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VAT TAX ISSUE IN BRAZIL AND PRIOR PERIOD ADJUSTMENTS | 12 Months Ended
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Jan. 31, 2015
Vat Tax Issues Disclosure [Abstract] |
VAT Tax Issue [Text Block] | 10. VAT TAX ISSUE IN BRAZIL AND PRIOR PERIOD ADJUSTMENTS Asserted Claims and Prior Period Adjustments VAT (i.e. Value Added Tax) 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 based on exchange rates at the time of the claim). 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$2.3) million and fines and interest currently at R$8.3 million (US$3.1 million), for a total of R$14.6 (US$5.5) million. The Company intends to defend itself through a regulatory process and wait for the next amnesty period. Of other claims, our attorney informs us that three claims totaling R$1.3 (US$0.5) 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 a forthcoming, anticipated amnesty periods imposed by the local Brazilian authorities. Of this R$6.2 (US$2.3) million claim, R$3.4 (US$1.3) million is eligible for future credit. The future credit amount had been recorded at the USD value at the exchange rate prevailing in 2010 when recorded, but has not been recorded on the books have been adjusted due to open contingencies (see prior period adjustment for see on VAT taxes in brazil below). 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$5.8 million (R$15.4 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 consolidated balance sheet as of January 31, 2014 and has been fully paid as of January 31, 2015. Of three remaining claims, our attorney informs us that R$1.0 (US $0.4) million will be successfully defended based on a lapse of statute of limitations and R$0.3 (US $0.1) million based on state auditor misunderstanding. No accrual has been made for these items. In December 2013, the Company 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 the total claim including interest and penalties totaling approximately US $200,000. In July 2014, management settled this claim for an amount of US $75,000 (R$ 172,000) net present value which will be paid in 120 monthly installments of R$ 4,500 (US $1,691) fixed with no interest or monetary depreciation. An amount of US $75,000 (R$ 172,000) has been charged to expense in Q2FY15. 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$1.6 million charge to expense recorded by Lakeland in the first quarter of fiscal 2011. A table summarizing all four different VAT claims remaining open and their status is listed below:
|  |  | Interest |  |  |  |  |  | Approximate |  | Loss |  |  |  |  |
Principal |  | & Penalty |  | Total |  |  | for Totals |  | Possibility |  | Strategy |  | Collateral |
R$ |  | R$ |  | R$ |  | US $ |  |  |  |  |  |  |
| 305,897 |  |  | 534,038 |  |  | 839,935 |  | $ | 315,492 |  | Remote |  | To await Judicial Process and negotiate judicial deposit |  | New Land |
| 573,457 |  |  | 1,337,933 |  |  | 1,911,390 |  | $ | 717,947 |  | Remote |  | To await Judicial Process and negotiate judicial deposit |  | Plant |
| 6,209,836 |  |  | 8,356,422 |  |  | 14,566,258 |  |  | 5,471,306 |  | Probable |  | To await Judicial Process and negotiate judicial deposit |  | - |
| 402,071 |  |  | 826,346 |  |  | 1,228,417 |  | $ | 461,412 |  | Remote |  | To await Judicial Process and negotiate judicial deposit |  | New Land |
| 7,491,261 |  |  | 11,054,740 |  |  | 18,546,000 |  | $ | 6,966,157 |  |  |  |  |  |  |
The R$ 6,209,836 for the larger VAT claim is intended to be paid into the next amnesty and as such is included on the consolidated balance sheet as a long-term liability of US $2,332,508 as of January 31, 2015. Numbers may not add due to rounding. 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 and January 31, 2015, along with potential future credits. Balance Sheet Treatment The Company has reflected the above items on its January 31, 2015, balance sheet as follows:
|  |  |  | R $ millions |  | US $ millions |
Long-term liabilities |  | Taxes payable |  |  | 6.2 |  |  | 2.3 |
Prior Period Adjustment for Credit on VAT taxes in Brazil In April 2010, the Company had recorded a credit of approximately $R3.4 million ($1.9 million at time of recording in 2010 and $1.3 million at exchange rates at January 31 2015) arising on the payment of VAT taxes into the anticipated future amnesty. This credit results from the fact that these VAT taxes were paid to the neighboring state of Pernambuco and the State of Bahia is demanding payment in full to them even though a discounted amount of taxes had already been paid to Pernambuco and the credit is allowed for these paid taxes but against future taxes due. It has since been determined that while the Company is entitled to such credit upon payment of the taxes into a future amnesty program, there is a possibility this credit could be challenged by a supervisor in the Bahia tax department. Based on research which failed to reveal any instances in which such a challenge has been made and prevailed, the Company believes that in the case of such challenge it is also remote that such challenge would prevail. Further, the Company paid an earlier claim for VAT taxes into an amnesty program in 2010 and received this credit which was utilized in full with no such challenge. However, since there is a contingency open as to the granting of this credit, (i.e. it is contingent upon paying the tax into a future amnesty program and the credit not being challenged by the Bahia tax department), however small, US GAAP prohibits this from being recorded as a “contingent asset” and therefore the Company has adjusting the consolidated balance sheets as at January 31, 2013 and January 31, 2014, to eliminate this “contingent asset.” There will be no impact on the net income (loss) or earnings (loss) per share for the years ended January 31, 2014 and 2015. Prior Period Adjustment for exchange rates on VAT taxes in Brazil The VAT liability was not entered on the Brazil subsidiary’s books in earlier years but was treated as a consolidation entry and, accordingly, was not adjusted by the changing foreign exchange rates. This will be a favorable adjustment of $0.7 million and will reduce the liability in US dollars. Accordingly, the Company has adjusted the consolidated balance sheets as at January 31, 2013 and January 31, 2014 It should be noted that these assets would have been eliminated in any case in the event of the effectuation of the proposed sale of the Company’s Brazilian subsidiary. Further, this, along with the other prior period adjustment referred to above may reduce the Company’s basis in its Brazil subsidiary to below zero. The Company’s board has announced its approval to transfer the operations of its Brazil subsidiary in a sale. In such case, if and when the sale is consummated, it may result in reporting a gain on such sale to the extent of negative basis. Upon a sale of Lakeland Brazil the buyer would assume these VAT tax liabilities. See Note 17. There will be no impact on the net income (loss) or earnings (loss) per share for the years ended January 31, 2014 and 2015.

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