Note 6 – Income Taxes

The United States enacted significant tax reform into law on December 22, 2017. U.S. Tax Reform made complex and broad changes to the U.S. tax laws that affect our fiscal year 2018 in two primary ways.

First, effective as of January 1, 2018, U.S. Tax Reform reduces the U.S. federal corporate income tax rate from 35 percent to 21 percent. Since the Company’s fiscal year ends in August, Lindsay has a blended U.S. federal statutory income tax rate for fiscal year 2018 of 25.7% (four months at 35% and eight months at 21%). The U.S. federal statutory income tax rate is expected to be 21 percent for fiscal year 2019 and future years.

As a result of the enactment of a lower U.S. statutory corporate income tax rate, the Company remeasured U.S. deferred income tax assets and liabilities based on the rates at which they are expected to reverse in the future. The Company recorded a $0.8 million expense related to this required remeasurement.

Second, U.S. Tax Reform requires companies to pay a one-time deemed repatriation tax on certain undistributed earnings of foreign subsidiaries. The Company recorded a $1.7 million provisional expense for the deemed repatriation tax.

U.S. Tax Reform also established new income tax provisions that will affect the Company’s fiscal year 2019, including, but not limited to, eliminating the U.S. manufacturing deduction, and establishing a new minimum tax on global intangible low-taxed income (“GILTI”). The Company is allowed to make an accounting policy election to either treat the GILTI tax as a period expense or to provide U.S. deferred income taxes on certain foreign differences between the financial statement and tax basis of foreign assets and liabilities. An analysis of the new GILTI rules and how they may impact the Company is incomplete. Accordingly, no policy election has been made regarding the treatment of the GILTI tax. Further, we did not record a deferred tax liability for these differences.

The U.S. Securities and Exchange Commission issued SAB 118, which provides guidance on accounting for the tax effects of U.S. Tax Reform. SAB 118 provides a measurement period that should not extend beyond one year from the U.S. Tax Reform enactment date for companies to complete the accounting under ASC 740. In accordance with SAB 118, a company must reflect the income tax effects of those aspects of U.S. Tax Reform for which the accounting under ASC 740 is complete. To the extent that a company’s accounting for certain income tax effects of U.S. Tax Reform is incomplete but it can determine a reasonable estimate, it must record a provisional estimate in the financial statements. If a company cannot determine a provisional estimate to be included in the financial statements, it should continue to apply ASC 740 on the basis of the provisions of the tax laws that were in effect immediately before U.S. Tax Reform. The deemed repatriation tax expense is provisional, and may be adjusted during the following fiscal year within the measurement period, as a result of continuing analysis of U.S. Tax Reform, which may include additional implementation guidance from the IRS, state tax authorities, the SEC, the FASB, or the Joint Committee on Taxation, and updated information from foreign affiliates.

For financial reporting purposes earnings (losses) before income taxes include the following components:

	For the years ended August 31,
($ in thousands)	2018		2017		2016
United States	$	25,116	$	21,969	$	17,805
Foreign		8,737		13,746		11,483
	$	33,853	$	35,715	$	29,288

Significant components of the income tax provision are as follows:

	For the years ended August 31,
($ in thousands)	2018			2017			2016
Current:
Federal	$	9,313		$	7,873		$	10,570
State		1,047			781			976
Foreign		3,266			4,785			3,230
Total current		13,626			13,439			14,776
Deferred:
Federal		517			(688	)		(5,456	)
State		(47	)		(43	)		(268	)
Foreign		(520	)		(172	)		(31	)
Total deferred		(50	)		(903	)		(5,755	)
Total income tax provision	$	13,576		$	12,536		$	9,021

Total income tax provision resulted in effective tax rates differing from that of the statutory United States federal income tax rates. The reasons for these differences are:

	For the years ended August 31,
($ in thousands)	2018						2017						2016
	Amount			%			Amount			%			Amount			%
U.S. statutory rate	$	8,700			25.7		$	12,500			35.0		$	10,251			35.0
State and local taxes, net of federal tax benefit		743			2.2			480			1.3			350			1.2
Foreign tax rate differences		809			2.4			(486	)		(1.4	)		(195	)		(0.7	)
U.S. tax reform		2,496			7.4			—			—			—			—
Deferred tax asset valuation allowance		758			2.2			(21	)		—			(124	)		(0.4	)
Domestic production activities deduction		(727	)		(2.1	)		(700	)		(2.0	)		(960	)		(3.3	)
Other		797			2.3			763			2.2			(301	)		(1.0	)
Effective rate	$	13,576			40.1		$	12,536			35.1		$	9,021			30.8

Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of the Company’s deferred tax assets and liabilities are as follows:

	August 31,
($ in thousands)	2018			2017
Deferred tax assets:
Allowance for doubtful accounts	$	947		$	2,084
Accrued expenses		8,142			12,459
Warranty		1,648			2,957
Defined benefit pension plan		1,528			2,666
Inventory		1,935			1,923
Share-based compensation		925			1,578
Vacation		797			1,422
Net operating loss and capital loss carry forwards		2,868			1,420
Deferred revenue		536			793
Other		665			964
Gross deferred tax assets		19,991			28,266
Valuation allowance		(3,562	)		(2,804	)
Net deferred tax assets	$	16,429		$	25,462

Deferred tax liabilities:
Intangible assets	$	(6,648	)	$	(15,422	)
Property, plant, and equipment		(4,219	)		(5,920	)
Total deferred tax liabilities	$	(10,867	)	$	(21,342	)

Net deferred tax assets	$	5,562		$	4,120

In assessing the ability to realize deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income, and tax planning strategies in making this assessment. Because the Company has a recent history of generating cumulative losses in a certain foreign tax jurisdiction, management did not consider projections of future taxable income as persuasive evidence for the recoverability of deferred tax assets in that jurisdiction. Therefore, the Company recorded a valuation allowance of $2.9 million as of August 31, 2015, which has decreased to $2.4 million as of August 31, 2018 for the certain foreign tax jurisdiction. Additionally, in fiscal 2018 the Company sold its filtration business, generating a $5.1 million capital loss. The Company believes it is more likely than not that the benefit from the capital loss will not be realized. Therefore, the Company recorded a valuation allowance of $1.2 million as of August 31, 2018.

The Company does not intend to, and has not historically, repatriated earnings of its foreign subsidiaries. Thus, the Company has not provided a deferred income tax liability on these undistributed earnings that are indefinitely reinvested. The Company would recognize a deferred income tax liability if the Company were to determine that such earnings were no longer indefinitely reinvested. During fiscal year 2018, U.S. Tax Reform was enacted, requiring companies to pay a one-time deemed repatriation tax on certain unrepatriated earnings of foreign subsidiaries, and generally eliminating U.S. federal income taxes on dividends from foreign subsidiaries. There are other taxes that may be incurred if the Company would repatriate earnings of its foreign subsidiaries. It is not practicable to estimate the amount of income taxes that would be incurred if the Company would repatriate earnings of its foreign subsidiaries.

The Company recognizes tax benefits only for tax positions that are more likely than not to be sustained upon examination by tax authorities. The amount recognized is measured as the largest amount of benefit that is greater than 50 percent likely to be realized upon settlement. Unrecognized tax benefits are tax benefits claimed in the Company’s tax returns that do not meet these recognition and measurement standards.

A reconciliation of changes in unrecognized tax benefits is as follows:

	August 31,
($ in thousands)	2018			2017
Unrecognized tax benefits at September 1	$	1,498		$	1,260
Increases for positions taken in current year		117			371
Increases for positions taken in prior years		43			129
Decreases for positions taken in prior years		(21	)		—
Reduction resulting from lapse of applicable statute of limitations		(38	)		(224	)
Decreases for settlements with tax authorities		(200	)		(38	)
Unrecognized tax benefits at August 31	$	1,399		$	1,498

The net amount of unrecognized tax benefits at both August 31, 2018 and 2017 that, if recognized, would impact the Company’s effective tax rate was $1.1 million. Recognition of these tax benefits would have a favorable impact on the Company’s effective tax rate. The Company recognizes accrued interest and penalties related to unrecognized tax benefits in income tax expense. Total accrued liabilities for interest and penalties included in the unrecognized tax benefits liability were $1.0 million and $0.8 million for the years ended August 31, 2018 and 2017, respectively.

While it is expected that the amount of unrecognized tax benefits will change in the next twelve months as a result of the expiration of statutes of limitations, the Company does not expect this change to have a significant impact on its results of operations or financial position.

The Company files income tax returns in the United States and in state, local, and foreign jurisdictions. The U.S. Internal Revenue Service (“IRS”) began an income tax audit for fiscal year 2016 in the fall of 2017. At August 31, 2018, the Company does not believe the outcome of the IRS examination is likely to be material to our consolidated financial statements. Other major jurisdictions where we conduct business generally have statutes of limitations ranging from three to five years.