. INCOME TAXES

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

	2015		2014		2013
Domestic operations	$	8,118	$	5,793	$	(2,633	)
Foreign operations		1,824		6,264		3,429
	$	9,942	$	12,057	$	796

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

	2015			2014			2013
Current:
Federal	$	1,744		$	155		$	124
Foreign		1,855			3,284			1,243
State		114			86			(48	)
Deferred:
Federal		670			2,175			(1,472	)
Foreign		(71	)		(426	)		503
State		386			71			608
	$	4,698		$	5,345		$	958

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

	2015			2014			2013
Expected tax expense	$	3,380		$	4,099		$	271
State taxes, net of federal effect		378			269			26
Foreign taxes, net of federal credits		235			123			353
Change in valuation allowance		(51	)		(428	)		(127	)
Tax reserve adjustments		361			465			141
Return to provision and other adjustments		(332	)		(265	)		(764	)
Losses not benefited		701			350			370
Dividend from subsidiary (net of foreign tax credit)		1			-			201
Tax rate change applied to deferred tax balances		-			278			880
Other permanent items		25			454			(393	)
Actual tax expense (benefit)	$	4,698		$	5,345		$	958

Significant changes in tax expense reconciliation in the year ended June 30, 2015 relate primarily to losses in foreign subsidiaries. In fiscal 2015, several of the subsidiaries in foreign countries reported financial losses. In most cases, no tax benefit from those losses was recognized since future income is not more likely than not to be recognized. Tax expense in fiscal 2015 was higher than previous years both because the losses that were not able to be benefitted for tax purposes were significantly higher and because the Company received no benefit from the lower statutory tax rate in those countries. There was a dividend of $2.3 million paid from the Company’s subsidiary in Brazil to the U.S. parent company out of the subsidiary’s fiscal 2015 earnings. While the dividend is fully taxable in the U.S., the impact to tax expense was negligible due to the use of foreign tax credits. Also, there were adjustments made to deferred tax assets due to provision to return adjustments and deferred tax balance adjustments of $0.3 million.

In the year ended June 30, 2014, the changes in the tax provision related to the following items, including 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.

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 was to increase tax expense by $

0.2 million 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 $0.4 million

The Company recorded a $0.3 million 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 that year.

A return to provision adjustment reducing tax expense by $0.3 million 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 had ceased operations in a previous year.

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:

For the year ended June 30, 2013 the Company reported an income tax benefit of $0.8 million 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.	$0.3 million 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.	$0.2 million 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.

$0.2 million 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.	$0.1 million 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 $0.9 million 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, $0.8 million 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 $0.1 million of deferred tax expense relates to a corporate tax rate reduction in the United Kingdom, which received royal assent during fiscal 2013.

Total deferred tax assets net of deferred tax liabilities at June 30, 2015 are $21.8 million. 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 had book losses in several recent years prior to fiscal 2014. 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 and 2015; 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 company acquired in fiscal 2012 have created additional domestic income; and e) the Company has had more domestic taxable income than losses in the last four years; The negative evidence considered include: a) before fiscal 2014, the 5 most recent years showed domestic book losses; and b) fiscal 2013 reflects both a book loss and a tax loss.

A valuation allowance has been provided on certain foreign NOLs due to the uncertainty of generating future taxable income in those jurisdictions. Similarly, 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. 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 2015, the valuation allowance increased by $1.2 million - $0.7 million due to the increase in foreign carryforward losses and $0.5 million due to the increase in foreign tax credits in excess of the foreign source income limitation in fiscal 2015. 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.

Accounting Standards Update 2013-11 was approved by the FASB in July 2013 and requires that companies report their tax reserves net of the impact of tax loss and credit carryforwards by its year beginning after December 15, 2013. The Company has implemented this pronouncement in Q1, fiscal 2015 with retrospective application as permitted by the standard; amounts presented for prior periods have been reclassified to conform. There is no effect to tax expense; on the balance sheet, there is a reduction in Deferred Tax Assets of $6.6 million and a reduction in Other Tax Obligations of $6.6 million on the June 30, 2015 Consolidated Balance Sheet and $7.8 million reduction in each of those accounts as of June 30, 2014.

Deferred income taxes at June 30, 2015 and 2014 are attributable to the following (in thousands):

	2015			2014
Deferred tax assets (current):
Inventories	$	2,597		$	3,596
Employee benefits (other than pension)		1,016			1,331
Book reserves		818			1,244
Other		687			385
Total current deferred tax assets		5,118			6,556
Valuation allowance		(564	)		(519	)
Current deferred tax asset	$	4,554		$	6,037

Deferred tax assets (long-term):

State NOL, various carryforward periods		801			1,181
Foreign NOL, various carryforward periods		1,908			1,042
Foreign tax credit carryforward, expiring 2017 – 2025		2,405			2,480
Pension benefits		13,224			10,098
Retiree medical benefits		2,499			2,218
Intangibles		1,713			2,178
Other		190			155
Total long-term deferred tax assets		22,740			19,352
Valuation allowance		(3,937	)		(2,815	)
Long-term deferred tax asset	$	18,803		$	16,537


Deferred tax liabilities (long-term):
Depreciation		(1,548	)		(2,037	)
Long-term deferred tax liabilities		(1,548	)		(2,037	)
Net deferred tax assets	$	21,809		$	20,537

As of June 30, 2015 and 2014, the net long-term deferred tax asset and deferred tax liabilities on the balance sheet are as follows (in thousands):

	2015			2014
Long-term assets	$	18,803		$	16,537
Long-term liabilities		(1,548	)		(2,037	)
	$	17,255		$	14,500

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, 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	)
Increases for tax positions taken during the current period		(423	)
Effect of exchange rate changes		440
Decrease relating to lapse of applicable statute of limitations		42
Balance at June 30, 2015	$	(11,192	)

The long-term tax obligations on the balance sheet as of June 30, 2015 and 2014 relate primarily to transfer pricing adjustments. The Company has also recorded a non-current tax receivable for $3.4 million and $3.8

million at June 30, 2015 and 2014, respectively, representing the corollary effect of transfer pricing competent authority adjustments.

During the next 12 months, it is possible that the Company will recognize a reduction of $0.4 million in its long term tax obligations due to the lapse of the applicable statute of limitations. 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 2012 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, 2015, the Company has resolved all open income tax audits. In international jurisdictions: 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 2010 through 2014.

The state tax loss carryforwards tax effected benefit of $0.8 million expires at various times over the next 4 to 19 years. The foreign tax credit carryforward of $2.4 million expires in the years 2017 through 2025.

At June 30, 2015, the estimated amount of total unremitted earnings of foreign subsidiaries is $70 million. The Company received a cash dividend from a foreign subsidiary from current year earnings of $2.3 million in fiscal 2015. 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 likely incurrence of U.S. federal and state income tax consequences.