Veru 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

Sep. 30, 2020

Note 14 – Income Taxes

The Company accounts for income taxes using the liability method, which requires the recognition of deferred tax assets or liabilities for the tax-effected temporary differences between the financial reporting and tax bases of its assets and liabilities, and for net operating loss (NOL) and tax credit carryforwards.

On December 22, 2017, significant changes were enacted to the U.S. tax law pursuant to the federal tax legislation commonly referred to as the Tax Cuts and Jobs Act of 2017 (the “Tax Act”). The Tax Act includes a permanent reduction in the U.S. federal corporate income tax rate from 35% to 21%, a one-time repatriation tax on deferred foreign income, and changes to deductions, credits and business-related exclusions.

The Tax Act repealed the alternative minimum tax (AMT) for corporations. The law provided that AMT carryovers could be utilized to reduce or eliminate the tax liability in subsequent years or to obtain a tax refund. The Company had $0.5 million of its AMT credit carryovers in prepaid expenses and other current assets and other assets due to the expectation that the AMT credits will be refundable over the next several years as of September 30, 2019. The Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”), which was enacted on March 27, 2020, accelerated the ability to claim a refund of the entire refundable credit to 2018, with an election when filing. The Company received the refund of $0.5 million in August 2020.

The Tax Act also limited the annual net interest deduction to 30% of the Company’s adjusted taxable income (ATI), beginning in 2018. Any excess may be carried over and offset taxable income in a future year within the allowable limit. The CARES Act raised the limit on business interest deductions from 30% of ATI to 50% of ATI for the 2019 and 2020 tax years. However, the Tax Act also provided an exemption for qualified small businesses or businesses with average gross receipts of $25 million or less for the three previous tax years. The Company was not subject to the limitation in prior years because it qualified as a small business. Beginning fiscal 2020, the Company no longer qualifies for the exemption and recorded a deferred tax asset for $0.9 million.

In the U.K., the corporation tax rate was scheduled to decline from 19% to 17% commencing April 1, 2020. In March 2020, the U.K. government announced the U.K. tax rate would remain at 19%, which was enacted in July 2020 upon Royal Assent of the Finance Act 2020. The increase in the tax rate increased the value of the deferred tax assets in the U.K. to the newly enacted tax rate, which resulted in a $1.3 million income tax benefit for the year ended September 30, 2020.

Within the calculation of the Company’s annual effective tax rate the Company has used assumptions and estimates that may change as a result of future guidance, interpretations, and rule-making from the Internal Revenue Service, the SEC, the FASB and/or various other taxing jurisdictions. For example, the Company anticipates that state jurisdictions will continue to determine and announce their conformity to the Tax Act which would have an impact on the annual effective tax rate. The Company’s calculations are based on the information available, prepared or analyzed (including computations) in reasonable detail.

The Company completes a detailed analysis of its deferred income tax valuation allowances on an annual basis or more frequently if information comes to its attention that would indicate that a revision to its estimates is necessary. In evaluating the Company’s ability to realize its deferred tax assets, management considers all available positive and negative evidence on a country-by-country basis, including past operating results, forecasts of future taxable income, and the potential Section 382 limitation on the NOL carryforwards due to a change in control. In determining future taxable income, management makes assumptions to forecast U.S. federal and state, U.K. and Malaysia operating income, the reversal of temporary differences, and the implementation of any feasible and prudent tax planning strategies. These assumptions require significant judgment regarding the forecasts of the future taxable income in each tax jurisdiction and are consistent with the forecasts used to manage the Company’s business. From fiscal 2006 through fiscal 2015, the Company generated taxable income on a consolidated basis. However, the Company had a cumulative pretax loss in the U.S. for fiscal 2020 and the two preceding fiscal years. Forming a conclusion that a valuation allowance is not needed is difficult when there is significant negative evidence such as cumulative losses in recent years. Management has projected future pretax losses in the U.S. driven by the investment in research and development, and based on their analysis concluded that an additional valuation allowance of $4.1 million should be recorded against the U.S. deferred tax assets related to federal and state NOL carryforwards as of September 30, 2020. As of September 30, 2020 and 2019 respectively, the Company has recorded a valuation allowance of $11.7 million and $7.6 million against U.S. deferred tax assets. In addition, the Company’s U.K. holding company for the non-U.S. operating companies, The Female Health Company Limited, continues to have a full valuation allowance of $2.4 million. The operating U.K. subsidiary, The Female Health Company (UK) plc does not have a valuation allowance due to projections of future taxable income for the next 10 years.

The Tax Act caused NOLs generated in taxable years ending after December 31, 2017 to have an indefinite carryforward period. Indefinite-lived intangibles such as the IPR&D assets that are recorded as U.S. deferred tax liabilities or “naked credits” could be utilized as a source of taxable income against those NOLs. The U.S. has a full valuation allowance except to the extent the naked credits are expected to reverse and generate indefinite-lived NOLs. The Company had $18 million in IPR&D assets that represented $4.1 million in deferred tax liabilities as of September 30, 2019. The $14.1 million impairment of the IPR&D assets recognized in the year ended September 30, 2020 resulted in additional tax expense and in increase in the valuation allowance of $3.2 million as of September 30, 2020. The IPR&D deferred tax liability balance as of September 30, 2020 is $0.9 million.

As of September 30, 2020, the Company had U.S. federal and state NOL carryforwards of approximately $41.7 million and $25.7 million, respectively, for income tax purposes with $13.5 million and $19.8 million, respectively, expiring in years 2022 to 2038 and $28.2 million and $5.9 million, respectively, which can be carried forward indefinitely. The Company’s U.K. subsidiary has U.K. NOL carryforwards of approximately $61.3 million as of September 30, 2020, which can be carried forward indefinitely to be used to offset future U.K. taxable income.

Income (loss) before income taxes was taxed by the following jurisdictions for the years ended September 30, 2020 and 2019:


	2020		2019

Domestic	$	(20,008,999)	$	(12,838,076)
Foreign		(42,977)		516,777
Total	$	(20,051,976)	$	(12,321,299)

A reconciliation between the effective tax rate and the U.S. statutory rate and the related income tax benefit is as follows:


	2020				2019
	Amount		Tax Rate		Amount		Tax Rate
Income tax benefit at U.S. federal statutory rates	$	(4,210,916)	21.0	%	$	(2,587,472)	21.0	%
State income tax benefit, net of federal benefits		(326,045)	1.6			(200,385)	1.6
Effect of change in U.K. tax rate		(1,337,263)	6.7			—	—
Non-deductible expenses – other		114,699	(0.6)			8,171	(0.1)
Effect of foreign income tax rates		238,645	(1.2)			67,637	(0.5)
Effect of global intangible low-taxed income		143,219	(0.7)			99,514	(0.8)
Effect of change in state tax rate		—	—			57,981	(0.5)
Other		54,689	(0.2)			51,490	(0.4)
Change in valuation allowance		4,244,531	(21.2)			2,199,131	(17.8)
Income tax benefit	$	(1,078,441)	5.4	%	$	(303,933)	2.5	%

The federal and state income tax (benefit) expense for the years ended September 30, 2020 and 2019 is summarized below:



	2020		2019

Deferred – U.S.	$	(229,313)	$	(552,018)
Deferred – U.K.		(1,033,131)		76,246
Deferred – Malaysia		7,432		37,708
Subtotal		(1,255,012)		(438,064)

Current – U.S.		(10,484)		(2,728)
Current – Malaysia		187,055		136,859
Subtotal		176,571		134,131

Income tax benefit	$	(1,078,441)	$	(303,933)

Significant components of the Company’s deferred tax assets and liabilities are as follows:



	2020		2019
Deferred tax assets:
Federal net operating loss carryforwards	$	8,759,589	$	8,971,569
State net operating loss carryforwards		1,682,104		1,689,536
AMT credit carryforward		—		35,180
Foreign net operating loss carryforwards – U.K.		11,655,853		10,486,476
Foreign capital allowance – U.K.		113,522		103,400
U.K. bad debts		1,900		1,700
Share-based compensation – U.K.		91,839		49,081
U.S. deferred rent		40,236		43,558
Share-based compensation		1,255,983		804,378
Interest expense		850,248		—
Other, net – U.S.		334,706		356,026
Gross deferred tax assets		24,785,980		22,540,904
Valuation allowance for deferred tax assets		(14,074,740)		(9,830,209)
Net deferred tax assets		10,711,240		12,710,695
Deferred tax liabilities:
In process research and development		(882,427)		(4,072,740)
Developed technology		(369,237)		(424,657)
Covenant not-to-compete		(49,832)		(65,993)
Other, net – Malaysia		(11,297)		(3,865)
Other		(6,371)		(6,376)
Net deferred tax liabilities		(1,319,164)		(4,573,631)
Net deferred tax asset	$	9,392,076	$	8,137,064

The deferred tax amounts have been classified in the accompanying consolidated balance sheets as follows:



	2020		2019

Long-term deferred tax asset – U.K.	$	9,466,800	$	8,433,669
Total long-term deferred tax asset	$	9,466,800	$	8,433,669

Long-term deferred tax liability – U.S.	$	(63,427)	$	(292,740)
Long-term deferred tax liability – Malaysia		(11,297)		(3,865)
Total long-term deferred tax liability	$	(74,724)	$	(296,605)

ASC Topic 740 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. ASC Topic 740 developed a two-step process to evaluate a tax position and also provides guidance on de-recognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. The Company has not recorded a reserve for any tax positions for which the ultimate deductibility is highly certain but for which there is uncertainty about the timing of such deductibility.

The Company files tax returns in all appropriate jurisdictions, including foreign, U.S. federal and state tax returns. The following summarizes open tax years in the relevant jurisdictions:

For the U.S., a tax return may be audited any time within 3 years from filing date. The U.S. open tax years are for fiscal 2017 through 2019, which expire in years 2021 through 2023, respectively.

For Malaysia, a tax return may be audited any time within 5 years from filing date (7 months after the fiscal year end). The Malaysia open tax years are for 2015 through 2019, which expire on December 31, 2020 through 2024.

For the U.K., a tax return may be audited within 1 year from the later of: the filing date or the filing deadline (1 year after the end of the accounting period). The U.K. open tax year is for 2019, which expires in 2021.

The fiscal 2020 tax returns for all jurisdiction have not been filed as of the date of this filing. As of September 30, 2020 and 2019, the Company has no recorded liability for unrecognized tax benefits.

The Company recognizes interest and penalties related to uncertain tax positions as income tax expense as incurred. No expense for interest and penalties was recognized for the years ended September 30, 2020 and 2019.