Pieris Pharmaceuticals, Inc. 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

Dec. 31, 2018

The Company reported a loss before income taxes consisting of the following (in thousands):



	Years Ended December 31,
	2018			2017
Domestic	$	(10,633	)	$	(13,840	)
Foreign	(16,433		)	(2,704		)
Loss before income taxes	$	(27,066	)	$	(16,544	)

The components of the (benefit) provision for income taxes are as follows (in thousands):



	Years Ended December 31,
	2018			2017
Current:
Federal	$	—		$	—
State	—			—
Foreign	(148		)	1,103
Total current	(148		)	1,103
Deferred:
Federal	—			—
State	—			—
Foreign	(164		)	—
Total deferred	(164		)	—
(Benefit) provision for income taxes	$	(312	)	$	1,103

The reconciliation of the federal statutory rate to the Company’s effective tax rate is as follows:



	2018		2017
Federal income tax rate	21.0	%	34.0	%
Tax Reform - Change in enacted rate	—		(22.2	)
Foreign rate differential	7.4		(1.2	)
State tax, net of federal benefit	0.7		2.4
US tax on foreign income	(8.1	)	—
Share-based awards compensation	2.0		—
Permanent items	0.8		—
Other	0.5		1.8
Change in valuation allowance	(23.1	)	(21.5	)
Effective income tax rate	1.2	%	(6.7	)%

The components of deferred tax assets and liabilities related to net tax effects of temporary differences between the carrying amount of assets and liabilities for financial reporting purposes and the amounts used for income taxes purposes were as follows (in thousands):



	Years Ended December 31,
	2018			2017
Deferred tax assets:
Net operating loss carryforwards	$	27,879		$	22,170
Share-based awards compensation	2,359			1,280
Accrued compensation	304			350
Depreciation and other	125			89
Deferred Revenue	641			1,504
Total deferred tax assets	31,308			25,393
Deferred tax liabilities:
Unrealized gain on investments	(394		)	(143		)
Other	(98		)	—
Total deferred tax liabilities	(492		)	(143		)
Less: valuation allowance:	(30,816		)	(25,250		)
Net deferred tax asset	$	—		$	—

The Company operates in multiple jurisdictions. Accordingly, the Company files US federal and state income tax returns as well as returns in multiple foreign jurisdictions. In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income, and tax-planning strategies in making this assessment. Management believes it is more likely than not that the results of future operations will not generate sufficient taxable income in the United States or in its foreign jurisdictions to realize the full benefits of its deferred tax assets. As of December 31, 2018, we continue to maintain a full valuation allowance against all net deferred tax assets.

The cumulative amount of earnings of our foreign subsidiaries are expected to be permanently invested in the foreign subsidiaries. Deferred taxes have not been provided on the excess of book basis over tax basis, or the excess tax basis over book basis in the shares of our foreign subsidiaries because these basis differences are not expected to reverse in the foreseeable future and are essentially permanent in duration. Our intention is to reinvest the earnings of the foreign subsidiaries indefinitely.

The increase in the valuation allowance of deferred tax assets of $5.6 million was primarily influenced by the operating losses generated in current tax year.

As of December 31, 2018, the Company had net operating loss carryforwards for US federal income tax purposes of $15.3 million and net operating loss carryforwards for state income tax purposes of $20.1 million. Tax loss carryforwards that were created prior to December 31, 2017 expire through 2037, all tax loss carryforwards created after that date do not expire. In the United States, utilization of the NOL carryforwards may be subject to a substantial annual limitation under Section 382 of the Code and similar state provisions due to ownership change limitations that have occurred previously or that could occur in the future. These ownership changes may limit the amount of NOL carryforwards that can be utilized annually to offset future taxable income and tax, respectively. The Company has not currently completed a study to assess whether an ownership change has occurred, or whether there have been multiple ownership changes since the acquisition of the US entity in 2014. Since the Company has incurred net operating losses since inception, it has never been subject to a revenue agent review. The Company is currently open to examination under the statute of limitations by the Internal Revenue Service and state jurisdictions for the tax years ended 2014 through 2018. Carryforward tax attributes generated in years past may still be adjusted upon future examination if they have or will be used in a future period. The Company is currently not under examination by the Internal Revenue Service or any other jurisdictions for any tax years.

As of December 31, 2018, the Company had German corporate income tax and trade tax net operating loss carryforwards of approximately $80.3 million and $79.4 million respectively. Under current German laws, tax loss carryforwards may only be used to offset any relevant later assessment period (calendar year) $1.2 million plus 60% of the exceeding taxable income and trade profit of such period. In addition, certain transactions, including transfers of shares or interest in the loss holding entity, may result in the partial or total forfeiture of tax losses existing at that date. Partial or total forfeiture of tax losses may further occur in corporate reorganizations of the loss holding entity. Tax years ended December 31, 2014 or later remain subject to examination by the German tax authorities.

The Company accounts for uncertain tax positions pursuant to ASC 740 which prescribes a recognition threshold and measurement process for financial statement recognition of uncertain tax positions taken or expected to be taken in a tax return. If the tax position meets this threshold, the benefit to be recognized is measured at the largest amount of benefit that is more likely than not (determined by cumulative probability) of being realized upon ultimate settlement with the taxing authority. The Company recorded an uncertain tax position related to a prior year position, that if successfully challenged by tax authorities could result in the loss of certain tax attributes. The balance of uncertain tax positions will remain until such time that settlement is reached with the relevant tax authorities or should the statute of limitations expire. The Company recognizes interest and penalties, if any, related to uncertain tax positions in income tax expense. No interest and penalties related to uncertain tax positions were accrued at December 31, 2018 and December 31, 2017.

The following table sets forth a reconciliation of the beginning and ending amounts of unrecognized tax benefits, excluding the impact of interest and penalties, for the years ended December 31, 2018 and 2017 (in thousands):



Unrecognized tax benefits at December 31, 2017	$	6,451
Currency translation adjustment	(294		)
Unrecognized tax benefits at December 31, 2018	$	6,157

The Company does not expect unrecognized tax benefits to change significantly over the next 12 months. The full amount of unrecognized tax benefits would impact the effective rate, subject to valuation allowance considerations, if recognized.

Enacted Tax Legislation

On December 22, 2017, the TCJA was signed into law making significant changes to the Internal Revenue Code. Changes include, but are not limited to, a corporate tax rate decrease from 35% to 21% effective for tax years beginning after December 31, 2017, the transition of U.S international taxation from a worldwide tax system to a territorial system, and a one-time transition tax on the mandatory deemed repatriation of cumulative foreign earnings as of December 31, 2017. ASC 740 requires the tax effects of changes in tax laws must be recognized in the period in which the law is enacted, or December 22, 2017 for the Act. ASC 740 also requires deferred tax assets and liabilities to be measured at the enacted tax rate expected to apply when temporary differences are to be realized or settled. Thus, at the date of enactment, the Company’s deferred taxes were re-measured utilizing the new federal income tax rate of 21%. On December 22, 2017, the SEC staff issued Staff Accounting Bulletin No. 118, Income Tax Accounting Implications of the TCJA, or SAB 118, which allows the recording of provisional amounts during a measurement period not to extend beyond one year of the enactment date. In accordance with SAB 118, we determined that our deferred tax asset value and associated valuation allowance reduction of $3.7 million was a provisional amount and a reasonable estimate at December 31, 2017. The Company finalized its accounting for the impact of changes in US tax laws in the three months ended December 31, 2018. No significant adjustments to the provisional amount were made.

The TCJA also subjects a US shareholder to tax on global-intangible low tax income (GILTI) earned by certain foreign subsidiaries. An entity can make an accounting policy election to either recognize deferred taxes for temporary basis differences expected to reverse as GILTI in future years or to provide for the tax expense related to GILTI in the year the tax is incurred as a period expense only. The Company will account for GILTI in the year the tax is incurred as a period cost.