7. INCOME TAXES

In December 2017, the U.S. Tax Cuts and Jobs Act (the "Tax Reform Act ") was enacted. The Tax Reform Act significantly revised the U.S. corporate income tax regime by, among other things, lowering the U.S. corporate tax rate from 35% to 21% effective January 1, 2018, and implementing a modified territorial tax system from a global system by adding provisions related to Global Intangible Low Taxed Income ("GILTI") and Foreign-derived Intangible Income ("FDII") among other provisions. The GILTI and FDII provisions under the Tax Reform Act became effective for the Company in fiscal 2019. The Tax Reform Act also imposed a one–time transition tax on deemed repatriation of historical earnings of foreign subsidiaries, which was recorded in fiscal 2018. In December 2017, the United States Securities and Exchange Commission (“SEC”) issued Staff Accounting Bulletin No. 118 (“SAB 118”), which provides guidance on accounting for the tax effects of the Tax Reform Act.

The Tax Reform Act created a new requirement that GILTI income earned by Controlled Foreign Corporations (“CFC’s”) must be included in the gross income of the CFC’s U.S. shareholder effective for us in fiscal 2019 for the Company. Under U.S. Generally Accepted Accounting Principles, we are allowed to make an accounting policy choice of either (1) treating taxes due on U.S. inclusions in taxable income related to GILTI as a current period expense when incurred (the “period cost method”) or (2) factoring such amounts into the Company’s measurement of its deferred taxes (the “deferred method”). We have elected the period cost method to account for GILTI tax.

The Tax Reform Act also created FDII for US companies that derive income from the export of tangible and intangible property and services effective for us in fiscal 2019. We have recorded a deduction attributable to FDII based on our current operations.

In the fiscal years set forth below, the provision for income taxes consisted of the following (in thousands):


	Year Ended October 31,
	2019		2018		2017
Current:
U.S. taxes	$	1,854	$	6,333	$	308
Foreign taxes		3,715		5,203		4,185
		5,569		11,536		4,493
Deferred:
U.S. taxes		(31)		(326)		1,236
Foreign taxes		291		(204)		(128)
		260		(530)		1,108
	$	5,829	$	11,006	$	5,601

A comparison of income tax expense at the U.S. statutory rate to the Company’s effective tax rate is as follows (dollars in thousands):


	Year Ended October 31,
	2019			2018			2017
Income before income taxes:
Domestic	$	9,793		$	14,101		$	5,477
Foreign		13,531			18,395			15,239
	$	23,324		$	32,496		$	20,716
Tax rates:
U.S. statutory rate		21	%		23	%		34	%
Effect of tax rate of international jurisdictions different than U.S. statutory rates		4	%		2	%		(5)	%
Valuation allowance		1	%		0	%		1	%
State taxes		1	%		0	%		0	%
Tax Credits		(2)	%		(1)	%		(3)	%
Effect of Tax Rate Changes		0	%		4	%		0	%
Transition Tax		(1)	%		7	%		0	%
US tax on distributed and undistributed earnings		3	%		0	%		0	%
US benefit of foreign intangible income		(3)	%		0	%		0	%
Other		1	%		(1)	%		0	%
Effective tax rate		25	%		34	%		27	%

The Tax Reform Act also made comprehensive changes to U.S. federal income tax laws by moving from a global to a modified territorial tax regime. As a result, cash repatriated to the U.S. is generally no longer subject to U.S federal income tax. At October 31, 2019, undistributed earnings of our foreign subsidiaries are expected to be permanently reinvested. Accordingly, we have not provided for any withholding taxes on the undistributed earnings of our foreign subsidiaries since January 1, 2018.

Deferred income taxes are determined based on the difference between the amounts used for financial reporting purposes and tax bases of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. Deferred taxes are adjusted for changes in tax rates and tax laws when changes are enacted. Valuation allowances are recorded to reduce deferred tax assets when it is more likely than not that a tax benefit will not be realized. Net deferred tax assets and liabilities are classified as non-current in the consolidated financial statements.

As of October 31, 2019, we had deferred tax assets established for accumulated net operating loss carryforwards of $1.4 million, primarily related to certain states in the U.S. and foreign jurisdictions. We also had deferred tax assets for research and development tax credits of $0.8 million. We have established a valuation allowance against some of these carryforwards due to the uncertainty of their full realization. As of October 31, 2019 and 2018, the balance of this valuation allowance was $2.2 million and $2.1 million, respectively.

Significant components of our deferred tax assets and liabilities at October 31, 2019 and 2018 are as follows (in thousands):


	October 31,
	2019		2018
Deferred Tax Assets:
Accrued inventory reserves	$	1,224	$	1,325
Accrued warranty expenses		363		499
Compensation related expenses		2,723		2,644
Unrealized exchange gain/loss		143		159
Other accrued expenses		170		170
Net operating loss carryforwards		1,380		1,316
Other credit carryforwards		766		686
Other		293		350
		7,062		7,149
Less: Valuation allowance – net operating loss and other credit carryforwards		(2,227)		(2,106)
Deferred tax assets		4,835		5,043

Deferred Tax Liabilities:
Net derivative instruments		(313)		(208)
Property and equipment and capitalized software development costs		(2,632)		(2,370)
Other		(204)		(231)
Net deferred tax assets	$	1,686	$	2,234

As of October 31, 2019, we had net operating losses carryforwards for international and U.S. income tax purposes of $5.9 million, of which $5.2 million related to foreign jurisdictions will expire within 5 years beginning in fiscal 2020 and $0.7 million will expire between 5 and 20 years. We also had tax credits of $765,000 that will expire between years 2023 and 2030.

A reconciliation of the beginning and ending amount of unrecognized tax benefits, excluding the related accrual for interest or penalties, is as follows (in thousands):


	2019		2018		2017
Balance, beginning of year	$	180	$	1,101	$	1,102
Additions based on tax positions related to the current year		36		37		37
Additions (reductions) related to prior year tax positions		—		(945)		(20)
Reductions due to statute expiration		(23)		(18)		(74)
Other		—		5		56
Balance, end of year	$	193	$	180	$	1,101

The entire balance of the unrecognized tax benefits and related interest at October 31, 2019, if recognized, could affect the effective tax rate in future periods.

We recognize accrued interest and penalties related to unrecognized tax benefits as components of our income tax provision. As of October 31, 2019, the amount of interest accrued, reported in other liabilities, was approximately $32,000, which did not include the federal tax benefit of interest deductions. The statute of limitations with respect to unrecognized tax benefits will expire between July 2020 and August 2023.

We file U.S. federal and state income tax returns, as well as tax returns in several foreign jurisdictions. A summary of open tax years by major jurisdiction is presented below:


United States federal		Fiscal 2016 through the current period
Germany¹		Fiscal 2017 through the current period
Taiwan		Fiscal 2017 through the current period

¹Includes federal as well as state, provincial or similar local jurisdictions, as applicable.