Note 9 – Income taxes

The components of income before income taxes are as follows:



(In thousands)		Years Ended December 31,
		2012		2011		2010
Domestic	$	24,100	$	6,488	$	31,801
Foreign		90,737		104,646		96,311
	$	114,837	$	111,134	$	128,112

The provision for income taxes charged to operations is as follows:



(In thousands)		Years Ended December 31,
		2012		2011		2010
Current tax expense:
U.S. federal	$	24,538	$	19,381	$	14,605
State		1,217		1,180		779
Foreign		10,544		8,568		3,752
Total current	$	36,299	$	29,129	$	19,136
Deferred tax expense (benefit):
U.S. federal	$	(10,305)	$	(12,790)	$	1,545
State		53		(234)		(39)
Foreign		(1,347)		957		(1,646)
Total deferred	$	(11,599)	$	(12,067)	$	(140)
Change in valuation allowance		-		-		-
Total provision	$	24,700	$	17,062	$	18,996

Deferred tax liabilities (assets) at December 31, 2012 and 2011 as follows:



(In thousands)		December 31,
		2012		2011
Capitalized software	$	7,432	$	7,933
Depreciation and amortization		15,404		16,910
Intangible assets		9,920		-
Unrealized gain on derivative instruments		709		105
Undistributed earnings of foreign subsidiaries		8,437		9,024
Gross deferred tax liabilties		41,902		33,972
Operating loss carryforwards		(86,285)		(61,148)
Intangible assets		-		(10,800)
Vacation and other accruals		(5,895)		(6,432)
Inventory valuation and warranty provisions		(11,773)		(10,724)
Doubtful accounts and sales provisions		(1,229)		(1,084)
Unrealized exchange loss		(1,664)		(33)
Deferred revenue		(3,987)		(1,991)
Accrued rent expenses		(219)		(132)
GSA accrual		-		(4,831)
10% minority stock investment		(932)		(915)
Stock-based compensation		(5,471)		(4,640)
Research and development tax credit carryforward		(2,421)		(4,562)
Foreign tax credit carryforward		-		(1,006)
Other		(561)		(518)
Gross deferred tax assets		(120,437)		(108,816)
Valuation allowance		91,649		79,864
Net deferred tax liability	$	13,114	$	5,020

A reconciliation of income taxes at the U.S. federal statutory income tax rate to our effective tax rate follows:



	Years Ended December 31,
	2012		2011		2010
U.S. federal statutory rate	35	%	35	%	35	%
Foreign taxes (less) than federal statutory rate	(5)		(7)		(9)
Research and development tax credits	-		(3)		(3)
Enhanced deduction for certain research and development expenses	(15)		(16)		(10)
State income taxes, net of federal tax benefit	1		1		1
Employee share-based compensation	2		1		-
Intercompany profit	2		3		1
Nondeductible acquisition costs	2		-		-
Other	-		1		-
Effective tax rate	22	%	15	%	15	%

As of December 31, 2012, we had a federal net operating loss carryforward of $4.2 million which expires in the year 2030, and federal tax credit carryforwards of $2.4 million which can be carried forward and expires during the years 2019 to 2030. These carryforwards are subject to limitations following a change in ownership.

As of December 31, 2012, 15 of our subsidiaries had available, for income tax purposes, foreign net operating loss carryforwards of an aggregate of approximately $445 million, of which $7.9 million expires during the years 2017 to 2022 and $437 million of which may be carried forward indefinitely. Our tax valuation allowance relates primarily to our ability to realize certain of these foreign net operating loss carryforwards and benefits of tax deductible goodwill in excess of book goodwill.

In 2003, we restructured the organization of our manufacturing operation in Hungary. The tax deductible goodwill in excess of book goodwill created by this restructuring resulted in our being required to record a gross deferred tax asset of $91 million. Because we did not expect to have sufficient taxable income in the relevant jurisdiction in future periods to realize the benefit of this deferred tax asset, a full valuation allowance was established. Following the approval of the merger of our Hungarian manufacturing operation with its Hungarian parent company in December 2007, we released $9.7 million, $8.7 million and $18.3 million in 2009, 2008 and 2007, respectively, of the valuation allowance previously established for the excess tax deductible goodwill to reflect the tax benefit we expected to realize in future periods.

Effective January 1, 2010, a new tax law in Hungary provided for an enhanced deduction for the qualified research and development expenses of NI Hungary Software and Hardware Manufacturing Kft. (“NI Hungary”). During the three months ended December 31, 2009, we obtained confirmation of the application of this new tax law for the qualified research and development expenses of NI Hungary. Based on the application of this new tax law to the qualified research and development expense of NI Hungary, we no longer expect to have sufficient future taxable income in Hungary to realize the benefits of these tax assets. As such, we recorded an income tax charge of $21.6 million during the three months ended December 31, 2009, $18.4 million of which was related to a valuation allowance on the previously recognized assets created by the restructuring and $3.2 million of which was related to tax benefits from other assets that we will no longer be able to realize as a result of this change. We do not expect to realize the tax benefit of the remaining assets created by the restructuring and therefore we had a full valuation allowance against those assets at December 31, 2012.

We have not provided for U.S. federal income and foreign withholding taxes on approximately $568 million of certain non-U.S. subsidiaries’ undistributed earnings as of December 31, 2012. These earnings would become subject to taxes of approximately $188 million, if they were actually or deemed to be remitted to the parent company as dividends or if we should sell our stock in these subsidiaries. We intend to permanently reinvest the undistributed earnings.

We account for uncertainty in income taxes recognized in our financial statements using prescribed recognition thresholds and measurement attributes for financial statement disclosure of tax positions taken or expected to be taken on our tax returns. We recognized no material adjustment to the liability for unrecognized income tax benefits. A reconciliation of the beginning and ending amount of unrecognized tax benefit is as follows:



(In thousands)		2012		2011
Balance at beginning of period	$	19,494	$	14,953
Additions based on tax positions related to the current year		3,150		6,300
Additions for tax positions of prior years		1,764		1,908
Reductions as a result of settlement with taxing authorities		(285)		-
Reductions as a result the lapse of the applicable statute of limitations		(2,256)		(3,667)
Reduction for tax positions of prior years		(947)		-
Balance at end of period	$	20,920	$	19,494

All of our unrecognized tax benefits at December 31, 2012 would affect our effective income tax rate if recognized.

We recognize interest and penalties related to income tax matters in income tax expense. During the years ended December 31, 2012 and 2011, we recognized interest expense related to uncertain tax positions of approximately $782,000 and $627,000, respectively.

The tax years 2005 through 2012 remain open to examination by the major taxing jurisdictions in which we file income tax returns. The Internal Revenue Service commenced an examination of our US income tax return for 2008 in the fourth quarter of 2012 as a result of a refund claim filed for that year. The IRS has not proposed any adjustments as of December 31, 2012. As the statute of limitations has expired for 2008 and any assessment would be limited to the amount of the refund claim, we do not anticipate any potential adjustment would result in a material change to our financial position.