INCOME TAXES

The Tax Act was enacted in December 2017 and included several provisions that affected Cadence significantly, such as a one-time, mandatory transition tax on its previously untaxed foreign earnings and a reduction in the federal corporation income tax rate from 35% to 21% as of January 1, 2018, among others.

Cadence is required to recognize the effect of tax law changes in the period of enactment, which in the case of the Tax Act was December 2017, even though the effective date for most provisions of the Tax Act is January 1, 2018. The Securities and Exchange Commission issued Staff Accounting Bulletin No. 118, which allows registrants to record reasonable estimates or to apply tax laws in effect prior to the enactment of the Tax Act for a period of up to one year from the date of enactment when it does not have the necessary information available, prepared or analyzed in reasonable detail to complete its accounting for the changes in taxation. This provisional period ends when a company has obtained, prepared and analyzed the information necessary to finalize its accounting, but cannot extend beyond December 22, 2018.

Cadence was unable to complete the accounting for the effects of the Tax Act in fiscal 2017 because of the complexity and ambiguity of certain tax and accounting effects of the Tax Act. Cadence made reasonable estimates and recorded provisional amounts for the following effects of the Tax Act:


•	Transition tax on the deemed repatriation of past earnings of foreign subsidiaries;


•	Remeasurement of U.S. deferred taxes for the U.S. tax rate reduction;


•	Deferred taxes on past earnings of foreign subsidiaries that may be repatriated in the future; and


•	Unrecognized tax benefits related to the transition tax.

Cadence was unable to make reasonable estimates for the following tax law changes and applied the tax laws in effect prior to the enactment of the Tax Act:


•	Deferred taxes related to global intangible low-taxed income; and


•	Assessment of the valuation allowance applying the comprehensive changes in tax laws under the Tax Act.

Cadence expects to refine and complete the accounting for the Tax Act during fiscal 2018 as it obtains, prepares and analyzes additional information. Cadence also expects that additional guidance and interpretation of the tax law changes and accounting for the tax effects of the Tax Act will be available during fiscal 2018.

Cadence’s income before provision for income taxes included income from the United States and from foreign subsidiaries for fiscal 2017, 2016 and 2015, was as follows:



	2017		2016		2015
	(In thousands)
United States	$	81,619	$	84,694	$	47,867
Foreign subsidiaries	233,427		152,459		219,729
Total income before provision for income taxes	$	315,046	$	237,153	$	267,596

During fiscal 2017, 2016 and 2015, Cadence’s foreign subsidiaries were generally subject to lower statutory tax rates than the United States statutory federal income tax rate of 35%.

Cadence’s provision for income taxes was comprised of the following items for fiscal 2017, 2016 and 2015:



	2017			2016			2015
	(In thousands)
Current:
Federal	$	(2,193	)	$	4,839		$	(10,265	)
State and local	(2,097		)	50			(713		)
Foreign	35,301			34,047			24,622
Total current	31,011			38,936			13,644

Deferred:
Federal	76,494			(5,291		)	(13,165		)
State and local	5,571			6,006			1,751
Foreign	(2,131		)	(5,584		)	(1,734		)
Total deferred	79,934			(4,869		)	(13,148		)

Tax expense allocated to shareholders’ equity	—			—			14,683

Total provision for income taxes	$	110,945		$	34,067		$	15,179

The provision for income taxes differs from the amount estimated by applying the United States statutory federal income tax rate of 35% to income before provision for income taxes for fiscal 2017, 2016 and 2015 as follows:



	2017			2016			2015
	(In thousands)
Provision computed at federal statutory income tax rate	$	110,266		$	83,003		$	93,659
State and local income tax, net of federal tax effect	5,867			5,534			3,621
Foreign income tax rate differential	(65,296		)	(36,098		)	(56,873		)
Impact of 2017 Tax Act*	96,798			—			—
Stock-based compensation	(24,455		)	(13,132		)	2,687
Change in deferred tax asset valuation allowance	4,689			1,243			(11,066		)
Tax credits	(26,789		)	(39,765		)	(19,243		)
Repatriation of foreign earnings	—			25,145			50
Tax effects of intra-entity transfer of assets	(8,450		)	(7,661		)	(7,928		)
Domestic production activity deduction	(2,474		)	(2,826		)	—
Withholding taxes	11,225			9,870			5,119
Tax settlements, foreign	3,086			5,620			—
Increase in unrecognized tax benefits not included in tax settlements	4,054			614			3,530
Other	2,424			2,520			1,623
Provision for income taxes	$	110,945		$	34,067		$	15,179
Effective tax rate	35		%	14		%	6		%

____________

* The provisional amount related to the remeasurement of U.S. deferred tax assets and liabilities based on the rates at which they are expected to reverse in the future was $25.2 million. The provisional amount related to the one-time transition tax on the mandatory deemed repatriation of foreign earnings was $67.2 million.

Cadence adopted the new accounting standard related to stock-based compensation in fiscal 2016, which requires the excess tax benefits or deficiencies to be reflected in the consolidated income statements as a component of the provision for income taxes, whereas these income tax effects were previously recognized in stockholders’ equity in the consolidated balance sheets. Cadence adopted the accounting standard on a prospective basis and prior fiscal periods were not restated. Total excess tax benefits recognized in the provision for income taxes in fiscal 2017 and fiscal 2016 were $32.0 million and $17.2 million, respectively.

The components of deferred tax assets and liabilities consisted of the following as of December 30, 2017 and December 31, 2016:



	As of
	December 30, 2017			December 31, 2016
	(In thousands)
Deferred tax assets:
Tax credit carryforwards	$	164,687		$	180,999
Reserves and accruals	42,357			62,438
Intangible assets	13,112			23,335
Capitalized research and development expense for income tax purposes	10,621			19,093
Operating loss carryforwards	20,650			23,175
Deferred income	12,178			14,842
Capital loss carryforwards	20,266			20,580
Stock-based compensation costs	15,782			20,087
Depreciation and amortization	7,665			12,202
Investments	3,201			6,442
Prepaid expenses	—			26,526
Total deferred tax assets	310,519			409,719
Valuation allowance	(95,491		)	(92,920		)
Net deferred tax assets	215,028			316,799

Deferred tax liabilities:
Intangible assets	(36,683		)	(35,651		)
Undistributed foreign earnings	(23,563		)	(24,529		)
Other	(2,730		)	(119		)
Total deferred tax liabilities	(62,976		)	(60,299		)
Total net deferred tax assets	$	152,052		$	256,500

Cadence remeasured its fiscal 2017 federal deferred tax assets and liabilities at the applicable tax rate of 21% in accordance with the Tax Act.

Cadence regularly reviews its deferred tax assets for recoverability and establishes a valuation allowance if it is more likely than not that some portion of the deferred tax assets will not be realized. Because the Tax Act includes significant changes to tax laws that potentially impact Cadence’s valuation allowance analysis and Cadence could not make a reasonable estimate of the effect of such changes, Cadence reviewed its valuation allowance by applying the tax law in effect prior to the enactment of the Tax Act. During fiscal 2017, Cadence determined that there was sufficient positive evidence to conclude that $215.0 million of deferred tax assets were more likely than not to be realized. The evidence that the Company relied on to make this determination included the following:


•	The magnitude and duration of Cadence’s historical profitability in the United States;


•	Cadence’s multi-year history of approximately 90% of the aggregate value of its bookings being of a type that generates revenue recognized over time;


•	Cadence’s existing revenue backlog as of December 30, 2017 that provides Cadence with an objective source of future revenues to be recognized in fiscal 2018 and subsequent periods; and


•	Cadence’s expectation of having sufficient sources of income in the future to prevent the expiration of deferred tax assets.

Cadence will provide adjustments to the fiscal 2017 valuation allowance during fiscal 2018 upon obtaining, preparing and analyzing the information necessary to update and finalize its accounting for the tax effects of the Tax Act.

During fiscal 2017 and 2016, Cadence maintained valuation allowances of $95.5 million and $92.9 million, respectively, on certain federal, state and foreign deferred tax assets because the realization of these deferred tax assets require future income of a specific character or amount that Cadence considered uncertain. The valuation allowance primarily relates to the following:


•	Tax credits in certain states that are accumulating at a rate greater than Cadence’s capacity to utilize the credits and tax credits in certain states where it is likely the credits will expire unused;


•	Federal, state and foreign deferred tax assets related to investments and capital losses that can only be utilized against gains that are capital in nature; and


•	Foreign tax credits that can only be fully utilized if Cadence has sufficient income of a specific character in the future.

As of December 30, 2017, Cadence’s operating loss carryforwards were as follows:



	Amount		Expiration Periods
	(In thousands)
Federal	$	13,638	from 2021 through 2036
California	198,173		from 2019 through 2036
Other states (tax effected, net of federal benefit)	3,081		from 2019 through 2037
Foreign (tax effected)	866		from 2025 through indefinite

As of December 30, 2017, Cadence had tax credit carryforwards of:



	Amount		Expiration Periods
	(In thousands)
Federal*	$	87,746	from 2023 through 2037
California	52,628		indefinite
Other states	9,153		from 2018 through 2037
Foreign	15,160		from 2018 through 2037

_____________

*Certain of Cadence’s foreign tax credits have yet to be realized and as a result do not yet have an expiration period.

Under the Tax Act, all foreign earnings are subject to U.S. taxation. Accordingly, Cadence does not expect to indefinitely reinvest the earnings from its foreign subsidiaries, although Cadence continues to evaluate the accounting for all of the tax effects of the Tax Act during fiscal 2018.

Examinations by Tax Authorities

Taxing authorities regularly examine Cadence’s income tax returns. As of December 30, 2017 Cadence’s earliest tax years that remain open to examination and the assessment of additional tax include:



Jurisdiction		Earliest Tax Year Open to Examination

United States - Federal		2014
United States - California		2013
Hungary		2012

Unrecognized Tax Benefits

The changes in Cadence’s gross amount of unrecognized tax benefits during fiscal 2017, 2016 and 2015 are as follows:



	2017			2016			2015
	(In thousands)
Unrecognized tax benefits at the beginning of the fiscal year	$	98,540		$	87,820		$	97,224
Gross amount of the increases (decreases) in unrecognized tax benefits of tax positions taken during a prior year*	688			(155		)	(7,331		)
Gross amount of the increases in unrecognized tax benefits as a result of tax positions taken during the current year	13,141			11,342			7,513
Amount of decreases in unrecognized tax benefits relating to settlements with taxing authorities, including the utilization of tax attributes	—			—			(9,571		)
Reductions to unrecognized tax benefits resulting from the lapse of the applicable statute of limitations	(3,028		)	(149		)	(119		)
Effect of foreign currency translation	838			(318		)	104
Unrecognized tax benefits at the end of the fiscal year	$	110,179		$	98,540		$	87,820

Total amounts of unrecognized tax benefits that, if upon resolution of the uncertain tax positions would reduce Cadence’s effective tax rate	$	63,108		$	56,248		$	48,335

_________

* Includes unrecognized tax benefits of tax positions recorded in connection with acquisitions

The total amounts of interest, net of tax, and penalties recognized in the consolidated income statements as provision (benefit) for income taxes for fiscal 2017, 2016 and 2015 were as follows:



	2017		2016		2015
	(In thousands)
Interest	$	1,865	$	1,166	$	110
Penalties	218		3		(127		)

The total amounts of gross accrued interest and penalties recognized in the consolidated balance sheets as of December 30, 2017 and December 31, 2016 were as follows:



	As of
	December 30, 2017		December 31, 2016
	(In thousands)
Interest	$	2,511	$	1,332
Penalties	151		265