Income Taxes

12 Months Ended

Jan. 31, 2020

Note 14—Income Taxes

The components of income (loss) before income taxes are as follows:


	January 31
	2020			2019		2018
(In thousands)
Domestic	$	1,930		$	6,859	$	2,110
Foreign		(560	)		449		3,047

	$	1,370		$	7,308	$	5,157

The components of the (benefit) provision for income taxes are as follows:


	January 31
	2020			2019			2018
(In thousands)
Current:
Federal	$	660		$	1,807		$	592
State		221			457			251
Foreign		368			952			284

		1,249			3,216			1,127

Deferred:
Federal	$	(1,364	)	$	(843	)	$	903
State		(282	)		(170	)		(25	)
Foreign		8			(625	)		(134	)

		(1,638	)		(1,638	)		744

	$	(389	)	$	1,578		$	1,871

Total income tax (benefit)/provision differs from the expected tax (benefit)/provision as a result of the following:


	January 31
	2020			2019			2018
(In thousands)
Income Tax Provision at Statutory Rate	$	288		$	1,534		$	1,697
U.S. Corporate Rate Change		—			52			1,010
State Taxes, Net of Federal Tax Effect		(48	)		226			149
Foreign Rate Deferential		315			558			752
Transition Tax on Repatriated Earnings		—			14			104
Meals and Entertainment		31			56			40
Share Based Compensation		(145	)		(127	)		24
Change in Valuation Allowance		256			—			—
Change in Reserves Related to ASC 740 Liability		(352	)		(34	)		(20	)
Domestic Production Deduction		—			—			(47	)
Return to Provision Adjustment		(207	)		58			(122	)
TrojanLabel Earn Out Liability Adjustment		—			—			(316	)
Global Intangible Low Taxed Income		107			—			—
R&D Credits		(209	)		(218	)		(537	)
Foreign Derived Intangible Income		(107	)		(53	)		—
Foreign Tax Credits		(344	)		(477	)		(833	)
Other		26			(11	)		(30	)

	$	(389	)	$	1,578		$	1,871

The Company’s effective tax rate for 2020 was (28.4)% compared to 21.6% in 2019 and 36.3% in 2018. The decrease in the effective tax rate in 2020 from 2019 is primarily related to lower

pre-tax

income in 2020 compared to 2019 and 2018. Specific items decreasing the effective tax rate include foreign derived intangible income (“FDII”), the release of ASC 740 liabilities, R&D credit utilization, and return to provision adjustments. This decrease was offset by valuation allowances recorded on unbenefited losses in China and on carryforward foreign tax credits expected to expire unused.

The decrease in the effective tax rate for 2019 as compared to 2018 is primarily related to impacts of the Tax Act including the reduction in the statutory tax rate from 35% to 21% along with the absence of the

one-time

U.S. deferred remeasurement and Transition Tax charges. This decrease was offset by the absence of R&D credits from amended tax returns and the absence of the

non-taxable

TrojanLabel earn out liability adjustment in TrojanLabel ApS impacting the fiscal 2018 effective tax rate.

The components of deferred income tax expense arise from various temporary differences and relate to items included in the statement of income. The tax effects of temporary differences that gave rise to significant portions of the deferred tax assets and liabilities are as follows:


	January 31
	2020			2019
(In thousands)
Deferred Tax Assets:
Inventory	$	2,094		$	1,800
Honeywell Royalty Liability		2,583			3,146
State R&D Credits		1,496			1,305
Share-Based Compensation		582			493
Compensation Accrual		159			155
Warranty Reserve		205			201
Unrecognized State Tax Benefits		116			133
Deferred Service Contract Revenue		111			91
Bad Debt		165			101
Net Operating Loss		443			505
Foreign Tax Credit		113			—
Other		295			142

		8,362			8,072
Deferred Tax Liabilities:
Intangibles		776			2,660
Accumulated Tax Depreciation in Excess of Book Depreciation		1,002			982
Other		188			238

		1,966			3,880

Subtotal		6,396			4,192
Valuation Allowance		(1,752	)		(1,304	)

Net Deferred Tax Assets	$	4,644		$	2,888

The valuation allowance of $1.8 million at January 31, 2020 and $1.3 million at January 31, 2019 related to domestic research and development tax credit carryforwards, foreign tax credit carryforwards, and net operating loss carryforwards in China, all of which are expected to expire unused. The valuation allowance increased $0.5 million in 2020 due to the generation of domestic research and development credits, and foreign tax credits in excess of the Company’s ability to currently utilize them. The Company also recorded a full valuation allowance against the carryforward net operating losses in China, as the future realization is not reasonably assured. The Company has reached these conclusions after considering the availability of taxable income in prior carryback years, tax planning strategies, and the likelihood of future taxable income and credits exclusive of reversing temporary differences and carryforwards in the relevant jurisdictions.

We believe that it is reasonably possible that some unrecognized tax benefits, accrued interest and penalties could decrease income tax expense in the next year due to either the review of previously filed tax returns or the expiration of certain statutes of limitation. The changes in the balances of unrecognized tax benefits, excluding interest and penalties are as follows:


	2020			2019			2018
(In thousands)
Balance at February 1	$	618		$	665		$	708
Increases in current period tax positions		2			7			55
Reductions related to lapse of statutes of limitations		(26	)		(54	)		(98	)
Reductions related to settlement with tax authorities		(232	)		—			—

Balance at January 31	$	362		$	618		$	665

During fiscal 2020, the Company recognized $114,000 of income and $8,000 and $24,000 of expense in 2019 and 2018, respectively, related to a change in interest and penalties, which are included as a component of income tax expense in the accompanying statements of income. The Company has accrued potential interest and penalties of $0.3 million and $0.5 million at the end of January 31, 2020 and 2019, respectively.

The Company and its subsidiaries file income tax returns in U.S. federal jurisdictions, various state jurisdictions, and various foreign jurisdictions. The Company was previously under audit by the IRS for the tax years ended January 31, 2015, 2016, and 2017. On June 6, 2019, the Company received formal communication regarding the close of the audit with no additional changes made by the IRS. Therefore, the Company’s reserves for federal uncertain tax positions relating to the years in question have been released. The Company released $232,000 relating to the federal tax exposure for the years previously under audit and $74,000 of related interest (net of federal benefit) and penalties.

The Company was also notified of an income tax audit from the state of Rhode Island, but, no significant items have been raised at this time other than information requests. No assessments have been made as of January 31, 2020.

U.S. income taxes have not been provided on $4.9 million of undistributed earnings of the Company’s foreign subsidiaries since it is the Company’s intention to permanently reinvest such earnings offshore. If the earnings were distributed in the form of dividends, the Company would not be subject to U.S. tax as a result of the Tax Act but could be subject to foreign income and withholding taxes. Determination of the amount of this unrecognized deferred income tax liability is not practical.