NOTE 3

INCOME TAXES

On December 22, 2017, the U.S. government enacted comprehensive tax legislation commonly referred to as the Tax Cuts and Jobs Act (the “Tax Act”). The Tax Act made broad and complex changes to the U.S. tax code by reducing the U.S. federal corporate tax rate from 34 percent to 21 percent, requiring companies to pay a one-time transition tax on certain unrepatriated earnings of foreign subsidiaries, generally eliminating U.S. federal income taxes on dividends from foreign subsidiaries, creating a new limitation on deductible interest expense and changing rules related to uses and limitations of net operating loss carryforwards created in tax years beginning after December 31, 2017.

The SEC staff subsequently issued Staff Accounting Bulletin 118 (“SAB 118”), which provides a one-year measurement for companies to complete the accounting for the effects of the Tax Act. In accordance with SAB 118, where accounting is complete, a company must reflect the income tax effects of those aspects, but to the extent that a company’s accounting is incomplete but a reasonable estimate may be made, a provisional estimate should be recorded in the financial statements. Where a company is unable to determine a provisional estimate, SAB 118 permits application of the tax laws that were in effect immediately before the enactment.

Due to the reduction of the corporate tax rate as part of the Tax Act, the Company recorded during the third quarter of Fiscal 2018 a provisional decrease to deferred tax assets of $780,195 and corresponding decrease to the valuation allowance. The change in tax rate did not impact tax expense due to the valuation allowance recorded against the net deferred tax asset.

The Act also provided for a tax on the deemed repatriation of previously untaxed accumulated earnings and profits of foreign subsidiaries. The Company was not subject to this tax due to an accumulated loss in the Company’s foreign subsidiary.

The provision for income taxes is as follows:

 

		Year ended May 31,
		2018				2017				2016
Current		$	25,915			$	28,009			$	20,002
Deferred			808,548				(356,169	)			(533,357	)
Change in valuation allowance			(808,548	)			356,169				533,357
Total provision for income taxes		$	25,915			$	28,009			$	20,002

 

Deferred tax assets are comprised of the following components:

 

		2018				2017
Basis difference of assets		$	202,763			$	307,846
Inventory related items			189,893				287,543
Other reserves and liabilities			87,519				122,083
Net operating loss carryforward			1,136,358				1,723,418
General business and other credit carryforward			456,343				449,048
Other deferred items, net			29,182				20,667
Gross deferred tax assets			2,102,058				2,910,605
Deferred tax asset valuation allowance			(2,102,058	)			(2,910,605	)
Net deferred tax asset		$	0			$	0

Deferred tax assets are evaluated and a valuation allowance is established if it is more likely than not that all or a portion of the deferred tax asset will not be realized. The Company has recorded a substantial deferred tax asset related to temporary differences between book and tax basis of assets and liabilities. During the year ended May 31, 2018, the Company decreased its valuation allowance $808,548 as a result of the decrease in the Company’s deferred tax assets due to the impact of the reduction of the corporate rate as part of the Tax Act and current year income. During the years ended May 31, 2017 and 2016, the Company increased its valuation allowance $356,169 and $533,357, respectively, as a result of the increase in the Company’s deferred tax assets. The Company has provided a full valuation allowance against all of its deferred tax assets as the recent losses have been given more weight than projected future income when determining the need for a valuation allowance.

The Company has federal net operating loss carryforwards of approximately $4.2 million which begin to expire in 2030 along with the federal general business and other credit carryforwards. The Company has state net operating loss carryforwards of approximately $4.7 million which begin to expire in 2024.

The provision for income taxes differs from the amount of income taxes determined by applying the U.S. statutory federal tax rate to pre-tax loss due to the following:

 

		Year ended May 31,
		2018				2017				2016
Statutory federal tax rate			28.6	%			(34.0	)%			(34.0	)%
State taxes, net of federal benefit			2.6				(4.4	)			(4.4	)
Change in deferred tax valuation allowance			(350.8	)			34.1				35.7
Impact of Tax Act			329.8				0.0				0.0
Stock-based compensation			6.6				2.2				1.2
R&E tax credits			1.6				1.6				0.7
Effect of foreign income tax rates			1.3				(0.3	)			1.1
Deferred tax true-up			(12.6	)			1.8				0.3
State minimum taxes			5.1				1.1				0.4
Permanent and other differences			(1.2	)			0.6				0.3
Effective tax rate			11.0	%			2.7	%			1.3	%

Each year the Company files income tax returns in the various federal, state and local income taxing jurisdictions in which it operates. These tax returns are subject to examination and possible challenge by the taxing authorities. Positions challenged by the taxing authorities may be settled or appealed by the Company. As a result, there is an uncertainty in income taxes recognized in the Company’s financial statements in accordance with ASC Topic 740. The Company applies this guidance by defining criteria that an individual income tax position must meet for any part of the benefit of that position to be recognized in an enterprise’s financial statements and provides guidance on measurement, derecognition, classification, accounting for interest and penalties, accounting in interim periods, disclosure, and transition. The liability for unrecognized tax benefits was $0 as of May 31, 2018 and 2017.

Interest and penalties associated with uncertain tax positions are recognized as components of the “Provision for income taxes.” The liability for payment of interest and penalties was $0 as of May 31, 2018 and 2017.

Several tax years are subject to examination by major tax jurisdictions. In the United States, federal tax years ended May 31, 2015 and after are subject to examination. In the United Kingdom, tax years ended May 31, 2013 and after are subject to examination.