. INCOME TAXES

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

	2016			2015		2014
Domestic operations	$	(17,541	)	$	8,118	$	5,793
Foreign operations		(2,834	)		1,824		6,264
	$	(20,375	)	$	9,942	$	12,057

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

	2016			2015			2014
Current:
Federal	$	(317	)	$	1,744		$	155
Foreign		866			1,855			3,284
State		94			114			86
Deferred:
Federal		(6,092	)		670			2,175
Foreign		47			(71	)		(426	)
State		(843	)		386			71
	$	(6,245	)	$	4,698		$	5,345

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

	2016			2015			2014
Expected tax expense	$	(6,928	)	$	3,380		$	4,099
State taxes, net of federal effect		(740	)		378			269
Foreign taxes, net of federal credits		278			235			123
Change in valuation allowance		196			(51	)		(428	)
Tax reserve adjustments		250			361			465
Return to provision and other adjustments		(167	)		(332	)		(265	)
Losses not benefited		885			701			350
Tax rate change applied to deferred tax balances		-			-			278
Other permanent items		(19	)		26			454
Actual tax expense (benefit)	$	(6,245	)	$	4,698		$	5,345

Significant changes in tax expense reconciliation in the year ended June 30, 2016 relate primarily to losses in both domestic and foreign entities. Substantial benefit is reflected for US federal and state income taxes primarily as a result of increases in deferred tax assets related to pension expense and the write-down of fixed assets. In fiscal 2016, several of the subsidiaries in foreign countries reported financial losses. In these cases, no tax benefit from those losses was recognized and an additional valuation allowance was taken to reduce any deferred tax assets since future income is not more likely than not to be recognized.

The tax rate in fiscal 2015 was higher than in the previous year 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.

In fiscal 2014, the tax authorities in China reviewed the intercompany transfer pricing of a 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 in fiscal 2014

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.

Total deferred tax assets net of deferred tax liabilities at June 30, 2016 are $29.6 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 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 and 2015; b) losses in fiscal 2016 are primarily due to one-time events including a $19 million pension expense, most of which is not deductible for tax purposes until paid; c) cost saving plans are being implemented by the Company; d) prior year taxable income is available for carryback losses; e) tax planning opportunities, including an election to revoke the LIFO election; and f) forecasted domestic profits for future years. The negative evidence considered is that fiscal 2016 showed domestic book and tax losses

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 U.S. 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 2016, the valuation allowance increased by $0.7 million primarily due to the increase for foreign losses. 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.

Deferred income taxes at June 30, 2016 and 2015 are attributable to the following (in thousands):

	2016			2015
Deferred tax assets (current):
Inventories	$	2,888		$	2,597
Employee benefits (other than pension)		988			1,016
Book reserves		1,347			818
Other		308			687
Total current deferred tax assets		5,531			5,118
Valuation allowance		(1,013	)		(564	)
Current deferred tax asset	$	4,518		$	4,554

Deferred tax assets (long-term):

State NOL, various carryforward periods	$	975		$	801
Foreign NOL, various carryforward periods		1,738			1,908
Foreign tax credit carryforward, expiring 2017 – 2026		2,638			2,405
Pension benefits		19,573			13,224
Retiree medical benefits		2,790			2,499
Depreciation		286			-
Intangibles		1,243			1,713
Other		274			190
Total long-term deferred tax assets		29,517			22,740
Valuation allowance		(4,233	)		(3,937	)
Long-term deferred tax asset	$	25,284		$	18,803


Deferred tax liabilities (long-term):
Depreciation		(187	)		(1,548	)
Long-term deferred tax liabilities		(187	)		(1,548	)
Net deferred tax assets	$	29,615		$	21,809

Foreign operations deferred tax assets relate primarily to inventory (current) and pension benefits (long term). Amounts related to foreign operations included in the long-term portion of deferred tax 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, 2013	$	(10,978	)
Increases for tax positions taken in prior years		(204	)
Increases for tax positions taken during the current period		(259	)
Effect of exchange rate changes		(9	)
Decrease relating to settlement		241
Balance at June 30, 2014		(11,209	)
Increases for tax positions taken during the current period		(405	)
Effect of exchange rate changes		440
Decrease relating to lapse of applicable statute of limitations		42
Balance at June 30, 2015		(11,132	)
Increases for tax positions taken during the current period		(184	)
Effect of exchange rate changes		82
Decrease relating to lapse of applicable statute of limitations		414
Balance at June 30, 2016	$	(10,820	)

The long-term tax obligations as of June 30, 2016 and 2015 relate primarily to transfer pricing adjustments. The Company has also recorded a non-current tax receivable for $2.7 million and $3.4

million at June 30, 2016 and 2015, respectively, representing the corollary effect of transfer pricing competent authority adjustments.

The Company has identified no new uncertain tax positions at June 30, 2016 for which it is currently likely that the total amount of unrecognized tax benefits will significantly increase or decrease within the next twelve months. The Company recognizes interest and penalties related to income tax matters in income tax expense and has booked an increase of $0.1 million in fiscal 2016 for interest expense.

The Company’s U.S. federal tax returns for years prior to fiscal 2013 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, 2016, 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 2011 through 2015.

The state tax loss carryforwards tax effected benefit of $1.0 million expires at various times over the next 2 to 20 years. The foreign tax credit carryforward of $2.6 million expires in the years 2017 through 2026 and has a full valuation allowance against it.

At June 30, 2016, the estimated amount of total unremitted earnings of foreign subsidiaries is $67.0 million. The Company received a cash dividend from a foreign subsidiary of $2.3 million in fiscal 2015 out of earnings for that year. The Company has no plans to repatriate 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.