Income Taxes

12 Months Ended

Jun. 30, 2019

On December 22, 2017, the U.S. government enacted the Tax Cuts and Jobs Act (the “Tax Act”). The Tax Act reduced the corporate federal tax rate from 28% to 21% effective January 1, 2018 and implemented a modified territorial tax system. Since the Company has a June 30th fiscal year-end, the lower tax rate resulted in a blended U.S. statutory federal rate of approximately 28% for the fiscal year ended June 30, 2018. The U.S. statutory federal rate is 21% for fiscal year ended June 30, 2019 and subsequent fiscal years. As part of of the Tax Act, U.S. companies are required to pay a one-time transition tax on the deemed repatriation of undistributed foreign earnings and to remeasure deferred tax assets and liabilities.

The Tax Act includes a mandatory deemed repatriation of all undistributed foreign earnings that are subject to a U.S. income tax as part of the transition. For the fiscal year ended June 30, 2018, the Company recognized provisional income tax expense of $9.6 million for a one-time transition tax liability on total post-1986 foreign subsidiaries’ earnings and profits (“E&P”) that were previously deferred from U.S. income taxes. The Company completed its analysis for this item withing the permitted measurement period under the guidance of Staff Accounting Bulletin No. 118 (“SAB 118”) and determined an adjustment was necessary. As a result, a discrete tax benefit for $0.2 million was recorded during the quarter ended December 31, 2018. The Company will continue to distribute the earnings of its Canadian subsidiary, but earnings from Brazil will continue to be considered retained indefinitely for reinvestment and all other foreign geographies are immaterial. It has been the practice of the Company to reinvest those earnings in the businesses outside the United States. Apart from the one-time transition tax, any incremental deferred income taxes on the unremitted foreign earnings are not expected to be material.

As part of accounting for the Tax Act, the Company remeasured certain deferred tax assets and liabilities based on the rates at which such deferred taxes are expected to reverse in the future, which is generally 21%. For the fiscal year ended June 30, 2018 the Company recognized provisional discrete income tax benefit of $1.6 million for the remeasurement of the Company’s deferred tax asset and liability balances. The Company completed its analysis for this item within the permitted measurement period under the guidance of SAB 118 and determined that the provisional amount should not be adjusted.

The Tax Act created a provision known as global intangible low-tax income ("GILTI") that imposes a tax on certain earnings of foreign subsidiaries. The GILTI tax became effective for the Company during fiscal year 2019 and an accounting policy election was made to treat the tax as a current period expense. The Company recognized GILTI tax of approximately $0.4 million for the fiscal year ended June 30, 2019.

Income tax expense (benefit) consists of:



	Fiscal Year Ended June 30,
	2019			2018			2017
	(in thousands)
Current:
Federal	$	17,742		$	38,263		$	31,149
State	4,404			3,503			2,615
Foreign	(157		)	9,203			269
Total current	21,989			50,969			34,033
Deferred:
Federal	(4,328		)	(9,987		)	(3,832		)
State	(806		)	(1,962		)	(397		)
Foreign	3,456			(11,248		)	2,445
Total deferred	(1,678		)	(23,197		)	(1,784		)
Provision for income taxes	$	20,311		$	27,772		$	32,249

A reconciliation of the U.S. Federal income tax expense at a statutory rate of 21% for the fiscal year ended June 30, 2019, a blended statutory rate of 28.0% for the fiscal year ended June 30, 2018 and a statutory rate of 35% for the fiscal year ended and June 30, 2017 to actual income tax expense is as follows:



	Fiscal Year Ended June 30,
	2019			2018			2017
	(in thousands)
U.S. statutory rate	21.0		%	28.0		%	35.0		%
U.S. Federal income tax at statutory rate	$	16,361		$	17,094		$	35,524
Increase (decrease) in income taxes due to:
State and local income taxes, net of Federal benefit	2,727			1,883			1,729
Tax credits	(1,808		)	(1,825		)	(1,430		)
Valuation allowance	2,142			1,530			444
Effect of foreign operations, net	2,103			(1,396		)	(1,477		)
Stock compensation	35			1,049			(61		)
Capitalized acquisition costs	69			48			231
Nontaxable income	(828		)	(9		)	(4,437		)
Disallowed interest	1,600			1,888			2,011
Net favorable recovery	(2,670		)	—			—
Other	1,085			(1,438		)	(285		)
U.S. Tax Reform transition tax	(827		)	9,609			—
U.S. Tax Reform impact of rate change on deferred taxes	—			(1,615		)	—
Belgium Tax Reform impact of rate change on deferred taxes	—			1,040			—
Other jurisdictions impact of rate change on deferred taxes	(43		)	(86		)	—
Global intangible low taxed income (GILTI) tax	365			—			—
Provision for income taxes	$	20,311		$	27,772		$	32,249

The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and liabilities are presented below:



	June 30,
	2019			2018
	(in thousands)
Deferred tax assets derived from:
Allowance for accounts receivable	$	10,681		$	12,874
Inventories	4,561			4,060
Nondeductible accrued expenses	9,848			7,426
Net operating loss carryforwards	6,241			5,350
Tax credits	6,530			5,795
Timing of amortization deduction from goodwill	6,406			5,756
Deferred compensation	6,396			5,696
Stock compensation	3,034			2,809
Timing of amortization deduction from intangible assets	3,110			2,510
Total deferred tax assets	56,807			52,276
Valuation allowance	(7,238		)	(5,098		)
Total deferred tax assets, net of allowance	49,569			47,178
Deferred tax liabilities derived from:
Timing of depreciation and other deductions from building and equipment	(6,719		)	(7,468		)
Timing of amortization deduction from goodwill	(3,742		)	(1,782		)
Timing of amortization deduction from intangible assets	(15,779		)	(17,498		)
Total deferred tax liabilities	(26,240		)	(26,748		)
Net deferred tax assets	$	23,329		$	20,430

The components of pretax earnings are as follows:



	Fiscal Year Ended June 30,
	2019		2018			2017
	(in thousands)
Domestic	$	67,426	$	66,416		$	79,871
Foreign	10,482		(5,491		)	21,624
Worldwide pretax earnings	$	77,908	$	60,925		$	101,495

As of June 30, 2019, there were (i) gross net operating loss carryforwards of approximately $4.0 million for U.S. federal income tax purposes; (ii) gross state net operating loss carryforwards of approximately $7.3 million; (iii) foreign gross net operating loss carryforwards of approximately $19.0 million; (iv) state income tax credit carryforwards of approximately $2.5 million that will began to expire in the 2020 tax year; and (v) withholding tax credits of approximately $4.0 million; and (vi) foreign tax credits of $0.5 million. The Company maintains a valuation allowance of $2.3 million for foreign net operating losses, a less than $0.1 million valuation allowance for state net operating losses, a $4.0 million valuation allowance for withholding tax credits, a $0.5 million valuation allowance for foreign tax credits, and $0.3 million valuation allowance for state income tax credits, and a less than $0.1 million valuation allowance for the notional interest deduction, where it was determined that, in accordance with ASC 740, it is more likely than not that they cannot be utilized.

The Company adopted ASU 2016-09 during fiscal year 2018 which required the Company to recognize excess tax benefits and tax deficiencies as income tax expense or benefit for stock award settlements that were previously recognized as additional paid-in-capital. As a result of these changes, the Company recognized net tax expense of less than $0.1 million and $1.0 million for the fiscal years ended June 30, 2019 and 2018, respectively.

As of June 30, 2019, the Company had gross unrecognized tax benefits of $1.2 million, $1.0 million of which, if recognized, would affect the effective tax rate. This reflects a decrease of $0.9 million on a gross basis over the prior fiscal year. The Company does not expect that the total amounts of unrecognized tax benefits will significantly increase or decrease within the next twelve months.

The Company recognizes interest and penalties related to unrecognized tax benefits within the income tax expense line in the accompanying Consolidated Income Statement. Accrued interest and penalties are included within the related tax liability line in the Consolidated Balance Sheet. The total amount of interest and penalties accrued, but excluded from the table below were $1.0 million, $1.2 million and $1.1 million for the fiscal years ended June 30, 2019, 2018 and 2017, respectively. A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows:



	June 30,
	2019			2018			2017
	(in thousands)
Beginning Balance	$	2,053		$	2,176		$	2,148
Additions based on tax positions related to the current year	69			157			174
Additions for tax positions of prior years	—			—			—
Reduction for tax positions of prior years	(888		)	(280		)	(146		)
Ending Balance	$	1,234		$	2,053		$	2,176

Financial results for the Belgium business produced pre-tax loss of less than $0.1 million for the year ended June 30, 2019. However, the Belgium business reported cumulative taxable income for two of the five prior years. In the judgment of management, it is more likely than not that the deferred tax asset will be realized. A corporate tax reform law was enacted in Belgium on December 25, 2017, which reduces the corporate tax rate from 33% to 25% over a three-year period. The company remeasured certain deferred tax assets and liabilities based on the rates at which such deferred taxes are expected to reverse in the future. As a result, the Company recognized income tax expense of $1.0 million during the year ended June 30, 2018.

During the quarter ended June 30, 2017, a lawsuit filed by ScanSource Brazil with the Brazilian Supreme Court in 2014 regarding the tax treatment of certain Brazilian state-provided tax benefits was settled in Scansource Brazil’s favor. As a result, Scansource Brazil was awarded and recovered a tax settlement. The Company recorded, discrete to the June 30, 2017 quarter, the income tax benefit associated with that recovery equal to approximately $4.5 million.

A Supplemental Law was issued in Brazil during the Company's fiscal year 2019 which affirmed that Brazilian state-provided benefits are not subject to income tax. The Company recorded, discrete to the June 30, 2019 quarter, an income tax benefit of $3.1 million related to the confirmation of the recovery of state-provided tax benefits.

The Company conducts business globally and, as a result, one or more of its subsidiaries files income tax returns in the United States federal, various state, local and foreign jurisdictions. In the normal course of business, the Company is subject to examination by taxing authorities in countries in which it operates. With certain exceptions, the Company is no longer subject to state and local, or non-United States income tax examinations by tax authorities for tax years before June 30, 2014.