Note 11 - Income Tax

12 Months Ended

Jun. 30, 2014

Income Tax Disclosure [Abstract]

Income Tax Disclosure [Text Block]

11. INCOME TAXES

Components of earnings (loss) before income taxes are as follows (in thousands):

	2014		2013			2012
Domestic operations	$	5,793	$	(2,633	)	$	(14,614	)
Foreign operations		6,264		3,429			14,725
	$	12,057	$	796		$	111

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

	2014			2013			2012
Current:
Federal	$	155		$	124		$	(392	)
Foreign		3,284			1,243			4,239
State		86			(48	)		455
Deferred:
Federal		2,175			(1,472	)		(5,195	)
Foreign		(426	)		503			656
State		71			608			(540	)
	$	5,345		$	958		$	(777	)

Reconciliations of expected tax expense at the U.S. statutory rate to actual tax expense (benefit) are as follows (in thousands):

	2014			2013			2012
Expected tax expense	$	4,099		$	271		$	38
State taxes, net of federal effect		269			26			(170	)
Foreign taxes, net of federal credits		123			353			(751	)
Change in valuation allowance		(428	)		(127	)		(201	)
Tax reserve adjustments		465			141			(286	)
Return to provision adjustments		(265	)		(764	)		-
Losses not benefited		350			370			206
Dividend from subsidiary (net of foreign tax credit)		-			201			-
Tax rate change applied to deferred tax balances		278			880			-
Other permanent items		454			(393	)		387
Actual tax expense (benefit)	$	5,345		$	958		$	(777	)

Significant changes in tax expense reconciliation in the year ended June 30, 2014 relate to the following items which are described more fully below: Additional reserves related to the settlement of an audit in China; change in the valuation allowance related to operations in China; an additional tax rate change enacted in the U.K. and return to provision adjustments. Information related to similar items in fiscal 2013 is reflected below. Similar items for the year ended June 30, 2012 were not significant and continue to be classified in the preceding table as components of other permanent items.

In fiscal 2014, the tax authorities in China reviewed the intercompany transfer pricing of Chinese subsidiary and made adjustments to the prices for tax purposes to the calendar years 2010 through 2012. The net result was a substantial reduction in the Company’s carryforward tax losses and a small payment of tax and penalties; the net effect is to increase tax expense by $204,000 which is included in the tax reserve adjustments. Since the Company had a history of tax losses, there was a full valuation allowance reflected against the tax impact of the loss carryforward at June 30, 2013. The entity also had substantial profits in fiscal 2014. As a result, the full amount of its carryforward tax losses, after audit adjustments, were utilized and the valuation allowance reducing the deferred tax assets for those losses and other temporary differences was released. The effect was a reduction in the valuation allowance of $428,000.

The Company recorded a $278,000 deferred income tax expense in the year ended June 30, 2014 to reflect the impact of a corporate tax rate reduction in the United Kingdom. The tax rate reduction from 23 percent to 20 percent received royal assent during fiscal 2014 and the impact of that reduction on our deferred tax assets was recorded in the first quarter of the year.

A return to provision adjustment reducing tax expense by $265,000 was booked in fiscal 2014. The amount relates primarily to a revision of the estimated deduction on the U.S. tax return filed for fiscal 2013 for losses on the intercompany receivable from and investment in the Dominican Republic subsidiary which has ceased operations.

No benefit is reflected for losses in subsidiaries outside the U.S. which do not have the ability to carry the losses back for a tax refund and which do not have sufficient positive evidence supporting that the losses will be more likely than not to be used to reduce future taxes.

Significant changes in the tax expense reconciliation in the year ended June 30, 2013 relate to the following items which are described more fully below:  Return to provision adjustments primarily in the U.S. for foreign tax credits, research credits and state taxes; the tax impact of a dividend from a foreign subsidiary and a change in the effective state tax rate in the U.S. and a legislated change in the tax rate in the U.K. applied to deferred tax balances.

For the year ended June 30, 2013 the Company reported an income tax benefit of $764,000 related to differences between the Company’s tax returns filed in fiscal 2013 for earlier periods and the corresponding original estimates used for financial statement purposes. This benefit was primarily driven by the following four significant return to provision adjustments:

a. $350,000 reduction to tax expense related to foreign tax returns primarily related to our estimates of required Brazilian statutory transfer pricing adjustments compared to actual amounts imposed by the Brazilian government.

b. $162,000 reduction to U.S. tax expense primarily related to changes in U.S. state taxes from the 2012 estimate to the amounts reflected on the actual state tax returns filed.

c. $160,000 reduction to tax expense related to Company’s decision to claim foreign tax credits for foreign taxes deducted in the fiscal 2012 provision and on selected tax returns for earlier years. The reduction in tax expense is the net benefit after considering the Company’s corresponding valuation allowance on portions of its foreign tax credit carryforward.

d. $92,000 reduction to tax expense related to the Company’s decision to elect to use the Simplified Alternative Method of calculating the federal tax credit for research expenses on its 2012 tax return.

The Company also recorded $880,000 of deferred income tax expense in the year ended June 30, 2013 to reflect the year over year change in the tax rates the Company applies to our deferred tax balances. Of this amount, $782,000 is attributable to a decrease in the Company’s state effective tax rate due to changes in state tax rates and apportionment of profits in the jurisdictions the Company operates in. The remaining $98,000 of deferred tax expense relates to a corporate tax rate reduction in the United Kingdom, which received royal assent during fiscal 2013. An additional $278,000 deferred tax expense in fiscal 2014 relates to the U.K. corporate tax rate reduction from 23 percent to 20 percent which received royal assent in July 2013.

Total deferred tax assets net of deferred tax liabilities at June 30, 2014 are $28,342,000. While these deferred tax assets reflect the tax effect of temporary differences between book and taxable income in all jurisdictions in which the Company has operations, the majority of the assets relate to operations in the U.S. where the Company has had book losses in recent years prior to the current year. The Company has considered the positive and negative evidence to determine the need for a valuation allowance offsetting the deferred tax assets in the U.S. and has concluded that it is more likely than not that the deferred tax assets net of the recorded valuation allowance will be realized.

Key positive evidence considered include: a) Significant domestic book profits in 2014; b) losses in prior recent years are primarily due to the recession and one-time events including a $16 million pension expense in fiscal 2012; c) cost saving plans have been implemented by the Company; d) earnings of a newly acquired company have created additional domestic income; e) the Company has had more domestic taxable income than losses in the last three years; and f) the U.S. federal tax loss carryforward does not start to expire until fiscal year 2029. The negative evidence considered include: a) before the current year, the 5 most recent years have shown domestic book losses; and b) fiscal 2013 reflects both a book loss and a tax loss.

In order to fully utilize the U.S. federal NOL, the Company will need to generate $18 million of U.S. taxable income. While the book losses in prior years are a significant negative factor, the fact that the Company had book and tax profits in 2014, has reduced its federal tax loss carryforward over the last three years and has implemented cost saving measures which will benefit future periods, all of which can be objectively verified, overcome the negative evidence. Thus, the Company believes it is more likely than not that the domestic deferred tax assets will be realized with the exception of certain items described below.

A valuation allowance has been provided on certain state NOLs as a result of their much shorter carryforward periods and the uncertainty of generating adequate taxable income at the entity and state level.   Similarly, a valuation allowance has been provided on certain foreign NOLs due to the uncertainty of generating future taxable income in those jurisdictions. In addition, a valuation allowance has been provided for foreign tax credit carryforwards due to the uncertainty of generating sufficient foreign source income in the future. In fiscal 2014, the allowance decreased by $1.2 million primarily related to operations in China where the Company had sufficient profit in fiscal 2014 to fully utilize its tax loss carryforward and to the portion of foreign tax credits which expired in 2014. The need for a valuation allowance is reevaluated as facts and assumptions change over time.

Deferred income taxes at June 30, 2014 and 2013 are attributable to the following (in thousands):

	2014			2013
Deferred tax assets (current):
Inventories	$	3,596		$	2,954
Employee benefits (other than pension)		1,331			827
Book reserves		1,244			1,435
Other		385			313
Total current deferred tax assets		6,556			5,529
Valuation allowance		(415	)		(551	)
Current deferred tax asset	$	6,141		$	4,978
Deferred tax assets (long-term):
Federal NOL, carried forward	$	6,150		$	6,715
State NOL, various carryforward periods		1,181			1,178
Foreign NOL, various carryforward periods		1,042			1,574
Foreign tax credit carryforward, expiring 2017 – 2023		3,754			4,398
Pension benefits		10,098			10,889
Retiree medical benefits		2,218			4,144
Intangibles		2,178			2,643
Other		506			721
Total long-term deferred tax assets		27,127			32,262
Valuation allowance		(2,889	)		(3,988	)
Long-term deferred tax asset	$	24,238		$	28,274
Deferred tax liabilities (long-term):
Depreciation		(2,037	)		(2,182	)
Long-term deferred tax liabilities		(2,037	)		(2,182	)
Net deferred tax assets	$	28,342		$	31,070

As of June 30, 2014 and 2013, the net long-term deferred tax asset and deferred tax liabilities on the balance sheet are as follows (in thousands):

	2014			2013
Long-term assets	$	24,238		$	28,274
Long-term liabilities		(2,037	)		(2,182	)
	$	22,201		$	26,092

Foreign operations deferred assets relate primarily to inventory and book reserves (current) and pension benefits (long term).  Amounts related to foreign operations included in the long-term portion of deferred liabilities relate to depreciation.

The Company is subject to U.S. federal income tax and various state, local and foreign income taxes in numerous jurisdictions. The Company’s domestic and international tax liabilities are subject to the allocation of revenues and expenses in different jurisdictions and the timing of recognizing revenues and expenses. Additionally, the amount of income taxes paid is subject to the Company’s interpretation of applicable tax laws in the jurisdictions in which it files.

Reconciliations of the beginning and ending amount of unrecognized tax benefits are as follows (in thousands):

Balance at June 30, 2011	$	(11,127	)
Increases for tax positions taken during a prior period		(32	)
Increases for tax positions taken during the current period		(955	)
Effect of exchange rate changes		473
Decrease relating to settlement		137
Decreases resulting from the expiration of the statute of limitations		914
Balance at June 30, 2012		(10,590	)
Increases for tax positions taken during a prior period		(212	)
Increases for tax positions taken during the current period		(381	)
Effect of exchange rate changes		140
Decrease relating to settlement		32
Balance at June 30, 2013		(11,011	)
Increases for tax positions taken in prior years		(204	)
Increases for tax positions taken during the current period		(268	)
Effect of exchange rate changes		(9	)
Decrease relating to settlement		241
Balance at June 30, 2014	$	(11,251	)

The long-term tax obligations on the balance sheet as of June 30, 2014 and 2013 relate primarily to transfer pricing adjustments.  The Company has also recorded a non-current tax receivable for $3.8 million at June 30, 2014 and 2013, representing the corollary effect of transfer pricing competent authority adjustments.

During the next 12 months, the Company does not expect there will be a significant change in the total amount of unrecognized tax benefits. The Company recognizes interest and penalties related to income tax matters in income tax expense.

The Company’s U.S. federal tax returns for years prior to fiscal 2011 are no longer subject to U.S. federal examination by the Internal Revenue Service; however, tax losses carried forward from earlier years are still subject to review and adjustment. In fiscal 2014, the tax authorities in China audited the transfer pricing of Starrett’s subsidiary in that country for calendar years 2010 through 2012. Adjustments reduced the tax loss carryforward and required a tax and penalty payment for calendar 2011. As of June 30, 2014, the Company has resolved all open income tax audits. In international jurisdictions: Argentina, Australia, Brazil, Canada, China, Germany, Japan, Mexico, New Zealand, Singapore and the United Kingdom, the years that may be examined vary by country. The Company’s most significant foreign subsidiary in Brazil is subject to audit for the calendar years 2009 through 2013.   

The federal NOL carryforward of $18 million expires beginning in 2029. The state tax loss carryforwards tax effected benefit of $1.2 million expires at various times over the next 1 to 20 years. The foreign tax credit carryforward of $3.8 million expires in the years 2017 through 2024.

At June 30, 2014, the estimated amount of total unremitted earnings of foreign subsidiaries is $71 million. The Company received a cash dividend from a foreign subsidiary for $2.4 million in fiscal 2013. The Company has no plans to repatriate additional prior year earnings of its foreign subsidiaries and, accordingly, no estimate of the unrecognized deferred taxes related to these earnings has been made. Cash held in foreign subsidiaries is not available for use in the U.S. without the incurrence of U.S. federal and state income tax consequences.