Income Taxes

The provision (benefit) for taxes consists of the following:



	Fiscal Year Ended
(in thousands)	January 26, 2014			January 27, 2013			January 29, 2012
Current tax provision
Federal	$	3,769		$	7,100		$	2,336
State	554			784			569
Foreign	14,962			5,745			4,615
Subtotal	19,285			13,629			7,520
Deferred tax provision (benefit)
Federal	23,938			(15,812		)	(4,417		)
State	(1,293		)	(148		)	1,232
Foreign	(5,945		)	(39,359		)	757
Subtotal	16,700			(55,319		)	(2,428		)
Provision (benefit) for taxes	$	35,985		$	(41,690	)	$	5,092

The provision (benefit) for taxes reconciles to the amount computed by applying the statutory federal rate to income before taxes as follows:



	Fiscal Year Ended
(in thousands)	January 26, 2014			January 27, 2013			January 29, 2012
Federal income tax at statutory rate	$	(44,968	)	$	86		$	32,963
State income taxes, net of federal benefit	(1,260		)	(2,472		)	(263		)
Foreign taxes at rates less than federal rates	(8,378		)	(9,655		)	(16,269		)
Tax credits generated	(5,523		)	(5,328		)	(2,222		)
Changes in valuation allowance	52,942			2,703			1,814
Goodwill impairment	40,840			—			—
Changes in uncertain tax positions	893			132			(3,235		)
Deemed dividends	726			1,101			1,250
Equity compensation	1,173			793			(1,312		)
Permanent differences	2,895			1,571			1,592
Sales exclusion - foreign jurisdiction	—			(10,689		)	(11,017		)
Dividend and U.S. tax on foreign earnings	—			(23,443		)	—
Revaluation of deferred taxes assets and liabilities	(12		)	3,510			—
Other	(3,343		)	1			1,791
Provision (benefit) for taxes	$	35,985		$	(41,690	)	$	5,092

The Company receives an income tax benefit from tax rate differentials due to its presence in foreign jurisdictions such as Switzerland and Canada where statutory rates are lower than US federal tax rates. This income tax benefit is reflected in the line item "Foreign taxes at rates less than federal rates".

The Company realized a decrease in the benefit from tax rate differentials in fiscal year 2014 compared to the benefit realized in fiscal year 2013 due to a higher effective tax rate in Switzerland after the Company received a new tax ruling in the third quarter of fiscal year 2014.

The Company, via its Swiss subsidiary, Semtech International AG, receives an income tax benefit in Switzerland because only a portion of its total earnings are subject to taxation in Switzerland. Specifically, in the third quarter of fiscal year 2014, the Company received a new Swiss tax ruling (“New Swiss Ruling”), with an effective date retroactive to the beginning of fiscal year 2014, which allows the Company to compute Swiss income tax using an allocated portion of its total pre-tax earnings that are attributable to the sourcing of production activities. This New Swiss Ruling superseded a Swiss tax ruling that was in effect during fiscal years 2012 and 2013 (“Previous Swiss Ruling”). The Previous Swiss Ruling required the Company to allocate each element of revenue and expense to activities sourced to Switzerland or outside Switzerland based on an analysis of where certain activities were being performed. The New Swiss Ruling is expected to reduce the overall volatility of our Swiss income taxes.

In prior years, the Company reflected the tax ruling benefit in the reconciliation line item “Sales exclusion - foreign jurisdiction”. As a result of the differences in the computation of how financial activity is excluded from taxation in Switzerland, the Company reflects the benefit from the New Swiss Ruling as "Foreign taxes at rates less than federal rates".

The Company is currently not aware of any uncertainties or trends relating to the foreign tax rate differential or the New Swiss Ruling that could significantly impact the Company’s income taxes in future periods.

The deferred tax assets and deferred tax liabilities are classified in the consolidated balance sheets as follows:



(in thousands)	January 26, 2014			January 27, 2013
Deferred tax assets
Current	$	2,946		$	7,473
Non-current	348			33,563
Subtotal	3,294			41,036
Deferred tax liabilities
Current	(930		)	(4,221		)
Non-current	(3,626		)	(2,042		)
Subtotal	(4,556		)	(6,263		)
Net deferred tax (liabilities) assets	$	(1,262	)	$	34,773

The Financial Accounting Standards Board’s (“FASB”) Accounting Standards Codification (“ASC”) Topic 740, Accounting for Income Taxes, requires that for a particular tax-paying component of an enterprise, and within a particular tax jurisdiction, (a) all current deferred tax liabilities and assets shall be offset and presented as a single amount and (b) all noncurrent deferred tax liabilities and assets shall be offset and presented as a single amount. Deferred tax liabilities and assets attributable to different tax-paying components of the enterprise or to different tax jurisdictions are not offset.

The components of the net deferred income tax assets and liabilities at January 26, 2014 and January 27, 2013 are as follows:



(in thousands)	January 26, 2014			January 27, 2013
Current deferred tax asset:
Deferred revenue	$	2,773		$	1,889
Inventory reserve	3,032			567
Payroll and related accruals	2,133			2,444
Bad debt reserve	416			323
Accrued service fees	591			626
Other deferred assets	1,562			2,593
Valuation allowance	(7,321		)	(969		)
Total current deferred tax asset	3,186			7,473
Non-current deferred tax asset:
Research and development charges	2,109			2,900
Research credit carryforward	39,350			49,257
Acquired NOL carryforward	31,165			28,595
Payroll and related accruals	6,268			5,389
Stock-based compensation	5,732			8,456
Other deferred assets	3,567			3,395
Valuation allowance	(53,931		)	(7,351		)
Total non-current deferred tax asset	34,260			90,641
Current deferred tax liability:
Inventory reserve - foreign	(430		)	(1,618		)
Bad debt reserve - foreign	(223		)	(773		)
Depreciation - foreign	—			(1,744		)
Other current deferred tax liability	(517		)	(86		)
Total current deferred tax liability	(1,170		)	(4,221		)
Non-current deferred tax liability:
Purchase accounting deferred tax liability	(32,466		)	(49,181		)
Depreciation and amortization	(3,695		)	(8,504		)
Other non-current deferred tax liability	(1,377		)	(1,435		)
Total non-current deferred tax liability	(37,538		)	(59,120		)
Net deferred tax (liability) asset	$	(1,262	)	$	34,773

The change in the net deferred tax asset differs from the deferred tax provision as a result of deferred tax assets that do not typically impact the provision. This includes the benefit related to tax deductions from the exercise of non-qualified stock options in excess of compensation cost recognized for financial reporting purposes (recorded as an increase to additional paid-in capital when realized).

As of January 26, 2014, the Company had federal and state net operating loss carryforwards of $81.6 million and $95.6 million, respectively, which, subject to certain limitations, are available to offset future taxable income through fiscal year 2033. A portion of these losses were generated by SMI prior to the Company’s purchase of SMI and therefore are subject to change of control provisions which limit the amount of acquired tax attributes that can be utilized in a given tax year. The Company does not expect these changes in control limitations to significantly impact its ability to utilize these attributes.

Included in the Company’s net operating loss carryforward deferred tax asset is approximately $8.0 million of deferred tax assets attributable to excess equity deductions related to stock awards that are not included on the Company’s consolidated balance sheet. Due to a provision within ASC 740, concerning when tax benefits related to excess stock option deductions can be credited to paid-in capital, the portion of the Company’s deferred tax asset related to such excess tax benefits must be excluded from the deferred tax asset balance, even if the facts and circumstances indicate that it is more likely than not that the deferred tax asset can be realized. The credit to paid-in-capital will be recorded when the benefit is reflected in our taxes payable.

As of January 26, 2014, the Company had gross federal and state research credits available of approximately $12.7 million and $13.1 million, respectively, which are available to offset taxable income. These credits will expire between fiscal years 2023 through 2034. As of January 26, 2014, the Company had federal Alternative Minimum Tax credits available of approximately $1.3 million. The Company also had Canadian research credits available of approximately $40.9 million. These credits will expire between fiscal years 2026 and 2034.

Realization of the net deferred tax assets is dependent on generating sufficient income during the periods in which temporary differences will reverse. During fiscal year 2014, the Company determined utilization of its net deferred tax assets in the United States and Canada was limited due to an inability to generate sufficient taxable income in these locations, and accordingly, recorded an increase to its valuation allowance reserve of $44.0 million and $8.4 million, respectively. The following table summarizes the changes in these allowances during fiscal years 2014, 2013 and 2012:



	Fiscal Year Ended
(in thousands)	January 26, 2014		January 27, 2013		January 29, 2012
Beginning balance	$	8,320	$	5,617	$	5,053
Additions	52,931		2,703		564
Releases	—		—		—
Ending balance	$	61,251	$	8,320	$	5,617

As of January 26, 2014, the Company had approximately $496.8 million of unremitted earnings related to the Company’s wholly owned foreign subsidiaries for which income taxes have not been provided.

Uncertain Tax Positions

The Company uses a two-step approach to recognize and measure uncertain tax positions (“UTP”). The first step is to evaluate the tax position for recognition by determining if the weight of available evidence indicates that it is more likely than not that the position will be sustained on audit, including resolution of related appeals or litigation processes, if any. The second step is to measure the tax benefit as the largest amount that is more than 50% likely of being realized upon ultimate settlement.

A reconciliation of the beginning and ending amount of gross unrecognized tax benefits (before federal impact of state items) is as follows:



	Fiscal Year Ended
(in thousands)	January 26, 2014			January 27, 2013			January 29, 2012
Beginning balance	$	13,144		$	13,759		$	17,011
Additions based on tax positions related to the current year	1,484			695			835
Reductions for tax positions of prior years	(214		)	(647		)	(4,087		)
Reductions for settlements with tax authorities	—			(663		)	—
Ending balance	$	14,414		$	13,144		$	13,759

Included in the balance of unrecognized tax benefits at January 26, 2014 and January 27, 2013, are $12.3 million and $11.1 million, respectively, of net tax benefits (after federal impact of state items) that, if recognized, would impact the effective tax rate.

The liability for UTP is reflected on the consolidated balance sheets as follows:



	Fiscal Year Ended
(in thousands)	January 26, 2014		January 27, 2013
Deferred tax assets - non-current	$	12,095	$	—
Accrued liabilities	—		188
Other long-term liabilities	252		10,887
Total accrued taxes	$	12,347	$	11,075

The Company’s policy is to include net interest and penalties related to unrecognized tax benefits within the provision for taxes on the consolidated statements of operations. The Company had approximately $293,000 of net interest and penalties accrued at January 26, 2014 and January 27, 2013.

As of January 26, 2014, it was reasonably possible that the total amounts of unrecognized tax benefits would decrease by up to $3.8 million within twelve months as a result of statutes of limitations for the taxing authority to challenge the position expiring. If recognized, this decrease will impact the effective tax rate. Tax years prior to 2009 (the Company’s fiscal year 2010) are generally not subject to examination by the Internal Revenue Service (“IRS”) except for items involving tax attributes that have been carried forward to tax years whose statute of limitations remains open. The Company is currently under IRS audit for fiscal year 2010 and fiscal year 2011, and expects to close those audits within the next twelve months. For state returns, the Company is generally not subject to income tax examinations for years prior to 2009 (the Company’s fiscal year 2010). The Company has a significant tax presence in Switzerland for which Swiss tax filings have been examined through fiscal year 2013. The Company is also subject to routine examinations by various foreign tax jurisdictions in which it operates.