Income Taxes

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



	Fiscal Year Ended
(in thousands)	January 25, 2015			January 26, 2014			January 27, 2013
Current tax provision
Federal	$	749		$	3,769		$	7,100
State	—			554			784
Foreign	7,810			14,962			5,745
Subtotal	8,559			19,285			13,629
Deferred tax provision (benefit)
Federal	508			23,938			(15,812		)
State	(100		)	(1,293		)	(148		)
Foreign	(419		)	(5,945		)	(39,359		)
Subtotal	(11		)	16,700			(55,319		)
Provision (benefit) for taxes	$	8,548		$	35,985		$	(41,690	)

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 25, 2015			January 26, 2014			January 27, 2013
Federal income tax at statutory rate	$	12,775		$	(44,968	)	$	86
State income taxes, net of federal benefit	(100		)	(1,260		)	(2,472		)
Foreign taxes at rates less than federal rates	(11,960		)	(8,378		)	(9,655		)
Tax credits generated	(5,302		)	(5,523		)	(5,328		)
Changes in valuation allowance	14,284			52,942			2,703
Goodwill impairment	—			40,840			—
Changes in uncertain tax positions	(5,167		)	893			132
Deemed dividends	2,513			726			1,101
Equity compensation	2,200			1,173			793
Permanent differences	(93		)	2,895			1,571
Sales exclusion - foreign jurisdiction	—			—			(10,689		)
Dividend and U.S. tax on foreign earnings	—			—			(23,443		)
Revaluation of deferred tax assets and liabilities	(432		)	(12		)	3,510
Other	(170		)	(3,343		)	1
Provision (benefit) for taxes	$	8,548		$	35,985		$	(41,690	)

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, 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 This New Swiss Ruling superseded a Swiss tax ruling that was in effect during fiscal years 2012 and 2013 (“Previous Swiss Ruling”).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.

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 25, 2015			January 26, 2014
Deferred tax assets
Current	$	2,478		$	2,946
Non-current	106			348
Subtotal	2,584			3,294
Deferred tax liabilities
Current	(1,444		)	(930		)
Non-current	(2,477		)	(3,626		)
Subtotal	(3,921		)	(4,556		)
Net deferred tax liabilities	$	(1,337	)	$	(1,262	)

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 25, 2015 and January 26, 2014 are as follows:



(in thousands)	January 25, 2015			January 26, 2014
Current deferred tax asset:
Deferred revenue	$	3,052		$	2,773
Inventory reserve	3,156			3,032
Payroll and related accruals	2,306			2,133
Bad debt reserve	927			416
Accrued service fees	608			591
Other deferred assets	1,191			1,562
Valuation allowance	(8,637		)	(7,321		)
Total current deferred tax asset	2,603			3,186
Non-current deferred tax asset:
Research and development charges	1,323			2,109
Research credit carryforward	40,819			39,350
NOL carryforward	29,144			31,165
Payroll and related accruals	7,148			6,268
Stock-based compensation	6,176			5,732
Other deferred assets	5,054			3,567
Valuation allowance	(66,899		)	(53,931		)
Total non-current deferred tax asset	22,765			34,260
Current deferred tax liabilities:
Inventory reserve - foreign	(826		)	(430		)
Bad debt reserve - foreign	(256		)	(223		)
Other current deferred tax liabilities	(373		)	(517		)
Total current deferred tax liabilities	(1,455		)	(1,170		)
Non-current deferred tax liabilities:
Purchase accounting deferred tax liabilities	(20,917		)	(32,466		)
Depreciation and amortization	(2,956		)	(3,695		)
Other non-current deferred tax liabilities	(1,377		)	(1,377		)
Total non-current deferred tax liabilities	(25,250		)	(37,538		)
Net deferred tax liabilities	$	(1,337	)	$	(1,262	)

As of January 25, 2015, the Company had federal and state net operating loss carryforwards of $87.0 million and $96.6 million, respectively, which, subject to certain limitations, are available to offset future taxable income through fiscal year 2034. A portion of these losses were generated by SMI prior to the Company’s purchase of SMI in fiscal year 2010 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 $8.4 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 25, 2015, the Company had gross federal and state research credits available of approximately $13.6 million and $13.8 million, respectively, which are available to offset taxable income. These credits will expire between fiscal years 2021 through 2035. As of January 25, 2015, the Company had federal Alternative Minimum Tax credits available of approximately $1.3 million. The Company also had Canadian research credits available of approximately $32.4 million. These credits will expire between fiscal years 2026 and 2035.

As of January 25, 2015, the Company has a full valuation allowance against its U.S. and Canadian deferred tax assets of approximately $75.5 million. The Company assessed whether a valuation allowance should be recorded against all of its deferred tax assets (“DTAs”) based on the consideration of all available evidence, using a “more likely than not” realization standard. The four sources of taxable income that must be considered in determining whether DTAs will be realized are, (1) future reversals of existing taxable temporary differences (i.e., offset of gross deferred tax assets against gross deferred tax liabilities); (2) taxable income in prior carryback years, if carryback is permitted under the tax law; (3) tax planning strategies and (4) future taxable income exclusive of reversing temporary differences and carryforwards.

In assessing whether a valuation allowance is required, significant weight is to be given to evidence that can be objectively verified. The Company evaluated its DTAs each reporting period, including an assessment of the cumulative income or loss over the most recent three-year period, to determine if a valuation allowance was required. A significant negative factor in the assessment was the Company’s three-year cumulative loss history as of January 25, 2015 and January 26, 2014 in Canada and the U.S.

After a review of the four sources of taxable income described above and in view of its three-year cumulative losses, the Company was not able to conclude that it is more likely than not that its DTAs in Canada and the U.S. at January 25, 2015 and January 26, 2014 will be realized. As a result, the Company recorded a full valuation allowance on its DTAs in Canada and the U.S, with a corresponding charge to the income tax provision, of approximately $14.3 million in fiscal 2015 and $52.9 million in fiscal 2014.

As of January 25, 2015, the Company had approximately $499.3 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 25, 2015			January 26, 2014
Beginning balance	$	14,414		$	13,144
Additions based on tax positions related to the current year	526			1,484
Reductions for tax positions of prior years, net	(3,982		)	(214		)
Reductions for settlements with tax authorities, net	(1,070		)	—
Ending balance	$	9,888		$	14,414

Included in the balance of unrecognized tax benefits at January 25, 2015 and January 26, 2014, are $7.8 million and $12.3 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 25, 2015		January 26, 2014
Deferred tax assets - non-current	$	7,522	$	12,095
Accrued liabilities	—		—
Other long-term liabilities	252		252
Total accrued taxes	$	7,774	$	12,347

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. Since the Company has sufficient net operating losses and R&D credit carryforwards, there would be no cash tax liability, and therefore no additional penalties or interest accrued during fiscal year 2015. The Company had approximately $293,000 of net interest and penalties accrued at January 25, 2015 and January 26, 2014.

Tax years prior to 2012 (the Company’s fiscal year 2013) 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 2013 and expects to close those audits within the next twelve months. The Company's positions are expected to be sufficient to address matters that may arise under examination. For state returns, the Company is generally not subject to income tax examinations for years prior to 2010 (the Company’s fiscal year 2011). 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.

Tangible Property Regulations

On September 13, 2013, the U.S. Treasury Department released final income tax regulations on the deduction and capitalization of expenditures related to tangible property. These final regulations apply to tax years beginning on or after January 1, 2014. Several of the provisions within the regulations will require a tax accounting method change to be filed with the IRS, resulting in a cumulative effect adjustment; however, given the Company’s full valuation allowance and loss position in the United States, management does not anticipate the impact of these changes to be material to the Company’s consolidated financial position.