Annual report pursuant to Section 13 and 15(d)

NOTE 14: - INCOME TAXES

v2.4.1.9
NOTE 14: - INCOME TAXES
12 Months Ended
Dec. 31, 2014
Income Tax Disclosure [Abstract]  
Income Tax Disclosure [Text Block]
NOTE 14:–                      INCOME TAXES

a.                 General:

As of December 31, 2014, Arotech has net operating loss (“NOL”) carryforwards for U.S. federal income tax purposes of $35,000,000, which are available to offset future taxable income, if any, expiring in 2021 through 2032. 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, 2014, the Company had net deferred tax assets before valuation allowance of $40.3 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 indefinitely-lived 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 indefinitely-lived intangible 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 indefinitely 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, 2014 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 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 no longer subject to IRS examination for periods prior to 2010, although carryforward losses that were generated prior to 2011 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 2010.

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

b.                 Israeli subsidiary (Epsilor-EFL):

Epsilor-EFL’s tax rate was 7.0% and 7.0% in 2014 and 2013, respectively, and will be reduced to 9% in 2015. 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 and tax exempt on dividends paid to an Israeli company. As of December 31, 2014, there are no tax exempt profits earned by Epsilor–EFL by Israel law that will be distributed as a dividend, and accordingly, no deferred tax liability was recorded as of December 31, 2014. Furthermore, management has indicated that it has no intention of declaring any dividend.

On August 5, 2013, the Law for Change of National Priorities (Legislative Amendments for Achieving the Budgetary Goals for 2013-2014), 2013 (hereinafter - the 2013 Amendments) was published in Reshumot (the Israeli government official gazette), which enacts, among other things, the following amendments:

·  
Raising the corporate tax rate to 26.5% (instead of 25%) beginning in 2014 and thereafter.

·  
Commencing tax year 2014 and thereafter the tax rate on the income of preferred enterprises of a qualifying company in Development Zone A as stated in the Encouragement of Capital Investment Law, 1959 (hereinafter - the Encouragement Law) shall increase to 9% (instead of 7% in 2014 and 6% in 2015 and thereafter) and for companies located in zones other than Zone A the rate shall increase to 16% (instead of 12.5% in 2014 and 12% in 2015 and thereafter).

·  
In addition, the tax rate on dividends distributed on January 1, 2014 and thereafter originating from preferred income under the Encouragement Law will be raised to 20% (instead of 15%).

c.                 Merger of Epsilor and EFL:

On June 25, 2009, two of the Company’s Israeli subsidiaries, Epsilor and EFL, entered into a merger agreement pursuant to which EFL merged all of its assets and liabilities into Epsilor, with Epsilor the survivor of the merger (the “Merged Company”).

Through the merger date, EFL accumulated certain tax losses (the “EFL Loss”). 20% of the EFL Loss was cancelled and is not available to offset any future income. The remaining amount of the EFL Loss (the “Remaining Loss”) was absorbed into the Merged Company and is available to offset the Merged Company’s income after July 1, 2009; provided that for the 16 tax years following the merger, losses will not be available to offset the Merged Company’s income in excess of the lesser of (i) 6.25% of the original amount of the Remaining Loss, or (ii) 50% of the Merged Company’s total taxable income in that year prior to giving effect to the application of any of the EFL Loss.

As of December 31, 2014, the Merged Company has tax loss carryforwards, generated by EFL, of $85.1 million, which is available indefinitely to offset future taxable income.

d.                 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,
 
   
2014
   
2013
 
U.S. operating loss carryforward
 
$
12,163,441
   
$
15,836,153
 
Foreign operating loss carryforward
   
21,284,600
     
23,852,782
 
Total operating loss carryforward
   
33,448,041
     
39,688,935
 
                 
Temporary differences:
               
Compensation and benefits
   
2,438,804
     
2,321,718
 
Warranty reserves
   
1,743,409
     
1,165,515
 
Foreign temporary differences
   
711,222
     
445,129
 
All other temporary differences
   
1,979,413
     
2,321,650
 
Total temporary differences
   
6,872,848
     
6,254,012
 
                 
Deferred tax asset before valuation allowance
   
40,320,889
     
45,942,947
 
Valuation allowance
   
(40,320,889
)
   
(45,942,947
)
                 
Total deferred tax asset
 
$
   
$
 
                 
Deferred tax liability – intangible assets
 
$
6,117,021
   
$
5,518,521
 

The Company provided valuation allowances for the deferred tax assets resulting from tax loss carryforwards and other temporary differences. 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. The change in the valuation allowance during 2014 was $5.6 million).

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

   
Year ended December 31
 
   
2014
   
2013
 
Domestic
 
$
4,455,370
   
$
4,215,005
 
Foreign
   
55,428
     
(888,315
)
   
$
4,510,798
   
$
3,326,690
 

f.                 Taxes on income were comprised of the following:

   
Year ended December 31
 
   
2014
   
2013
 
Current federal taxes
 
$
183,758
   
$
117,448
 
Current state and local taxes
   
316,444
     
210,299
 
Deferred taxes
   
598,500
     
598,500
 
Taxes in respect of prior years
   
(74,865
   
126,473
 
Expense
 
$
1,023,837
   
$
1,052,720
 
                 
Domestic
 
$
1,098,702
   
$
926,247
 
Foreign
   
(74,865
)    
126,473
 
Expense
 
$
1,023,837
   
$
1,052,720
 

g.                 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,
 
   
2014
   
2013
 
Income from continuing operations before taxes
 
$
4,510,798
   
$
3,326,690
 
                 
Statutory tax rate
   
34
%
   
34
%
Theoretical income tax on the above amount at the U.S. statutory tax rate
 
$
1,533,671
   
$
1,131,075
 
Deferred taxes for which valuation allowance was provided
   
(949,966
)
   
(797,899
)
Non-deductible credits
   
66,720
     
67,928
 
State taxes, net of federal benefit
   
269,508
     
327,747
 
Foreign income in tax rates other than U.S. rate
   
(4,989
)    
79,948
 
Taxes in respect of prior years
   
(74,865
   
126,473
 
Alternative minimum tax for which valuation allowance was not provided
   
183,758
     
117,448
 
                 
Actual tax expense
 
$
1,023,837
   
$
1,052,720