Annual report pursuant to Section 13 and 15(d)

NOTE 13: - INCOME TAXES

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NOTE 13: - INCOME TAXES
12 Months Ended
Dec. 31, 2016
Income Tax Disclosure [Abstract]  
Income Tax Disclosure [Text Block]
NOTE 13:–                      INCOME TAXES

a.           General:

As of December 31, 2016, Arotech has net operating loss (“NOL”) carryforwards for U.S. federal income tax purposes of $46.9 million, which are available to offset future taxable income, if any, expiring in 2021 through 2037. Utilization of U.S. net operating losses is subject to substantial annual limitations due to the “change in ownership” provisions of the Internal Revenue Code of 1986 and similar state provisions. The annual limitation may result in the expiration of net operating losses before utilization.

At December 31, 2016, the Company had net deferred tax assets before valuation allowance of $43.0 million. The deferred tax assets are primarily composed of federal, state and foreign tax NOL carryforwards. Due to uncertainties surrounding the Company’s ability to generate future taxable income to realize these assets, a full valuation allowance has been established to offset its net deferred tax asset. Additionally, the future utilization of the Company’s NOL carryforwards to offset future taxable income is subject to a substantial annual limitation as a result of IRC Section 382 changes that have occurred. Any carryforwards that will expire prior to utilization as a result of such limitations will be removed from deferred tax assets with a corresponding reduction of the valuation allowance.

The Company has indefinite-lived intangible assets consisting of trademarks and goodwill. These intangible assets are not amortized for financial reporting purposes. However, these assets are tax deductible, and therefore amortized over 15 years for tax purposes. As such, deferred income tax expense and a deferred tax liability arise as a result of the tax-deductibility of these assets. The resulting deferred tax liability, which is expected to continue to increase over time, will have an indefinite life, resulting in what is referred to as a “naked tax credit.” This deferred tax liability could remain on the Company’s balance sheet permanently unless there is an impairment of the related assets (for financial reporting purposes), or the business to which those assets relate were to be disposed of. Due to the fact that the aforementioned deferred tax liability could have an indefinite life, it is not netted against the Company’s deferred tax assets when determining the required valuation allowance. Doing so would result in the understatement of the valuation allowance and related deferred income tax expense.

The Company has also evaluated its income tax positions under FASB ASC 740-10 as of December 31, 2016 and the Company believes that it has no material uncertain tax positions and therefore has no uncertain tax position reserves and does not expect to provide for any such reserves. The Company does not believe that the unrecognized tax benefits will change within 12 months of this reporting date. It is the Company’s policy that any assessed penalties and interest on uncertain tax positions would be charged to income tax expense.

The Company does not provide for U.S. federal income taxes on the undistributed earnings of its foreign subsidiaries because such earnings, if any, are re-invested and, in the opinion of management, will continue to be re-invested indefinitely.

The Company files income tax returns, including returns for its subsidiaries, with federal, state, local and foreign jurisdictions. The Company is currently under examination by the IRS for 2014.  The Company is no longer subject to IRS examination for periods prior to 2013 although carryforward losses that were generated prior to 2013 may still be adjusted by the IRS if they are used in a future period. Additionally, the Company is no longer subject to examination in Israel for periods prior to 2014.

The Company files consolidated tax returns for its U.S. entities.

b.           Israeli subsidiary (Epsilor-EFL):

Epsilor-EFL’s tax rate was 25% for 2016 and 26.5% for 2015 and 2014, respectively. In addition, dividends paid from the profits of Epsilor-EFL are subject to tax at the rate of 15% in the hands of their recipient. Management has indicated that it has no intention of declaring a dividend.

The Israeli government has established certain development zones so as to incentivize business development and export activities. Companies that reside in this zone and meet certain criteria are subject to a favorable tax rates. Epsilor-EFL is located in an approved development zone, however, currently does not meet the criteria established by the government to obtain the tax incentives.

As of December 31, 2016, the Company has tax loss carryforwards, generated by the predecessor of Epsilor-EFL, of $82.1 million, which is available indefinitely to offset future taxable income. Due to the 2009 merger of EFL-Epsilor, the utilization of the tax loss carryforward is subject to annual limitations.

c.           Consolidated deferred income taxes:

Deferred income taxes reflect tax credit carryforwards and the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and amounts used for income tax purposes. Significant components of the Company’s deferred tax assets are as follows:

 
 
December 31,
 
 
 
2016
   
2015
 
U.S. operating loss carryforward
 
$
16,869,205
   
$
14,814,390
 
Foreign operating loss carryforward
   
19,696,756
     
20,228,547
 
Total operating loss carryforward
   
36,565,961
     
35,042,937
 
 
               
Temporary differences:
               
Compensation and benefits
   
2,417,056
     
2,417,056
 
Warranty reserves
   
1,263,499
     
1,394,672
 
Foreign temporary differences
   
1,112,113
     
735,948
 
All other temporary differences
   
1,704,555
     
2,327,485
 
Total temporary differences
   
6,497,223
     
6,875,161
 
 
               
Deferred tax asset before valuation allowance
   
43,063,184
     
41,918,098
 
Valuation allowance
   
(43,063,184
)
   
(41,918,098
)
 
               
Total deferred tax asset
 
$
   
$
 
 
               
Deferred tax liability – intangible assets
 
$
7,868,123
   
$
7,031,564
 

The Company provided valuation allowances for the deferred tax assets resulting from tax loss carryforwards and other temporary differences. At present, management currently believes that it is more likely than not that the deferred tax assets related to the operating loss carryforwards and other temporary differences will not be realized.

d.           Income from continuing operations before taxes on income are as follows:

 
 
Year ended December 31
 
 
 
2016
   
2015
   
2014
 
Domestic
 
$
(2,133,486
)
 
$
(3,071,694
)
 
$
4,455,370
 
Foreign
   
1,437,332
     
2,181,671
     
451,649
 
 
 
$
(696,154
)
 
$
(890,023
)
 
$
4,907,019
 

e.           Taxes on income were comprised of the following:

 
 
Year ended December 31
 
 
 
2016
   
2015
   
2014
 
Current federal taxes
 
$
   
$
   
$
183,758
 
Current state and local taxes
   
(24,634
)
   
246,403
     
316,444
 
Deferred taxes
   
836,561
     
914,543
     
598,500
 
Taxes in respect of prior years
   
(28,507
)
   
     
(74,865
)
Expense
 
$
783,420
   
$
1,160,946
   
$
1,023,837
 

f.            A reconciliation between the theoretical tax expense, assuming all income is taxed at the U.S. federal statutory tax rate applicable to income of the Company and the actual tax expense as reported in the Statements of Comprehensive Income is as follows:

 
 
Year ended December 31,
 
 
 
2016
   
2015
   
2014
 
Income (loss) from continuing operations before taxes
 
$
(696,154
)
 
$
(890,023
)
 
$
4,907,019
 
 
                       
Statutory tax rate
   
34
%
   
34
%
   
34
%
Theoretical income tax on the above amount at the U.S. statutory tax rate
 
$
(236,692
)
 
$
(302,608
)
 
$
1,668,386
 
Deferred taxes for which valuation allowance was provided
   
589,912
     
1,413,567
     
(969,983
)
Non-deductible expenses
   
22,746
     
31,841
     
66,720
 
State taxes, net of federal benefit
   
(16,258
)
   
181,771
     
269,508
 
Foreign income in tax rates other than U.S. rate
   
452,219
     
(163,625
)
   
(119,687
)
Taxes in respect of prior years
   
(28,507
)
   
     
(74,865
)
Alternative minimum tax for which valuation allowance was not provided
   
     
     
183,758
 
 
                       
Actual tax expense
 
$
783,420
   
$
1,160,946
   
$
1,023,837