NOTE 18. INCOME TAXES

The components of our income before income tax provision are summarized as follows (in thousands):

	Year Ended March 31,
	2018		2017			2016
Continuing operations:
United States	$	38,507	$	48,069		$	43,885
Foreign		4,893		3,043			3,262
Total - continuing operations	$	43,400	$	51,112		$	47,147
Discontinued operations:
United States	$	-	$	(101	)	$	893

The components of our income tax provision are summarized as follows (in thousands):

	Year Ended March 31,
	2018			2017			2016
Continuing operations:
Current:
Federal	$	11,423		$	16,629		$	13,204
State		1,243			2,237			1,562
Foreign		1,448			841			1,290
Total current income tax provision		14,114			19,707			16,056
Deferred:
Federal		2,698			(1,126	)		178
State		(558	)		(192	)		(128	)
Foreign		(31	)		(56	)		(33	)
Total deferred income tax provision (benefit)		2,109			(1,374	)		17
Total income tax provision - continuing operations	$	16,223		$	18,333		$	16,073

Discontinued operations and gain on sale of discontinued operations:
Current:
Federal	$	-		$	(35	)	$	(835	)
State		-			(3	)		(69	)
Total current income tax benefit		-			(38	)		(904	)
Deferred:
Federal		-			-			1,146
State		-			-			95
Total deferred income tax benefit		-			-			1,241
Total income tax provision (benefit) - discontinued operations and gain on sale of discontinued operations	$	-		$	(38	)	$	337

The income tax provision from continuing operations differs from the amount computed by applying the federal statutory income tax rate to income from continuing operations before income tax provision as follows (in thousands):

	Year Ended March 31,
	2018			2017			2016
Continuing operations:
Income taxes at federal income tax rate	$	13,674		$	17,889		$	16,502
State income taxes, net of federal benefits		364			1,284			917
Non-deductible compensation		326			549			543
Research and development tax credits		(492	)		(410	)		(607	)
Tax-exempt interest income		(3	)		(1	)		(2	)
Qualified production activities income benefit		(599	)		(910	)		(761	)
Federal rate change(1)		3,539			-			-
Other		(586	)		(68	)		(519	)
Total income tax provision from continuing operations	$	16,223		$	18,333		$	16,073

(1) The federal rate change is due to the impact of the Tax Act.

The difference between the effective tax rate and the federal income tax rate is as follows:

	Year Ended March 31,
	2018			2017			2016
Continuing operations:
Income taxes at federal income tax rate(1)		31.5	%		35.0	%		35.0	%
State income taxes, net of federal benefits		0.8	%		2.5	%		2.0	%
Non-deductible compensation		0.8	%		1.1	%		1.1	%
Research and development tax credits		(1.1	)%		(0.8	)%		(1.3	)%
Qualified production activities income benefit		(1.4	)%		(1.8	)%		(1.6	)%
Federal rate change		8.2	%		0.0	%		0.0	%
Other		(1.4	)%		(0.1	)%		(1.1	)%
Effective tax rate		37.4	%		35.9	%		34.1	%

(1) As of January 1, 2018, the U.S. federal corporate tax rate decreased from 35% to 21%, resulting in a blended statutory tax rate of 31.5% for fiscal 2018.

On December 22, 2017, the Tax Act was enacted into law making significant changes to the U.S. income tax system. The Tax Act, among other changes, reduces the U.S. federal corporate tax rate from 35% to 21% as of January 1, 2018, eliminates the federal benefit for qualified production activities, expands the deduction limitation for executive compensation and interest expense, creates a territorial system which will generally allow companies to repatriate future foreign earnings without incurring additional U.S. income taxes, subjects foreign earnings on which U.S. income tax is currently deferred to a one time transition tax and creates an incentive for U.S. companies to sell goods and services abroad. The Tax Act also includes provisions for Global Intangible Low-Taxed Income (“GILTI”) wherein U.S. tax is imposed, subject to offset by foreign tax credits, on income earned by foreign subsidiaries in excess of a deemed return on tangible assets of foreign corporations which applies after the fiscal year ending March 31, 2018. Because of the complexity of the new provisions, we are continuing to evaluate how the provisions will be accounted for under GAAP wherein companies are allowed to make an accounting policy election to either (i) account for GILTI as a component of tax expense in the period in which they are subject to the rules or (ii) account for GILTI in our measurement of deferred taxes. The decrease in the U.S. federal corporate tax rate from 35% to 21% results in a blended statutory tax rate of 31.5% for the fiscal year ended March 31, 2018.

The Company’s income tax provision and effective tax rate during fiscal 2018 was impacted by the Tax Act. As a result of the Tax Act, the Company made an additional estimated provision of $3.4 million in fiscal 2018, of which $2.9 million was recorded in the third quarter of fiscal 2018 and $0.5 million in the fourth quarter of fiscal 2018 for income tax resulting from the enactment of the Tax Act. The dollar decrease in the income tax provision during fiscal 2018, as compared to the same period last year, was attributable to lower pre-tax income and the reduction of the U.S. federal rate from 35% to a blended statutory tax rate of 31.5%, partially offset by a one-time non-cash charge of $3.4 million due to a reduction in deferred tax assets as a result of the reduction of the federal tax rate from 35% to 21% effective January 1, 2018. The increase in the effective tax rate during fiscal 2018, as compared to the same period last year, was primarily attributable to an additional provision for income tax resulting from the enactment of the Tax Act during fiscal 2018, as described above. The increase in the effective tax rate was partially offset by the reduction of the U.S. federal rate from 35% to a blended statutory tax rate of 31.5%, a lower effective state rate, higher foreign tax credits and the recognition of excess tax benefits as a component of income taxes in fiscal 2018 pursuant to ASU 2016-09, which we adopted effective the first quarter of fiscal 2018.

Income tax effects resulting from changes in tax laws are accounted for by the Company in accordance with the authoritative guidance, which requires that these tax effects be recognized in the period in which the law is enacted and the effects are recorded as a component of provision for income taxes from continuing operations. In December 2017, the Securities and Exchange Commission (“SEC”) staff issued Staff Accounting Bulletin No. 118, Income Tax Accounting Implications of the Tax Cuts and Jobs Act (“SAB 118”), which allows us to record provisional amounts during a measurement period not to extend beyond one year of the enactment date. Since the Tax Act was passed on December 22, 2017, and ongoing guidance and accounting interpretation are expected over the next 12 months, we consider the accounting of the deferred tax re-measurements to be incomplete due to the forthcoming guidance and our ongoing analysis of final year-end data and tax positions. We expect to complete our analysis within the measurement period in accordance with SAB 118. The Company’s provision for income taxes during fiscal 2018 is based on a reasonable estimate of the effects on its transition tax and existing deferred tax balances. The Company estimates it will incur no transition tax and has recorded a one-time non-cash charge of $3.4 million due to an estimated reduction in deferred tax assets as a result of the reduction of the federal rate from 35% to 21%. The computation of the transition tax could be impacted by further interpretations from the U.S. and state governments and regulatory organizations. The reduction of the deferred tax assets may be impacted by changes in the timing for the reversal of existing deferred tax assets and liabilities. Given the complexity of Tax Act, we may be refining our estimates of these provisional amounts as further guidance is issued from the U.S. Treasury, the SEC and the FASB.

Prior to the reporting period in which the Tax Act was enacted, our policy was to reinvest earnings of their foreign subsidiaries unless such earnings are subject to U.S. taxation. As of March 31, 2018, there were no significant foreign earnings that have not been subject to U.S. taxation. We do not have sufficient information available to finalize our analysis of the impact of the Tax Act on our repatriation policy, and therefore, the policy has not changed as of March 31, 2018. We expect to finalize our analysis during the quarter ending June 30, 2018 which may include a change in our repatriation policy.

Deferred Taxes

The following table presents the breakdown between current and non-current net deferred tax assets and liabilities (in thousands):

	March 31,
	2018			2017
Deferred tax assets, current	$	-		$	5,644
Deferred tax assets, non-current		7,913			4,392
Deferred tax liabilities, non-current		(203	)		(234	)
Total net deferred tax assets	$	7,710		$	9,802

Significant components of our deferred tax assets and liabilities are as follows (in thousands):

	March 31,
	2018			2017
Deferred tax assets:
Research and development tax credit carryforwards	$	1,218		$	917
Capitalized research and development		10			45
Inventory reserves		348			598
Deferred revenue from extended maintenance agreements		550			1,074
Warranty reserves		1,282			1,659
Accrued payroll and other accrued expenses		1,192			1,715
Share-based compensation		4,014			4,753
Alternative minimum tax credits		24			24
Tax on deferred intercompany profit		1,085			1,221
Other		595			696
Total deferred tax assets		10,318			12,702
Deferred tax liabilities:
Depreciation		(2,317	)		(2,518	)
Other		(291	)		(382	)
Total deferred tax liabilities		(2,608	)		(2,900	)
Net deferred tax assets	$	7,710		$	9,802

During the first quarter of fiscal 2018, we adopted ASU 2016-09, and as a result of adoption, during fiscal 2018 we recognized $0.3 million of excess tax benefits related to share-based payments in our income tax provision. These items were historically recorded in common stock. Prior to April 1, 2017, cash flows resulting from excess tax benefits were classified as a part of cash flows from financing activities. During fiscal 2017 and 2016, we recognized $24,000 and $1.6 million, respectively, of tax deductions related to share-based compensation, on a consolidated basis, in excess of recognized share-based compensation expense (“excess benefits”) that was recorded to shareholders’ equity. We recorded excess benefits to shareholders’ equity when the benefits result in a reduction in cash paid for income taxes.

A valuation allowance against deferred tax assets is provided when it is more likely than not that some portion of the deferred tax assets will not be realized. As of March 31, 2018 and 2017, we did not have a valuation allowance.

As of March 31, 2018, we had no federal or California net operating loss carryforwards. As of March 31, 2018, our California research and development tax credit carryforwards were $1.5 million. The California research and development tax credit will carryforward indefinitely.

Unrecognized Tax Benefits

During fiscal 2018, 2017 and 2016, we did not recognize any interest and penalties related to unrecognized tax benefits.

We file income tax returns in the U.S. federal jurisdiction, Germany, United Kingdom, Hong Kong and various state jurisdictions. The statute of limitations is three years for federal and four years for California. Our federal income tax returns are subject to examination for fiscal years 2015 through 2018. Our California income tax returns are subject to examination for fiscal years 2014 through 2018, with the exception of California tax credit carryovers. To the extent there is a research and development tax credit available for carryover to future years, the statute of limitations with respect to the tax credit begins in the year utilized. As a result of the timing for the utilization of California tax credit carryovers, our California research and development tax credits are subject to examination for fiscal years 2011 through 2018. We are subject to examination in Germany for fiscal years 2014 through 2018, in the United Kingdom for fiscal years 2013 through 2018 and in Hong Kong for fiscal years 2017 through 2018.

We are subject to income taxes in the United States and various foreign jurisdictions. Accordingly, we are subject to a variety of examinations by taxing authorities in these locations. In the third quarter of fiscal 2017, the state of California commenced an examination of our tax returns for fiscal years 2014 and 2015, which was completed in the second quarter of fiscal 2018 and there have not been any proposed assessments as a result of this examination. Our foreign subsidiary income tax returns for fiscal 2013 through 2015 are subject to examination by German tax authorities. The German tax examination commenced in the third quarter of fiscal 2018 and completed in the fourth quarter of fiscal 2018. The proposed assessment by such authorities in Germany was not significant. The German tax authorities notified the Company of its intent to audit fiscal years 2016 through 2018. As of March 31, 2018, the audit had not commenced.