| Income Taxes | 8. Income Taxes Our income (loss) before income taxes consisted of the following:
(in thousands)
Year ended September 30,
2020
2019
2018
Domestic
$
(73,865
)
$
(112,077
)
$
(114,591
)
Foreign
208,571
132,377
143,247
Total income before income taxes
$
134,706
$
20,300
$
28,656
Our provision (benefit) for income taxes consisted of the following:
(in thousands)
Year ended September 30,
2020
2019
2018
Current:
Federal
$
2,187
$
13,130
$
3,009
State
1,266
(945
)
2,003
Foreign
25,199
33,867
28,213
28,652
46,052
33,225
Deferred:
Federal
(26,811
)
22,911
(12,594
)
State
(4,063
)
1,759
(445
)
Foreign
6,233
(22,962
)
(43,517
)
(24,641
)
1,708
(56,556
)
Total provision (benefit) for income taxes
$
4,011
$
47,760
$
(23,331
) Taxes computed at the statutory federal income tax rates are reconciled to the provision (benefit) for income taxes as follows:
(in thousands)
Year ended September 30,
2020
2019
2018
Statutory federal income tax rate
$
28,288
21
%
$
4,263
21
%
$
7,021
25
%
Change in valuation allowance
(16,489
)
(12
)%
66,417
327
%
(181,047
)
(632
)%
Transition impact of U.S. Tax Act
—
—
%
—
—
%
126,122
440
%
Federal rate change
—
—
%
—
—
%
69,648
243
%
State income taxes, net of federal tax benefit
(2,998
)
(2
)%
607
3
%
2,401
8
%
Federal research and development credits
(5,483
)
(4
)%
(3,731
)
(18
)%
(3,058
)
(11
)%
Uncertain tax positions
3,072
2
%
2,611
13
%
(4,646
)
(16
)%
Foreign rate differences
(22,074
)
(16
)%
(26,952
)
(133
)%
(38,743
)
(135
)%
Foreign tax on U.S. provision
4,523
3
%
6,547
32
%
2,736
10
%
Excess tax benefits from restricted stock
(1,743
)
(1
)%
(5,940
)
(29
)%
(11,641
)
(41
)%
Audits and settlements
—
—
%
51
—
%
2,352
8
%
U.S. permanent items
6,590
5
%
2,483
12
%
5,408
19
%
BEAT
(1,759
)
(1
)%
1,759
9
%
—
—
%
GILTI, net of foreign tax credits
14,899
11
%
6,170
31
%
—
—
%
Foreign-Derived Intangible Income (FDII)
(2,461
)
(2
)%
(6,409
)
(32
)%
—
—
%
Other, net
(354
)
(1
)%
(116
)
(1
)%
116
1
%
Provision (benefit) for income taxes
$
4,011
3
%
$
47,760
235
%
$
(23,331
)
(81
)% In 2020, 2019, and 2018, our tax rate differed from the U.S. statutory federal income tax rate due to our corporate structure in which our foreign taxes are at a net effective tax rate lower than the U.S. rate. A significant amount of our foreign earnings is generated by our subsidiaries organized in Ireland. In 2020, 2019, and 2018, the foreign rate differential predominantly relates to these Irish earnings. In 2020, in addition to the foreign rate differential, our tax rate differed from the statutory federal income tax rate due to U.S. tax reform, the excess tax benefit related to stock-based compensation and the indirect effects of the adoption of ASC 606. Additionally, we recorded benefits for the reduction of the U.S. valuation allowance as a result of the Onshape acquisition. A further reduction to the valuation allowance was also recorded to reflect the impact from the scheduling of the reversal of existing temporary differences resulting in deferred tax liabilities that cannot be offset against deferred tax assets. On March 27, 2020, the U.S. Federal government enacted the Coronavirus Aid, Relief, and Economic Security Act (the “CARES ACT”). The CARES Act is an emergency economic stimulus package in response to the COVID-19 pandemic, which among other things contains numerous income tax provisions. We have determined that the impact of the CARES Act was not material to our consolidated financial statements. In 2019, our effective tax rate was higher than the statutory federal income tax rate due in large part to the scheduling of the reversal of existing temporary differences resulting in deferred tax liabilities that cannot be offset against deferred tax assets requiring an increase to the U.S. valuation allowance, U.S. tax reform (as described below) and foreign withholding taxes, an obligation of the U.S. parent. This is offset by foreign rate differences, the excess tax benefit related to stock-based compensation and the indirect effects of the adoption of ASC 606. In 2018, our effective tax rate was lower than the statutory federal income tax rate due to U.S. tax reform, as described below. Additionally, we have a full valuation allowance against deferred tax assets in the U.S., primarily related to net operating losses, tax credit carryforwards, capitalized research and development and deferred revenue. As a result, we have not recorded a benefit related to ongoing U.S. losses. Our foreign rate differential in 2018 includes the continuing rate benefit from a business realignment completed on September 30, 2014 in which intellectual property was transferred between two wholly-owned foreign subsidiaries. The realignment allows us to more efficiently manage the distribution of our products to European customers. In 2018, this realignment resulted in a tax benefit of approximately $24 million. We recorded foreign withholding taxes, an obligation of the U.S. parent, of $2.7 million in 2018. On December 22, 2017, the United States enacted tax reform legislation through the Tax Cuts and Jobs Act, (the "Tax Act"), which significantly changed existing U.S. tax laws by a reduction of the corporate tax rate, the implementation of a new system of taxation for non-U.S. earnings, the imposition of a one-time tax on the deemed repatriation of undistributed earnings of non-U.S. subsidiaries, and the expansion of the limitations on the deductibility of executive compensation and interest expense. As we have a September 30 fiscal year-end, a blended U.S. statutory federal rate of approximately 24.5% applied for our fiscal year ended September 30, 2018 and 21% for subsequent fiscal years. The Tax Act also provides that net operating losses generated in years ending after December 31, 2017 (our fiscal 2018) will be carried forward indefinitely and can no longer be carried back, and that net operating losses generated in years beginning after December 31, 2017 (our fiscal 2019) can only reduce taxable income by up to 80% when utilized in a future period. The Tax Act includes a provision to tax global intangible low-tax income (GILTI) of foreign subsidiaries, a deduction for Foreign-Derived Intangible Income (FDII), and the base erosion anti-abuse tax (BEAT) measure that taxes certain payments between a U.S. corporation and its foreign subsidiaries. The GILTI, FDII and BEAT provisions were effective for us beginning October 1, 2018. Our accounting policy is to treat tax on GILTI as a current period cost included in tax expense in the year incurred. In 2018, we provided no federal income taxes payable as a result of the deemed repatriation of undistributed earnings as the tax was offset by a combination of current year losses and existing attributes which had a full valuation allowance recorded against the related deferred tax assets. In 2018, we recorded state income taxes payable on the deemed repatriation of $1.7 million. We also recorded a deferred tax benefit of $14.1 million for the impact of the Tax Act on our net U.S. deferred income tax balances. This was primarily attributable to the reduction of the federal tax rate on the net deferred tax liability in the U.S., and the ability to realize net operating losses from the reversal of existing deferred tax assets which can now be carried forward indefinitely and can therefore be netted against deferred tax liabilities for indefinite-lived intangible assets. The U.S. Securities and Exchange Commission issued rules that allow for a period of up to one year after the enactment date of the Tax Act to finalize the recording of the related tax impacts. We finalized recording the impacts of the Tax Act in the quarter ended December 29, 2018 and did not record any significant adjustments. At September 30, 2020 and 2019, income taxes payable and income tax accruals recorded on the accompanying Consolidated Balance Sheets were $15.4 million ($7.0 million in accrued income taxes, $1.0 million in other current liabilities and $7.4 million in other liabilities) and $23.4 million ($17.4 million in accrued income taxes, $0.4 million in other current liabilities and $5.6 million in other liabilities), respectively. At September 30, 2020 and 2019, prepaid taxes recorded in prepaid expenses on the accompanying Consolidated Balance Sheets were $17.3 million and $5.3 million, respectively. We made net income tax payments of $52.6 million, $38.9 million and $22.6 million in 2020, 2019 and 2018, respectively. The significant temporary differences that created deferred tax assets and liabilities are shown below:
(in thousands)
September 30,
2020
2019
Deferred tax assets:
Net operating loss carryforwards
$
61,495
$
26,462
Foreign tax credits
8,074
—
Capitalized research and development
30,109
34,560
Pension benefits
14,370
14,838
Prepaid expenses
13,579
41,739
Deferred revenue
6,021
9,899
Stock-based compensation
13,630
12,306
Other reserves not currently deductible
15,130
20,986
Amortization of intangible assets
162,426
168,376
Research and development and other tax credits
70,695
49,995
Lease liabilities
52,224
—
Fixed assets
47,457
45,450
Capital loss carryforward
35,851
31,248
Deferred interest
—
10,864
Other
1,849
1,623
Gross deferred tax assets
532,910
468,346
Valuation allowance
(205,423
)
(177,663
)
Total deferred tax assets
327,487
290,683
Deferred tax liabilities:
Acquired intangible assets not deductible
(65,894
)
(42,554
)
Lease assets
(35,885
)
—
Pension prepayments
(1,155
)
(2,532
)
Deferred revenue
(594
)
(19,312
)
Depreciation
(7,481
)
—
Unbilled accounts receivable
(12,699
)
(31,005
)
Deferred income
(5,821
)
(19,040
)
Prepaid commissions
(17,124
)
(17,423
)
Other
(2,302
)
(1,866
)
Total deferred tax liabilities
(148,955
)
(133,732
)
Net deferred tax assets
$
178,532
$
156,951
In October 2016, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2016-16, Income Taxes (Topic 740): Intra-Entity Transfers of Assets Other Than Inventory. The purpose of ASU 2016-16 is to simplify the income tax accounting of an intra-entity transfer of an asset other than inventory and to record its effect when the transfer occurs. We adopted this standard beginning in the first quarter of 2019 using the modified retrospective method with a cumulative effect adjustment to accumulated deficit of $72.3 million, with a corresponding increase of $75.3 million to deferred tax assets, a $6.0 million decrease to income tax assets and a $3.0 million decrease to income tax liabilities. The adjustment primarily relates to deductible amortization of intangible assets in Ireland. Post adoption, our effective tax rate no longer includes the benefit of this amortization. We have concluded, based on the weight of available evidence, that a full valuation allowance continues to be required against our U.S. net deferred tax assets as they are not more likely than not to be realized in the future. We will continue to reassess our valuation allowance requirements each financial reporting period. For U.S. tax return purposes, net operating loss (NOL) carryforwards and tax credits are generally available to be carried forward to future years, subject to certain limitations. At September 30, 2020, we had U.S. federal NOL carryforwards from acquisitions of $128.7 million, of which $53.2 million expire in 2021 to 2037. The remaining carryforwards of $75.5 million do not expire. The utilization of these NOL carryforwards is limited as a result of the change in ownership rules under Internal Revenue Code Section 382. As of September 30, 2020, we had Federal R&D credit carryforwards of $42.2 million, which expire beginning in 2030 and ending in 2040, and Massachusetts R&D credit carryforwards of $26.9 million, which expire beginning in 2021 and ending in 2035. We also had foreign tax credits of $8.1 million, which expire in 2030. A full valuation allowance is recorded against the carryforwards. We also have NOL carryforwards in non-U.S. jurisdictions totaling $58.4 million, the majority of which do not expire, and non-U.S. tax credit carryforwards of $4.4 million that expire beginning in 2030 and ending in 2035. Additionally, we have amortization carryforwards of $907.4 million in a foreign jurisdiction. There are limitations imposed on the utilization of such attributes that could restrict the recognition of any tax benefits. As of September 30, 2020, we have a valuation allowance of $171.3 million against net deferred tax assets in the U.S. and a valuation allowance of $34.1 million against net deferred tax assets in certain foreign jurisdictions. The valuation allowance recorded against net deferred tax assets of certain foreign jurisdictions is established primarily for our capital loss carryforwards, the majority of which do not expire. However, there are limitations imposed on the utilization of such capital losses that could restrict the recognition of any tax benefits. The changes to the valuation allowance were primarily due to the following:
(in thousands)
Year ended September 30,
2020
2019
2018
Valuation allowance, beginning of year
$
177,663
$
141,950
$
279,683
Net release of valuation allowance (1)
—
(1,772
)
(2,791
)
Net increase (decrease) in deferred tax assets with a full valuation allowance (2)
27,760
37,485
(134,942
)
Valuation allowance, end of year
$
205,423
$
177,663
$
141,950
(1)
In 2019 and 2018 this is attributable to the release in foreign jurisdictions.
(2)
In 2020, this change is largely attributed to the Onshape acquisition, the adoption of ASC 842 and the impact to the change in scheduling of the reversal of existing temporary differences. In 2019, this is due in large part to a change in method of accounting for federal income tax purposes resulting in deferred tax liabilities that cannot be offset against available tax attributes in the scheduling of the reversal of existing temporary differences, and by the adoption of ASC 606. In 2018, this is primarily attributable to U.S. tax reform: the utilization of tax attributes used to offset the transition tax, the revaluation of the U.S. net deferred tax assets and liabilities, the ability to realize net operating losses from the reversal of existing deferred tax assets which can now be carried forward indefinitely and can therefore be netted against deferred tax liabilities for indefinite-lived intangibles. Our policy is to record estimated interest and penalties related to the underpayment of income taxes as a component of our income tax provision. In 2020 and 2019, we recorded interest expense of $0.3 million and $0.1 million, respectively, and in 2018 we reduced interest expense by $0.6 million. In 2020, 2019 and 2018, we had no tax penalty expense in our income tax provision. As of September 30, 2020 and 2019, we had accrued $0.6 million and $0.5 million of net estimated interest expense related to income tax accruals, respectively. We had no accrued tax penalties as of September 30, 2020, 2019 or 2018.
Year ended September 30,
Unrecognized tax benefits (in thousands)
2020
2019
2018
Unrecognized tax benefit, beginning of year
$
11,484
$
9,812
$
14,752
Tax positions related to current year:
Additions
2,173
1,466
1,456
Tax positions related to prior years:
Additions
2,452
1,375
—
Reductions
(2
)
(9
)
(4,631
)
Settlements
—
(1,160
)
—
Statute expirations
—
—
(1,765
)
Unrecognized tax benefit, end of year
$
16,107
$
11,484
$
9,812
If all of our unrecognized tax benefits as of September 30, 2020 were to become recognizable in the future, we would record a benefit to the income tax provision of $16.1 million (which would be partially offset by an increase in the U.S. valuation allowance of $7.7 next 12 months the amount of unrecognized tax benefits related to the resolution of multi-jurisdictional tax positions could be reduced by up to $ 1 million as audits close and statutes of limitations expire. In the fourth quarter of 2016, we received an assessment of approximately $12 million from the tax authorities in South Korea. The assessment relates to various tax issues, primarily foreign withholding taxes. We have appealed and intend to vigorously defend our positions. We believe that upon completion of a multi-level appeal process it is more likely than not that our positions will be sustained. Accordingly, we have not recorded a tax reserve for this matter. We paid this assessment in the first quarter of 2017 and have recorded the amount in other assets, pending resolution of the appeal process. If the South Korean tax authorities were to prevail then, in addition to the $12 million already assessed, the potential additional exposure through 2020 would be approximately $17 million. We are continuing to work with our advisors during the court process and still believe our position is sustainable. In the normal course of business, PTC and its subsidiaries are examined by various taxing authorities, including the IRS in the U.S. We regularly assess the likelihood of additional assessments by tax authorities and provide for these matters as appropriate. We are currently under audit by tax authorities in several jurisdictions. Audits by tax authorities typically involve examination of the deductibility of certain permanent items, transfer pricing, limitations on net operating losses and tax credits. Although we believe our tax estimates are appropriate, the final determination of tax audits and any related litigation could result in material changes in our estimates. As of September 30, 2020, we remained subject to examination in the following major tax jurisdictions for the tax years indicated:
Major Tax Jurisdiction
Open Years
United States
2016 through 2020
Germany
2015 through 2020
France
2017 through 2020
Japan
2015 through 2020
Ireland
2016 through 2020 Additionally, net operating loss and tax credit carryforwards from certain earlier periods in these jurisdictions may be subject to examination to the extent they are utilized in later periods. We incurred expenses related to stock-based compensation in 2020, 2019 and 2018 of $115.1 million, $86.4 million and $82.9 million, respectively. Accounting for the tax effects of stock-based awards requires that we establish a deferred tax asset as the compensation is recognized for financial reporting prior to recognizing the tax deductions. The tax benefit recognized in the Consolidated Statements of Operations related to stock-based compensation totaled $13.4 million, $16.6 million and $28.3 million in 2020, 2019 and 2018, respectively. Upon the settlement of the stock-based awards (i.e., exercise or vesting), the actual tax deduction is compared with the cumulative financial reporting compensation cost and any excess tax deduction is considered a windfall tax benefit and is recorded to the tax provision. In 2020, 2019 and 2018, windfall tax benefits of $1.3 million, $6.7 million and $13.2 million were recorded to the tax provision. Prior to the adoption of ASU 2016-09, windfall tax benefits were recorded to APIC when they resulted in a reduction in taxes payable. In the first quarter of 2018, as a result of the adoption of ASU 2016-09, we recognized previously unrecognized tax benefits of $37.0 million as increases in deferred tax assets for tax loss carryovers and tax credits, primarily in the U.S. A corresponding increase to the valuation allowance of $36.9 million was recorded because it was not more likely than not that these benefits would be realized. In April 2020, we became aware of a potential new interpretation of a withholding tax law in a non-U.S. jurisdiction and its application to certain transactions that was not previously reasonably knowable by us. We have evaluated this new interpretation and made an estimate of the potential tax liability, a reserve for which was recorded in the third quarter of 2020 and had an immaterial impact to our consolidated financial statements. In July 2015, the U.S. Tax Court issued an opinion in Altera Corp. v. Commissioner related to the treatment of stock-based compensation expense in an intercompany cost-sharing arrangement. The Company follows the 2015 Tax Court opinion, which was subsequently overturned by the Ninth Circuit Court of Appeals. All appeals have now been exhausted and the Altera decision is considered to be final in the Ninth Circuit. Because the Company does not reside in the Ninth Circuit and is therefore not bound by this decision, we have determined no adjustment is required to the consolidated financial statements as a result of this ruling. Prior to the passage of the U.S. Tax Act, the Company asserted that substantially all of the undistributed earnings of its foreign subsidiaries were considered indefinitely invested and accordingly, no deferred taxes were provided. Pursuant to the provisions of the U.S. Tax Act, these earnings were subjected to U.S. federal taxation via a one-time transition tax, and there is therefore no longer a material cumulative basis difference associated with the undistributed earnings. We maintain our assertion of our intention to permanently reinvest these earnings outside the U.S. unless repatriation can be done substantially tax-free, with the exception of a foreign holding company formed in 2018 and our Taiwan subsidiary. If we decide to repatriate any additional non-U.S. earnings in the future, we may be required to establish a deferred tax liability on such earnings. The amount of unrecognized deferred tax liability on the undistributed earnings would not be material. |
