Income Taxes

The following were the components of income before income taxes (in thousands):



	Fiscal Years Ended
	June 29, 2014		June 30, 2013		June 24, 2012
Domestic		$58,859		$31,046		($5,360	)
Foreign	88,711		76,511		53,007
Total income before income taxes		$147,570		$107,557		$47,647

The following were the components of income tax expense (in thousands):



	Fiscal Years Ended
	June 29, 2014			June 30, 2013			June 24, 2012
Current:
Federal		$3,423			$483			($4,031	)
Foreign	15,371			18,127			13,125
State	1,876			1,777			566
Total current	20,670			20,387			9,660
Deferred:
Federal	229			2,226			(4,786		)
Foreign	3,003			(177		)	(450		)
State	(523		)	(1,804		)	(1,189		)
Total deferred	2,709			245			(6,425		)
Income tax expense		$23,379			$20,632			$3,235

Actual income tax expense differed from the amount computed by applying the U.S. federal tax rate of 35% to pre-tax earnings as a result of the following (in thousands, except percentages):



	Fiscal Years Ended
	June 29, 2014			% of Income	June 30, 2013			% of Income	June 24, 2012			% of Income
Federal income tax provision at statutory rate		$51,645		35%		$37,645		35%		$16,676		35%
Increase (decrease) in income tax expense resulting from:
State tax provision, net of federal benefit	2,550			2%	1,146			1%	68			0%
State tax credits	(1,004		)	(1)%	(1,407		)	(1)%	(1,028		)	(2)%
Tax exempt interest	(815		)	0%	(853		)	(1)%	(1,064		)	(2)%
48C investment tax credit	(11,310		)	(8)%	(5,252		)	(5)%	(4,105		)	(9)%
Increase (decrease) in tax reserve	15,411			10%	(361		)	0%	(2,677		)	(6)%
Change in tax depreciation methodology	(18,475		)	(12)%	—			0%	—			0%
Research and development credits	(1,574		)	(1)%	(2,426		)	(2)%	(694		)	(1)%
Decrease in valuation allowance	(20		)	0%	(6		)	0%	(13		)	0%
Qualified production activities deduction	(2,362		)	(1)%	(866		)	(1)%	(177		)	(1)%
Stock-based compensation	2,024			1%	1,206			1%	336			1%
Statutory rate differences	(14,285		)	(10)%	(10,184		)	(10)%	(5,830		)	(12)%
Other	1,594			1%	1,990			2%	1,743			4%
Income tax expense		$23,379		16%		$20,632		19%		$3,235		7%

The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities were as follows (in thousands):



	June 29, 2014			June 30, 2013
Deferred tax assets:
Compensation		$4,843			$3,868
Inventories	18,672			16,050
Sales return reserve and allowance for bad debts	4,801			4,483
Warranty reserve	1,416			947
Federal and state net operating loss carryforwards	704			617
Federal credits	4,971			3,174
State credits	3,016			4,215
48C investment tax credits	22,731			7,216
Investments	958			976
Stock-based compensation	31,102			27,142
Deferred revenue	5,719			—
Other	876			1,209
Total gross deferred assets	99,809			69,897
Less valuation allowance	(1,571		)	(1,604		)
Deferred tax assets, net	98,238			68,293
Deferred tax liabilities:
Property and equipment	(25,660		)	(27,484		)
Intangible assets	(52,462		)	(37,921		)
Investments	(1,792		)	154
Prepaid taxes and other	(1,083		)	(997		)
Total gross deferred liability	(80,997		)	(66,248		)
Deferred tax asset, net		$17,241			$2,045

The components giving rise to the net deferred tax assets (liabilities) have been included in the Consolidated Balance Sheets as follows (in thousands):



	Balance at June 29, 2014
	Assets				Liabilities
	Current		Noncurrent		Current		Noncurrent
U.S. federal income taxes		$17,324		$—		$—		($10,948	)
Hong Kong and other income taxes	12,090		—		—		(1,225		)
Total net deferred tax assets/(liabilities)		$29,414		$—		$—		($12,173	)



	Balance at June 30, 2013
	Assets					Liabilities
	Current		Noncurrent			Current		Noncurrent
U.S. federal income taxes		$15,707		$—			$—		($25,504	)
Hong Kong and other income taxes	10,418		1,424		*	—		—
Total net deferred tax assets/(liabilities)		$26,125		$1,424			$—		($25,504	)



*	This amount is included in Other assets in the Consolidated Balance Sheets.

During the second quarter of fiscal 2014, the Company was notified by the Internal Revenue Service that it had been allocated up to $30 million of federal tax credits as part of the American Recovery and Reinvestment Act of 2009 - Phase II (Internal Revenue Code Section 48C). This $30 million allocation is in addition to the $39 million previously allocated to the Company in the third quarter of fiscal 2010. The $30 million allocation was based upon the Company’s plan to place into service approximately $100 million of qualified equipment at its U.S. manufacturing locations from fiscal 2013 through fiscal 2017. Property placed into service during fiscal 2013 generated $15 million of the potential $30 million Internal Revenue Code Section 48C credit. The remaining $15 million of Internal Revenue Code Section 48C credit was generated during the first three quarters of fiscal 2014. The tax benefit (net of related basis adjustments) will be amortized into income over the useful life (5 years ) of the underlying equipment that was placed into service to generate these credits. Since fiscal 2010, the Company has recognized an income tax benefit of $26.1 million related to the credits generated to date, with $11.3 million of this amount recognized as a tax benefit for the year ended June 29, 2014.

As of June 29, 2014 the Company had approximately $15.5 million of state net operating loss carryovers for which a full valuation allowance has been recognized. Additionally, the Company had $4.6 million of state income tax credit carryforwards. Both the state net operating loss carryovers and the state income tax credit carryforwards will begin to expire in fiscal 2017. Furthermore, the Company had approximately $0.8 million of alternative minimum tax credit carryforwards, $9.6 million of 48C credit carryforwards, $2.1 million of research and development credit carryforwards and $1.8 million of state income tax credit carryforwards that relate to excess stock option benefits which, if and when realized, will be recognized in Additional paid-in-capital in the Consolidated Balance Sheets.

U.S. GAAP requires a two-step approach to recognizing and measuring uncertain tax positions. 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 cumulatively more than 50% likely to be realized upon ultimate settlement.

As of June 30, 2013 the Company’s liability for unrecognized tax benefits was $2.7 million. The Company recognized a $18.0 million increase to the liability for unrecognized tax benefits due to uncertainty regarding a change in tax depreciation methodology adopted in the first quarter of fiscal 2014. In addition there was a $2.3 million decrease to the amount of unrecognized tax benefits following the settlement of prior year tax audits and statute expirations. As a result, the total liability for unrecognized tax benefits as of June 29, 2014 was $18.4 million. If any portion of this $18.4 million is recognized, the Company will then include that portion in the computation of its effective tax rate. Although the ultimate timing of the resolution and/or closure of audits is highly uncertain, the Company believes it is reasonably possible that approximately $0.2 million of gross unrecognized tax benefits will change in the next 12 months as a result of pending audit settlements or statute requirements.

The following is a tabular reconciliation of the Company’s change in uncertain tax positions (in thousands):



	Fiscal Years Ended
	June 29, 2014			June 30, 2013			June 24, 2012
Balance at beginning of period		$2,732			$4,421			$6,987
Increases related to prior year tax positions	18,040			546			—
Decreases related to prior year tax positions	(741		)	—			(1,966		)
Expiration of statute of limitations for assessment of taxes	(1,642		)	(2,235		)	(600		)
Balance at end of period		$18,389			$2,732			$4,421

The Company’s policy is to include interest and penalties related to unrecognized tax benefits within the Income tax expense line item in the Consolidated Statements of Income. Total interest and penalties accrued were as follows (in thousands):



	June 29, 2014		June 30, 2013
Accrued interest and penalties		$104		$154

Total interest and penalties recognized were as follows (in thousands):



	Fiscal Years Ended
	June 29, 2014			June 30, 2013			June 24, 2012
Recognized interest and penalties (benefit)		($51	)		($130	)		($292	)

The Company files U.S. federal, U.S. state and foreign tax returns. For U.S. federal purposes, the Company is generally no longer subject to tax examinations for fiscal years prior to 2011. For U.S. state tax returns, the Company is generally no longer subject to tax examinations for fiscal years prior to 2010. For foreign purposes, the Company is generally no longer subject to examination for tax periods 2004 and prior. Certain carryforward tax attributes generated in prior years remain subject to examination and adjustment. During the first quarter of fiscal 2014, the Company received a final assessment of $0.3 million from the Hong Kong Inland Revenue Department, representing closure of the audit for fiscal 2008 through fiscal 2010. The assessment was fully offset by a decrease to the amount of unrecognized tax benefits. During the third quarter of fiscal 2014, the Company settled its examination with the German Federal Central Tax Office for fiscal 2008 through fiscal 2010, resulting in an immaterial amount of additional tax expense.

The Company provides for U.S. income taxes on the earnings of foreign subsidiaries unless the subsidiaries’ earnings are considered indefinitely reinvested outside the United States. As of June 29, 2014, U.S. income taxes were not provided for on a cumulative total of approximately $320.8 million of undistributed earnings for certain non-U.S. subsidiaries, as the Company currently intends to reinvest these earnings in these foreign operations indefinitely. If, at a later date, these earnings were repatriated to the U.S., the Company would be required to pay taxes on these amounts. Determination of the amount of any deferred tax liability on these undistributed earnings is not practicable.

During the fiscal year ended June 26, 2011, the Company was awarded a tax holiday in Malaysia with respect to its manufacturing and distribution operations. This arrangement allows for 0% tax for 10 years starting in the fiscal year ended June 26, 2011. For the fiscal years ended June 30, 2013 and June 29, 2014, the Company did not meet the requirements for the tax holiday, and as such, no benefit has been recognized. In the fiscal year ended June 24, 2012 the Company’s net income increased by $2.1 million ($0.02 per basic share and $0.02 per diluted share), as a result of this arrangement.