INCOME TAXES

Income tax provision consists of the following:



	Fiscal Year Ended
	June 30, 2018			July 1, 2017			July 2, 2016
	(in thousands)
Current income tax provision (benefit):
United States	$	(221	)	$	1,231		$	1,014
Foreign	1,722			1,206			1,960
	1,501			2,437			2,974
Deferred income tax provision (benefit):
United States	(795		)	(539		)	(1,285		)
Foreign	(823		)	(259		)	(71		)
	(1,618		)	(798		)	(1,356		)
Total income tax provision	$	(117	)	$	1,639		$	1,618

The Company has gross tax credit carryforwards of approximately $8.7 million at June 30, 2018. Included in total tax credits carryforwards is approximately $8.0 million in research and development (R&D) tax credits.

Management also has reviewed its other deferred tax assets for purposes of determining whether or not a valuation allowance may be required. A valuation allowance against these deferred tax assets is required if it is more likely than not that some of the deferred tax assets will not be realized. Based on the Company’s profitability, it has been determined that it is more likely than not that the deferred tax assets will be realized.

On December 22, 2017, the Tax Cuts and Jobs Act (“Tax Act”) was signed into law. The Tax Act reduced Federal corporate tax rates effective January 1, 2018, and changed certain other provisions, many of which are not effective until the fiscal year ending in 2019. Effective tax rates for the quarter and the twelve months ended June 30, 2018, are blended rates reflecting the benefit of two quarters of Federal tax rate reductions for fiscal year 2018. These benefits were offset by discrete expenses relating to the revaluation of our U.S. net deferred tax assets, an adjustment relating to foreign exchange, and required adjustments associated with the transition from a global to a territorial tax system (discussed further below).

As a result of the U.S. tax system under the Tax Act from a global to a territorial model, a deemed one-time repatriation of all accumulated earnings and profits (AE&P) in Mexico and China occurred on December 31, 2017. For purposes of calculating the toll tax associated with this deemed repatriation, AE&P pools are stratified into two asset categories, subjected to certain allowable deductions and then the net amounts are subjected to the toll tax (15.5% for cash/cash equivalents and 8% for illiquid assets). Management has previously relied upon estimates of AE&P and the related tax pools in Mexico and China in order to calculate the amount of foreign earnings that may potentially be repatriated and the resulting potential U.S. tax liability (see further discussion below). Management has undertaken formal studies of the AE&P and tax pools in both Mexico and China and has increased its provisional calculation of the toll tax liability in the fourth quarter by $0.4 million to $1.2 million.

In addition to the $1.2 million toll tax described above, the Company recognized a $1.3 million discrete expense due to the revaluation of our U.S. net deferred tax assets. Offsetting these amounts, because of the shift to a territorial system of taxation in the U.S., the Company recognized a discrete benefit of approximately $1.3 million during the second quarter related to reversing its previously recognized estimated liability associated with estimated future repatriations from Mexico and China.

Compliance with the 2017 Tax Act will require significant complex computations not previously required by U.S. tax law. It is unclear how certain provisions of the 2017 Tax Act will be applied absent further legislative, regulatory, or accounting clarification and guidance. Also, on December 22, 2017, the staff of the SEC issued Staff Accounting Bulletin No. 118 (“SAB No. 118”). SAB No. 118 provides guidance on accounting for the tax effects of the 2017 Tax Act and allows registrants to record provisional amounts for a period of up to one year from the date of enactment of the 2017 Tax Act. We expect to refine and complete the accounting for the 2017 Tax Act during the first half of fiscal year 2019 as we finalize the formal AE&P and tax pools studies and as additional legislative, regulatory, and accounting guidance and interpretations become available.

In future years, because of the toll tax on AE&P described above, repatriations of cash will generally be tax-free in the U.S. However, withholding taxes in China and Mexico may still apply to any such future repatriations. Management has not changed its indefinite investment assertions with regards to the portion of AE&P in each jurisdiction that may be repatriated in the future. Accordingly, management estimates that future repatriations of cash from China may result in approximately $0.8 million of withholding tax. There would be no offsetting foreign tax credits in the U.S. and as such, this potential liability is a direct cost associated with actual repatriations.

A similar analysis was conducted with anticipated future repatriations in Mexico. Under Mexican tax law, any previously taxed earnings from before 2014 (“CUFIN”) are not subject to withholding when monies are repatriated to another country. Based on management’s estimated future repatriations from Mexico and based on the estimated AE&P in Mexico as of December 31, 2013, no withholding tax liability has been recognized as of June 30, 2018. If in the future, estimated future repatriations exceed CUFIN, the Company will be required to recognize a withholding tax as a deferred tax liability at that time. Similar to China, this withholding would not be creditable and would be a direct cost associated with the actual repatriation.

The Company expects to repatriate a portion of its foreign earnings based on increased net sales growth driving additional capital requirements domestically, cash requirements for potential acquisitions and to implement certain tax strategies. The Company currently expects to repatriate approximately $14.3 million of foreign earnings in the future. All other unremitted foreign earnings are expected to remain permanently reinvested for planned fixed assets purchases and improvements in foreign locations.

During the second quarter of fiscal year 2017, the Company signed a unilateral advance pricing agreement (APA) with the Large Taxpayer Division of Mexico’s Servicio de Administración Tributaria (SAT) under an elective framework that has been agreed to by the U.S. and Mexican authorities. The APA is part of a larger program affecting hundreds of U.S. companies with maquiladora operations in Mexico. The general impact of the APA is to increase margins between the maquiladora and U.S. parent company, shifting profits to Mexico from the U.S. The APA was finalized during the fourth quarter of fiscal 2017; the overall impact to the financial statements was not material.

The Company’s effective tax rate differs from the federal tax rate as follows:



	Fiscal Year Ended
	June 30, 2018			July 1, 2017			July 2, 2016
	(in thousands)
Federal income tax provision at statutory rates	$	(397	)	$	2,467		$	2,771
State income taxes, net of federal tax effect	(4		)	175			250
Foreign tax rate differences	103			(156		)	(442		)
Tax rate change	1,634			—			—
Provisional transition tax on accumulated foreign earnings	1,190			—			—
Effect of income tax credits	(687		)	(738		)	(1,254		)
Effect of repatriation of foreign earnings, net	(1,484		)	199			(161		)
Provision to return reconciliation	(401		)	8			(75		)
Other	(71		)	(316		)	529
Income tax provision	$	(117	)	$	1,639		$	1,618

The domestic and foreign components of income before income taxes were:



	Fiscal Year Ended
	June 30, 2018			July 1, 2017		July 2, 2016
	(in thousands)
Domestic	$	(4,593	)	$	3,553	$	2,228
Foreign	3,151			3,703		5,923
Income before income taxes	$	(1,442	)	$	7,256	$	8,151

Deferred income tax assets and liabilities consist of the following at:



	June 30, 2018			July 1, 2017
	(in thousands)
Deferred tax assets:
Tax credit carryforwards, net	$	3,946		$	4,164
Foreign subsidiaries - future tax credits	—			840
Inventory	667			840
Accruals	3,830			4,020
Mark-to-market adjustments	247			1,443
Arbitration settlement	1,100			—
Other	33			28
Deferred income tax assets	$	9,823		$	11,335
Deferred tax liabilities:
Foreign subsidiaries – unremitted earnings	(822		)	(2,288		)
Fixed assets	(289		)	(456		)
Identifiable intangibles	(670		)	(1,308		)
Other	(160		)	(302		)
Deferred income tax liabilities	$	(1,941	)	$	(4,354	)
Net deferred income tax assets	$	7,882		$	6,981
Balance sheet caption reported in:
Long-term deferred income tax asset	$	7,882		$	6,981
Net deferred income tax asset	$	7,882		$	6,981

Uncertain Tax Positions

The Company has R&D tax credits that approximate $8.0 million that have 20 year carryforwards before expiring. The Company’s R&D tax credits expire in various fiscal years from 2025 to 2038. The Company also has alternative minimum tax credits, which do not expire, approximating $726,000, which are now classified as a receivable due to the repeal of the alternative minimum tax.

As of June 30, 2018, the Company had unrecognized tax benefits of $4.0 million related to its gross R&D tax credits. The unrecognized tax benefits relate to certain R&D tax credits generated from 1997 to 2018.

A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows:



	Fiscal Year Ended
	June 30, 2018		July 1, 2017		July 2, 2016
	(in thousands)
Beginning Balance	$	3,947	$	3,760	$	3,446
Additions based on tax positions related to the current year	64		187		314
Ending Balance	$	4,011	$	3,947	$	3,760

The increase from the prior year is due to additional R&D credits that were recorded in 2018 as discussed above. Management does not anticipate any material changes to this amount during the next 12 months.

The Company recognizes interest accrued related to unrecognized tax benefits and penalties in its income tax provision. The Company has not recognized any interest or penalties in the fiscal years presented in these financial statements. The Company is subject to income tax in the U.S. federal jurisdiction, various state jurisdictions, Mexico and China. Certain years remain subject to examination but there are currently no ongoing exams in any taxing jurisdictions.