KLA Corporation Annual report pursuant to Section 13 and 15(d)

Annual report pursuant to Section 13 and 15(d)

Income Taxes

Income Taxes

12 Months Ended

Jun. 30, 2019

Income Tax Disclosure [Abstract]

INCOME TAXES

NOTE 13 — INCOME TAXES

The components of income before income taxes are as follows:



	Year ended June 30,
(In thousands)	2019		2018		2017
Domestic income before income taxes	$	545,401	$	716,015	$	615,906
Foreign income before income taxes	750,830		739,916		557,340
Total income before income taxes	$	1,296,231	$	1,455,931	$	1,173,246

The provision for income taxes is comprised of the following:



(In thousands)	Year ended June 30,
(In thousands)	2019			2018		2017
Current:
Federal	$	82,460		$	504,758	$	200,831
State	5,665			6,422		4,660
Foreign	59,274			41,414		38,208
	147,399			552,594		243,699
Deferred:
Federal	1,636			98,702		444
State	2,118			1,526		2,852
Foreign	(29,939		)	844		175
	(26,185		)	101,072		3,471
Provision for income taxes	$	121,214		$	653,666	$	247,170

The significant components of deferred income tax assets and liabilities are as follows:



(In thousands)	As of June 30,
(In thousands)	2019			2018
Deferred tax assets:
Tax credits and net operating losses	$	208,572		$	171,701
Employee benefits accrual	65,065			64,707
Stock-based compensation	9,432			8,902
Inventory reserves	67,249			62,232
Non-deductible reserves	21,633			29,841
Depreciation and amortization	—			701
Unearned revenue	16,126			11,104
Unrealized loss on investments	1,492			956
Other	55,518			25,602
Gross deferred tax assets	445,087			375,746
Valuation allowance	(166,571		)	(163,570		)
Net deferred tax assets	$	278,516		$	212,176
Deferred tax liabilities:
Unremitted earnings of foreign subsidiaries not indefinitely reinvested	$	(243,491	)	$	(7,146	)
Deferred profit	(15,718		)	(13,027		)
Depreciation and amortization	(515,643		)	—
Total deferred tax liabilities	(774,852		)	(20,173		)
Total net deferred tax assets (liabilities)	$	(496,336	)	$	192,003

The provision for income taxes and the significant components of deferred income tax assets and liabilities for the year ended June 30, 2019 includes the tax impact of the acquisition of Orbotech.

As of June 30, 2019, we, excluding Orbotech, had U.S. federal, state and foreign net operating loss (“NOL”) carry-forwards of approximately $20.5 million, $28.9 million and $23.1 million, respectively. Orbotech had U.S. federal, state, and foreign NOLs of approximately $49.0 million, $27.5 million and $53.6 million, respectively. Orbotech also had capital loss carry-forwards of approximately $44.6 million. The U.S. federal NOL carry-forwards will expire at various dates beginning in 2023 through 2033. The utilization of NOLs created by acquired companies is subject to annual limitations under Section 382 of the Internal Revenue Code. However, it is not expected that such annual limitation will significantly impair the realization of these NOLs. The state NOLs will begin to expire in 2019. Foreign NOLs and capital loss carry-forwards will be carried forward indefinitely. State credits of $225.8 million for us including Orbotech, will also be carried forward indefinitely.

The net deferred tax asset valuation allowance was $166.6 million and $163.6 million as of June 30, 2019 and June 30, 2018, respectively. The change was primarily due to an increase in the valuation allowance related to state credit carry-forwards generated in the fiscal year ended June 30, 2019, partially offset by a decrease in the valuation allowance related to foreign NOL carry-forwards. The valuation allowance is based on our assessment that it is more likely than not that certain deferred tax assets will not be realized in the foreseeable future. Of the valuation allowance as of June 30, 2019, $163.2 million relates to federal and state credit carry-forwards. The remainder of the valuation allowance relates to state NOL carry-forwards.

As of June 30, 2019, we intend to indefinitely reinvest $2.94 billion of cumulative undistributed earnings held by certain non-U.S. subsidiaries. If these undistributed earnings were repatriated to the U.S., the potential deferred tax liability associated with the undistributed earnings would be approximately $104.8 million.

We benefit from tax holidays in Israel and Singapore where we manufacture certain of our products. These tax holidays are on approved investments and are scheduled to expire at varying times in the next one to nine years. We are in compliance with all the terms and conditions of the tax holidays as of June 30, 2019. The net impact of these tax holidays was to decrease our tax expense by approximately $31.6 million, $39.7 million and $32.6 million in the fiscal years ended June 30, 2019, 2018 and 2017, respectively. The benefits of the tax holidays on diluted net income per share were $0.20, $0.25 and $0.21 for the fiscal years ended June 30, 2019, 2018 and 2017, respectively.

Our Israel tax holiday is scheduled to expire in June 2020. We will adopt Israel’s Preferred Technology Enterprise (“PTE”) regime after the expiration of the current holiday.

The reconciliation of the U.S. federal statutory income tax rate to our effective income tax rate is as follows:



	Year ended June 30,
	2019		2018		2017
Federal statutory rate	21.0	%	28.1	%	35.0	%
State income taxes, net of federal benefit	0.5	%	0.5	%	0.4	%
Effect of foreign operations taxed at various rates	(10.5	)%	(11.0	)%	(12.2	)%
Tax Cuts and Jobs Act of 2017 - Transition tax and deferred tax effects	(1.5	)%	30.3	%	—	%
Global intangible low-taxed income	3.5	%	—	%	—	%
Foreign derived intangible income	(4.0	)%	—	%	—	%
Research and development tax credit	(1.8	)%	(1.4	)%	(1.1	)%
Net change in tax reserves	1.4	%	(0.4	)%	1.3	%
Domestic manufacturing benefit	—	%	(1.1	)%	(1.5	)%
Effect of stock-based compensation	0.4	%	(0.1	)%	(0.2	)%
Other	0.4	%	—	%	(0.6	)%
Effective income tax rate	9.4	%	44.9	%	21.1	%

A reconciliation of gross unrecognized tax benefits is as follows:



	Year ended June 30,
(In thousands)	2019			2018			2017
Unrecognized tax benefits at the beginning of the year	$	63,994		$	68,439		$	50,365
Increases for tax positions from acquisitions	60,753			—			—
Increases for tax positions taken in prior years	13,001			4,642			6,788
Decreases for tax positions taken in prior years	(1,304		)	(6,045		)	(246		)
Increases for tax positions taken in current year	26,178			16,812			14,696
Decreases for settlements with taxing authorities	—			(9,666		)	—
Decreases for lapsing of statutes of limitations	(16,196		)	(10,188		)	(3,164		)
Unrecognized tax benefits at the end of the year	$	146,426		$	63,994		$	68,439

The amount of unrecognized tax benefits that would impact the effective tax rate was $136.1 million, $57.9 million and $68.4 million as of June 30, 2019, 2018 and 2017, respectively. The amount of interest and penalties recognized during the years ended June 30, 2019, 2018 and 2017 was expense of $2.9 million, expense of $0.1 million, and income of $2.2 million as a result of a release of unrecognized tax benefits, respectively. Our policy is to include interest and penalties related to unrecognized tax benefits within other expense (income), net. The amount of interest and penalties accrued as of June 30, 2019 and 2018 was approximately $21.8 million and $6.0 million, respectively.

We are subject to federal income tax examinations for all years beginning from the fiscal year ended June 30, 2016 and are under U.S. federal income tax examination for the fiscal year ended June 30, 2016. We are subject to state income tax examinations for all years beginning from the fiscal year ended June 30, 2015. We are also subject to examinations in other major foreign jurisdictions, including Singapore and Israel, for all years beginning from the calendar year ended December 31, 2012. We are under audit in Germany related to a wholly owned subsidiary of Orbotech for the years ended December 31, 2013 to December 31, 2015.

In May 2017, Orbotech received an assessment from the Israel Tax Authority (“ITA”) with respect to its fiscal years 2012 through 2014 (the “Assessment”, and the “Audit Period”, respectively), for an aggregate amount of tax against us, after offsetting all NOLs for tax purposes available through the end of 2014, of approximately NIS 218 million (approximately $61.0 million as of June 30, 2019), which amount includes related interest and linkage differentials to the Israeli consumer price index (as of date of the Assessment). We believe our recorded unrecognized tax benefits are sufficient to cover the resolution of the Assessment.

On August 31, 2018, Orbotech filed an objection in respect of the tax assessment (the “Objection”). Orbotech is now in the process of the second stage, in which the claims raised by it in the Objection are examined by different personnel at the ITA. In addition, the ITA can examine additional items and may assess additional amounts in the second stage. The second stage must be completed within one year of when the Objection was filed.

In connection with the above, there is an ongoing criminal investigation in Israel against Orbotech, which became our wholly owned subsidiary as of the acquisition date, certain of its employees and its tax consultant. On April 11, 2018, Orbotech received a “suspect notification letter” (dated March 28, 2018) from the Tel Aviv District Attorney’s Office (Fiscal and Financial). In the letter, it was noted that the investigation file was transferred from the Assessment Investigation Officer to the District Attorney’s Office. The letter further states that the District Attorney’s Office has not yet made a decision regarding submission of an indictment against Orbotech; and that if after studying the case, a decision is made to consider prosecuting Orbotech, Orbotech will receive an additional letter, and within 30 days, Orbotech may present its arguments to the District Attorney’s Office as to why it should not be indicted. To date, neither we nor Orbotech has received such an additional letter or any other correspondence or contact from the District Attorney’s Office. We will continue to monitor the progress of the District Attorney's Office investigation, however, cannot anticipate when the review of the case will be completed and what will be the results thereof. We intend to cooperate with the District Attorney’s Office to enable them to conclude their investigation.

It is possible that certain examinations may be concluded in the next twelve months. We believe that we may recognize up to $14.3 million of our existing unrecognized tax benefits within the next twelve months as a result of the lapse of statutes of limitations and the resolution of examinations with various tax authorities.