The ONE Group Hospitality, 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, 2016

Income Tax Disclosure [Abstract]

Income taxes

Income taxes:

The components of "income (loss) before income taxes" for the periods were as follows:



	Year ended
	December 31, 2016			December 31, 2015
Loss from continuing operations before provision for income taxes
Domestic	$	(5,769,069	)	$	(2,077,455	)
Foreign	(224,798		)	(135,337		)

Total	$	(5,993,867	)	$	(2,212,792	)

The components of our "provision (benefit) for income taxes" consist of the following:



	Year Ended
	December 31, 2016			December 31, 2015
Current tax expense:
Federal	$	—		$	—
State and local	61,920			533,815
Foreign	259,987			207,952
Total current tax expense	321,907			741,767
Deferred tax expense (benefit):
Federal	7,654,364			(7,631,243		)
State and local	2,393,893			(2,376,233		)
Foreign	(252		)	(50,778		)
Total deferred tax expense (benefit)	10,048,005			(10,058,254		)
Total income tax expense (benefit)	$	10,369,912		$	(9,316,487	)

The difference between the reported income tax expense and taxes determined by applying the applicable U.S. federal statutory income tax rate to (loss) income before taxes from continuing operations is reconciled as follows:



	Year ended
	December 31, 2016					December 31, 2015
Income tax benefit at federal statutory rate	$	(2,037,915	)	34.0	%	$	(752,349	)	34.0	%
State and local taxes – current	30,951			(0.5	)%	42,227			(1.9	)%
State and local taxes (benefits) – deferred	(746,820		)	12.5	%	(574,273		)	26.0	%
FICA tip credit	(430,360		)	7.2	%	(495,254		)	22.4	%
Foreign rate differential	(42,418		)	0.7	%	19,500			(0.9	)%
Foreign tax - unrepatriated earnings	784,999			(13.10	)%	—			—	%
Change in valuation allowance	12,029,957			(200.7	)%	(7,707,333		)	348.3	%
Other items, net	781,518			(13.1	)%	150,995			(6.8	)%
Total income tax expense	$	10,369,912		(173.0	)%	$	(9,316,487	)	421.1	%

Management assesses the available positive and negative evidence to estimate if sufficient future taxable income will be generated to use the existing deferred tax assets. A significant piece of objective negative evidence evaluated was the cumulative loss (excluding derivative income) incurred over the three-year period ended December 31, 2016. Such objective evidence is not solely determinative and accordingly, the Company considers all other available positive and negative evidence in its analysis. Based upon the Company's analysis, which included the recent decline in operating profits during the fourth quarter when compared to the fourth quarter of prior years, the Company believes it is more likely than not that the net deferred tax assets in the United States may not be fully realized in the future. On the basis of this evaluation, as of December 31, 2016, a valuation allowance of $12,029,957 has been recorded to reflect the portion of the deferred tax asset that is not more likely than not to be realized. The amount of the deferred tax asset considered realizable, however, could be adjusted if estimates of future taxable income during the carryforward period are reduced or increased or if objective negative evidence in the form of cumulative losses is no longer present and additional weight may be given to subjective evidence such as our projections for growth.

In June 2015, the Company made the decision to release the valuation allowance amounting to $7.7 million against its deferred tax assets net of deferred tax liabilities. Cumulative profitable quarters and projected future pretax income are sources of positive evidence that led the Company to conclude that it is more likely than not that it will realize its net deferred tax assets.

Deferred income taxes reflect the net 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 deferred tax assets and liabilities are presented below:



	Year ended
	December 31, 2016			December 31, 2015
Deferred tax assets:
Deferred rent liabilities	$	3,744,188		$	4,027,504
Lease incentives	1,565,606			508,351
Stock compensation	744,701			563,582
FICA tip credit carryforward	2,065,680			1,421,757
Net operating loss	6,246,404			1,899,676
Goodwill	2,861,663			3,258,403
Derivative expense	—			42,899
Inventory	10,200			9,789
Charitable contributions carryforward	30,283			6,131
Foreign tax credit carryforward	384,239			109,957
Deferred revenue	477,895			471,710
State and local tax credit carryforward	305,675			243,508

Total deferred tax assets	18,436,534			12,563,267

Deferred tax liabilities:
Depreciation and amortization	(5,321,194		)	(2,352,575		)
Basis in LLC interest	(20,353		)	(117,020		)
Unremitted foreign earnings	(784,999		)	—
ASC 740-10 liability	(229,000		)	—
Total deferred tax liabilities	(6,355,546		)	(2,469,595		)

Valuation allowance	(12,029,957		)	—

Net deferred tax assets	$	51,031		$	10,093,672

The Company accounts for unrecognized tax benefits in accordance with the provisions of FASB guidance which, among other directives, requires uncertain tax positions to be recognized only if they are more likely than not to be upheld based on their technical merits. The measurement of the uncertain tax position is based on the largest benefit amount that is more likely than not (determined on a cumulative probability basis) to be realized upon settlement. As of December 31, 2016, the Company has an uncertain tax position for which it has established a $229,000 deferred tax liability. As of December 31, 2015, the Company had no uncertain tax position. The Company believes the estimates and assumptions used to support its evaluation of tax benefit realization are reasonable.

The Company may, from time to time, be assessed interest or penalties by major tax jurisdictions, although any such assessments historically have been minimal and immaterial to the Company’s financial results. In the event the Company receives an assessment for interest and penalties, it has been classified in the consolidated financial statements as income tax expense.

The Company’s U.S. federal, state and local income tax returns prior to fiscal year 2013 are closed and management continually evaluates expiring statutes of limitations, audits, proposed settlements, changes in tax law and new authoritative rulings. The Company’s foreign income tax returns prior to fiscal year 2014 are closed and management continually evaluates expiring statutes of limitations, audits, proposed settlements, changes in tax law and new authoritative rulings.

As of December 31, 2016, Company has unremitted foreign earnings of $1,921,193. The Company considered the unremitted foreign earnings to be indefinitely reinvested and thus did not calculate the deferred income tax liability as of December 31, 2015. Upon repatriation of those earnings, in the form of dividends or otherwise, the Company would be subject to domestic income taxes, offset (in whole or in part) by foreign tax credits, related to income and withholding taxes payable to the various foreign countries. In 2016, the Company has changed its plans with respect to the permanent reinvestment of unremitted earnings and accordingly, has established a deferred tax liability of $784,999 and a corresponding deferred tax asset of $384,239 for the foreign tax credits as of December 31, 2016.

As of December 31, 2016, the Company has federal, state and foreign income tax net operating loss (NOL) carryforwards of $15,196,296, $12,068,283 and $418,634. The federal and state net operating loss will expire at various dates from 2026 to 2036. The foreign net operating losses can be carried forward indefinitely.