10. VAT TAX ISSUE IN BRAZIL

Asserted Claims

VAT tax in Brazil is at the state level. We commenced operations in Brazil in May 2008 through an acquisition of Qualytextil, S.A. (“QT”). At the time of the acquisition, and going back to 2004, the acquired company used a port facility in a neighboring state (Recife-Pernambuco), rather than its own, in order to take advantage of incentives, in the form of a discounted VAT tax, to use such neighboring port facility. We continued this practice until April 2009. The practice was stopped largely for economic reasons, resulting from additional trucking costs and longer lead time. The Bahia state auditors (state of domicile for the Lakeland operations in Brazil) initially reviewed the period from 2004-2006 and filed a claim for unpaid VAT taxes in October 2009. The claim asserted that the state VAT taxes are owed to the state of domicile of the ultimate importer/user and disregarded the fact that the VAT taxes had already been paid to the neighboring state.

The audit notice claimed that the taxes paid to Recife-Pernambuco should have been paid to Bahia in the amount of R$4.8 million and assessed fines and interest of an additional R$5.6 million for a total of R$10.4 million (approximately US$3.0 million, $3.5 million and $6.5 million, respectively).

Bahia had announced an amnesty for this tax whereby R$3.5 million (US$1.9 million) of the taxes claimed were paid by QT by the end of the month of May 2010, and the interest and penalties related thereto were forgiven. According to fiscal regulation of Brazil, R$2.1 million (US$1.1 million) of this amnesty payment has since been recouped as credits against future taxes due.

An audit for the 2007-2009 period has been completed by the State of Bahia. In October 2010, the Company received five claims for 2007-2009 from the State of Bahia, the largest of which was for taxes of R$6.2 (US$2.6) million and fines and interest currently at R$6.7 million (US$2.9 million), for a total of R$12.9 (US$5.5) million. The Company intends to defend and wait for the next amnesty period. Of other claims, our attorney informs us that three claims totaling R$1.3 (US$0.6) million in respect of fines and penalties will likely be successfully defended based on state auditor misunderstanding.

Lakeland intends to apply for amnesty and make any necessary payments upon the forthcoming, anticipated amnesty periods imposed by the local Brazilian authorities. Of this R$6.2 (US$2.6) million claim, R$3.4 (US$1.4) million is eligible for future credit. The future credit amount was recorded at the USD value at the exchange rate prevailing in 2010 when recorded.

The Company has changed its strategy regarding the large VAT tax claim as a result of the current cash flow needs in Brazil. In February 2014, as had been anticipated, the administrative proceedings have ended and a switch to a formal judicial proceeding became required. The Company is presently attempting to negotiate a guarantee with the administrative level in the Tax department whereby the Company would either pledge its inventory as collateral for the judicial deposit or alternately would agree to deposit into an escrow account with the court system a monthly judicial deposit of a negotiated percentage of its future sales in Brazil. The Company would then be able to avail itself of a later amnesty. Any amounts paid into the escrow would be available at such time to be applied to the amnesty payment. The Company believes it is more likely than not that it will have the cash from operations or the borrowing capacity at such time to fund such amnesty payment but no assurances can be given.

Such arrangement would result in a judicial tax claim filed against the Company for 20% greater than the total claim, or approximately US$6.6 million (R15.4 million). Of this amount, only a portion of any amount paid into future amnesty would be eligible for future credit as discussed elsewhere in this note.

Once this arrangement is completed, the formal judicial process could take from 5 to 10 years. The Company believes there is a strong likelihood that another amnesty would be offered by the state prior to such completion.

The Company has accepted amnesty for a smaller claim (the fifth referenced above) which will result in eight monthly payments of about US $18,000 (R$42,000) which reflects abatement of 80% of penalty and interest. An accrual of US $153,000 has been charged to expense and included in other accrued expenses on the Balance Sheet as of January 31, 2014.

Of three remaining claims, our attorney informs us that R$1.0 (US $0.6) million will be successfully defended based on a lapse of statute of limitations and R$0.3 (US $0.2) million based on state auditor misunderstanding. No accrual has been made for these items.

In December 2013, the company has just learned of a different VAT tax claimed by the State of Sao Paulo for a tax in the amount of approximately US $45,000 and total claim including interest and penalty totaling approximately US $200,000.

Management will continue to monitor the situation and revise its estimates as more information becomes available.

A table summarizing all five different VAT claims and their status is listed below:

			Interest &				Approximate
	Principle		Penalty		Total		for Totals		Loss Possibility	Strategy	Collateral
	R$		R$		R$		US $
		305,897		491,272		797,168		362,000	Remote	To wait Judicial Process	New Land
		573,457		1,098,475		1,671,932		760,000	Remote	To wait Judicial Process	Plant
		6,209,836		6,653,586		12,863,422		5,847,000	Probable	To wait Judicial Process and offer Judicial Deposit (approx. 3% net sales)	-
		402,071		770,133		1,172,204		533,000	Remote	To wait Judicial Process	New Land
		285,009		249,140		534,149		243,000	Loss Agreed	*Accept State Amnesty (8 installments, approx. BRL 42K)	-
		7,776,270		9,262,605		17,038,875		7,745,000		*After State Amnesty Accepted
		PRINCIPAL		INTEREST		TOTAL			State Requirements
		285,009		15,626		334,835			8 Installments representing accepted amnesty per above
Total		285,009		15,626		334,835		152,000

Numbers may not add due to rounding.

Set forth below are the total amounts of potential tax liability from both the original and larger of the five secondary claims, the amount of payments already made into amnesty or scheduled for future payment, which are not eligible for future credit (essentially the discount allowed as an incentive by the neighboring state), less the amount of VAT taxes actually paid which are available as a credit and the amounts of the escrow released by one of the three sellers of the Brazilian company acquired by the Company. The foregoing forms the basis for the US$1.6 million charge to expense recorded by Lakeland in the first quarter of fiscal 2011.

	BRL (millions)						US (millions)
Foreign exchange rate (at the time recorded								1.82		1.82		1.82
	Total Paid						Total Paid Or
	Or To Be						To Be Paid
	Paid Into						Into
	Government						Government
	Under		Total Not				Under		Total Not
	Amnesty		Available		Available		Amnesty		Available		Available For
	Program		For Credit¹		For Credit²		Program		For Credit¹		Credit²
Original claim 2004-2006		3.5		1.4		2.1		1.9		0.8		1.1
Second claim
Preacquisition 2007-April 2008		2.4		1.0		1.4		1.3		0.5		0.8
Postacquisition May 2008 - April 2009		3.3		1.4		1.9		1.8		0.8		1.0
Totals		9.2		3.8		5.4		5.0		2.1		2.9
Escrow released from one seller		1.0		1.0		-		0.5		0.5		-
Charged to expense at April 30, 2010		-		2.8		-		-		1.6		-

² The amount allowed as credit against future payments represents the VAT taxes actually previously paid to the neighboring state.

Future Accounting for Funds

Following earlier payment into the amnesty program in 2010 and December 2013, a portion of the taxes were since recouped via credits against future taxes due. The Company does not expect any further charges to expense. Any future payment into amnesty has already been reflected on our books as a liability at January 31, 2014, along with potential future credits.

Balance Sheet Treatment

The Company has reflected the above items on its January 31, 2014, balance sheet as follows:

		R$ millions		US$ millions⁽¹⁾
Noncurrent assets	VAT taxes eligible for future credit		3.4		1.9
Long-term liabilities	Taxes payable		6.2		3.3

⁽¹⁾ At exchange rate prevailing in 2010 when recorded.