOME TAXES

Loss from operations before income taxes consists of the following for the years ended September 30:



	2016		2015		2014
	(In thousands)

Domestic	$	(11,227)	$	(45,812)	$	(17,533)
Foreign		(1,932)		(6,699)		(5,369)

Total	$	(13,159)	$	(52,511)	$	(22,902)

The (provision) benefit for income taxes consisted of the following for the years ended September 30:



	2016		2015		2014
	(In thousands)

Current:
Federal	$	66	$	53	$	8
State		12		4		(12)
Foreign		16		-		-
		94		57		(4)

Deferred:
Federal		(4,766)		(5,975)		4,890
State		(397)		(853)		882
Foreign		(861)		3,221		(176)
Change in valuation allowance		4,457		6,274		(5,073)
		(1,567)		2,667		523

Total (provision) benefit	$	(1,473)	$	2,724	$	519

At September 30, 2016, the Company had U.S. federal tax loss carryforwards of $50.2 million, expiring at various dates through 2036, including $0.2 million resulting from an acquisition during 2004 which are subject to additional annual limitations as a result of the changes in ownership, and had $28.5 million in state tax loss carryforwards, which also expire at various dates through 2036. Included in the Federal and state net operating loss carryforwards are $7.6 million of tax deductions from share based compensation, which will be recorded as additional paid-in capital when realized. These loss carryforwards are available to reduce future federal, state and foreign taxable income but are subject to review and possible adjustment by the appropriate taxing authorities. The loss carryforwards, which may be utilized in any future period, may be subject to limitations based upon changes in the ownership of the Company’s stock. An alternative minimum tax credit of $7,000 is available to offset future regular federal taxes. Federal research and development credits of $1.0 million expire beginning in 2021. State research and development credits of $0.1 million expire at various years through 2030. In addition, the Company has the following net operating loss carryforwards: U.K. losses of $9.8 million with no expiration date, Australia losses of $3.5 million with no expiration date, Germany losses of $2.2 million with no expiration date, Singapore losses of $2.9 million with no expiration date, and Sweden losses of $10.6 million with no expiration date.

The components of the Company’s net deferred tax assets are as follows at September 30:



	2016		2015
	(In thousands)

Deferred tax liabilities:
Prepaid expenses	$	(296)	$	(271)
Acquired intangibles		(608)		(688)
		(904)		(959)
Deferred tax assets:
Net operating loss carryforwards		23,134		19,044
Research and development credits		1,316		955
Alternative minimum tax credits		7		7
Accounts and notes receivable reserves		18		52
Depreciation and amortization		2,709		2,538
Deferred rent		138		-
Other		306		265
		27,628		22,861

Total		26,724		21,902

Valuation allowance		(26,724)		(20,337)

Deferred tax asset, net	$	-	$	1,565

The valuation allowance relates to the Company’s U.S. and foreign net operating losses and other deferred tax assets and is recorded based upon the uncertainty surrounding their realizability, as these assets can only be realized via profitable operations in the respective tax jurisdictions. The Company records a deferred tax asset or liability based on the difference between the financial statement and tax basis of assets and liabilities, as measured by enacted tax rates assumed to be in effect when these differences reverse. In evaluating the Company’s ability to recover its deferred tax assets, the Company considers all available positive and negative evidence including its past operating results, the existence of cumulative income in the most recent fiscal years, changes in the business in which the Company operates and its forecast of future taxable income. In determining future taxable income, the Company is responsible for assumptions utilized including the amount of federal, state and international pre-tax operating income, the reversal of temporary differences and the implementation of feasible and prudent tax planning strategies.

During the fiscal year ended September 30, 2016, the Company reassessed its valuation allowance assertion with regards to Datawatch AB, the Company’s subsidiary located in Sweden. The Company analyzed forecasted profits, carryback potential, tax planning strategies, and the reversal of existing taxable temporary differences of the same type in the same period. Factors the Company considered were as follows:

History of net operating losses in Sweden;

The Company’s revised forecast indicates that its Sweden subsidiary will not achieve profitability with certainty in the foreseeable future;

Net operating losses have no expiration period;

The Swedish subsidiary has no carryback potential;

The Swedish subsidiary has no tax planning strategies available to recognize its deferred tax assets; and

Reversal temporary differences in Sweden will not allow the Swedish subsidiary to utilize its existing deferred tax assets.

Although the Swedish subsidiary has no expiration on its net operating loss carryovers, the negative evidence noted above outweighs this positive evidence. Accordingly, the Company has recorded a full valuation allowance on its deferred tax assets in Sweden during the fiscal year ended September 30, 2016.

The assumptions underlying the valuation allowance require significant judgment about the forecasts of future taxable income and are consistent with the plans and estimates that the Company is using to manage the underlying business. The Company had tax losses in each of the fiscal years 2016, 2015 and 2014. Accordingly, as of September 30, 2016, the Company determined that it is more likely than not that the deferred tax assets will not be realized in all of its jurisdictions and a full valuation allowance has been recorded in the U.S., U.K., Australia, Germany, Singapore, and Sweden.

The following table reconciles the Company’s tax (provision) benefit based on its effective tax rate to its tax benefit based on the federal statutory rate of 34% for the years ended September 30, 2016, 2015 and 2014 (in thousands):



	2016		2015		2014
	(In thousands)

Benefit at federal statutory rate	$	4,470	$	17,853	$	7,757
State, net of federal impact		264		579		474
Foreign income taxes		204		(555)		642
Valuation allowance increase		(6,385)		(6,164)		(5,073)
Return to provision adjustments		345		(621)		(48)
Foreign rate change		-		-		(394)
Stock-based compensation		(545)		(946)		(1,103)
NOL adjustment due to subsidiary liquidation		-		-		(1,345)
Acquisition costs		-		-		(59)
Change in uncertain tax positions		105		67		386
IRS audit adjustments		-		-		(535)
Goodwill and intangible asset impairment		-		(7,377)		-
Other		69		(112)		(183)

Income tax (expense) benefit	$	(1,473)	$	2,724	$	519

Provision for Uncertain Tax Positions

The Company applies the accounting requirements for uncertain tax positions which provide a comprehensive model for the financial statement recognition, measurement, presentation and disclosure of uncertain tax positions taken or expected to be taken in income tax returns. In accordance with these requirements, the Company first determines whether a tax authority would “more likely than not” sustain its tax position if it were to audit the position with full knowledge of all the relevant facts and other information. For those tax positions that meet this threshold, the Company measures the amount of tax benefit based on the largest amount of tax benefit that the Company has a greater than 50 percent chance of realizing in a final settlement with the relevant authority. Those tax positions failing to qualify for initial recognition are recognized in the first interim period in which they meet the more likely than not standard, or are resolved through negotiation or litigation with the taxing authority, or upon expiration of the statute of limitations.

At September 30, 2015, the Company had a cumulative tax liability of $0.3 million related to federal, state, and foreign tax exposure that could result in cash payments. The Company decreased the tax liability by $0.1 million during the fiscal year ended September 30, 2016. The decrease related to the statute of limitations expiring on U.S. and foreign uncertain tax positions. The Company does not expect its tax liability to change significantly during the next twelve months. The Company’s policy is to recognize interest and penalties related to uncertain tax positions as a component of income tax expense in its consolidated statements of operations. The Company has not accrued interest or penalties associated with this liability for the fiscal year ended September 30, 2016.

The Company’s unrecognized tax benefits (before consideration of any valuation allowance) represent differences between tax positions taken by the Company in its various consolidated and separate worldwide tax returns and the benefits recognized and measured for uncertain tax positions. This amount also represents the amount of unrecognized tax benefits that, if recognized, would favorably affect the effective income tax rate in any future periods. The change in the unrecognized tax benefits during the fiscal year ended September 30, 2016 was as follows (in thousands):


Balance at September 30, 2014	$	335
Additions/Reductions for prior year tax positions		(66)
Balance at September 30, 2015		269
Reductions for prior year tax positions		(114)
Balance at September 30, 2016	$	155

In the normal course of business, the Company is subject to examination by taxing authorities throughout the world, including such jurisdictions as the United Kingdom, Germany, Singapore, Australia and the United States, and as a result, files numerous consolidated and separate income tax returns in the U.S. federal jurisdiction and various state and foreign jurisdictions. The fiscal years ended September 30, 2013 through September 30, 2015 are generally still open to examination in the jurisdictions listed above. The Company was under audit by the Internal Revenue Service for the fiscal year ended September 30, 2011. The audit was completed during the fourth quarter ended September 30,2014 and resulted in the reduction of $0.5 million related to research credits, AMT credits, and NOL carryforwards which had a full valuation. The Company did not have to make any cash payments as a result of this audit.