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Income taxes
9 Months Ended
Sep. 30, 2014
Income Tax Disclosure [Abstract]  
Income Tax Disclosure Text Block

Note 34 – Income taxes

 

A reconciliation of the income tax expense computed by applying the Puerto Rico statutory tax rate to the income before provision for income taxes and the reported income tax expense is presented below:

 

  Quarters ended 
  September 30, 2014   September 30, 2013 
(In thousands) Amount % of pre-tax income    Amount% of pre-tax income 
Computed income tax expense at statutory rates $ 23,198 39% $ 94,880 39%
Net benefit of tax exempt interest income  (12,663) (21)    (7,608) (3) 
Deferred tax asset valuation allowance  (3,120) (5)    (2,399) (1) 
Non-deductible expenses  90 -    8,085 3 
Difference in tax rates due to multiple jurisdictions  (2,240) (4)    (2,348) (1) 
Initial adjustment in deferred tax due to change in tax rate  20,048 34    - - 
Effect of income subject to preferential tax rate  (3,385) (6)    (57,565) (24) 
Unrecognized tax benefits  (3,601) (6)    (7,727) (3) 
Others  8,340 14   (7,550) (3) 
Income tax expense$ 26,667 45% $ 17,768 7%

  Nine months ended 
  September 30, 2014   September 30, 2013 
(In thousands) Amount % of pre-tax income    Amount% of pre-tax income 
Computed income tax expense (benefit) at statutory rates $ (71,939) 39% $ 51,149 39%
Net benefit of tax exempt interest income  (37,607) 21    (27,484) (21) 
Deferred tax asset valuation allowance  (17,303) 9    (5,374) (4) 
Non-deductible expenses  178,219 (97)    23,844 18 
Difference in tax rates due to multiple jurisdictions  (12,728) 7    (8,296) (6) 
Initial adjustment in deferred tax due to change in tax rate  20,048 (11)    (197,467) (151) 
Effect of income subject to preferential tax rate[1]  (21,940) 12    (102,878) (78) 
Unrecognized tax benefits  (3,601) 2    (7,727) (6) 
Others  12,658 (7)    (2,256) (2) 
Income tax expense (benefit) $ 45,807 (25)% $ (276,489) (211)%
[1] For 2014, includes the impact of the Closing Agreement with the P.R. Treasury signed in June 2014.

Income tax expense amounted to $26.7 million for the quarter ended September 30, 2014, compared with $17.8 million for the same quarter of 2013.On July 1, 2014, the Government of Puerto Rico approved an amendment to the Internal Revenue Code, which, among other things, changed the income tax rate for capital gains from 15% to 20%. As a result, the Corporation recognized an income tax expense of $20.0 million during the third quarter of 2014, mainly related to the deferred tax liability associated with the portfolio acquired from Westernbank. Also, during the third quarter of 2014, $3.6 million of reserves for uncertain tax positions were reversed due to the expiration of the statute of limitation in the Puerto Rico operations compared with $7.7 million during the same quarter of 2013.

 

Income tax expense amounted to $45.8 million for the nine months ended September 30, 2014, compared with an income tax benefit of $276.5 million for the same period of 2013. The increase in income tax expense was primarily due to the recognition during the year 2013 of a tax benefit and a corresponding increase in the net deferred tax asset of the Puerto Rico operations as result of the increase in the marginal tax rate from 30% to 39% per Act Number 40 of the Puerto Rico Internal Revenue Code applicable to taxable years beginning after December 31, 2012. In addition, during 2013 the income tax benefit increased due to the loss generated on the Puerto Rico operations by the sale of non-performing assets net of the gain realized on the sale of EVERTEC's common stock.

 

For the nine months ended September 30, 2014, the non deductible expenses increased due to the interest expense on the early extinguishment of the note issued to the U.S. Treasury under TARP which is non-tax deductible.

 

The following table presents a breakdown of the significant components of the Corporation's deferred tax assets and liabilities.

(In thousands) September 30, 2014  December 31, 2013
Deferred tax assets:    
Tax credits available for carryforward$ 12,023$ 8,195
Net operating loss and other carryforward available   1,245,909  1,269,523
Postretirement and pension benefits  46,305  51,742
Deferred loan origination fees  6,835  7,164
Allowance for loan losses  728,334  760,956
Deferred gains  8,333  9,313
Accelerated depreciation  7,833  7,577
Intercompany deferred gains   2,767  3,235
Other temporary differences  26,989  34,443
 Total gross deferred tax assets  2,085,328  2,152,148
Deferred tax liabilities:    
Differences between the assigned values and the tax basis of assets and liabilities     
 recognized in purchase business combinations  34,764  37,938
FDIC-assisted transaction  83,770  79,381
Unrealized net gain on trading and available-for-sale securities   16,290  3,822
Other temporary differences  17,465  13,387
 Total gross deferred tax liabilities  152,289  134,528
Valuation allowance  1,210,780  1,257,977
Net deferred tax asset$ 722,259$ 759,643

The net deferred tax asset shown in the table above at September 30, 2014 is reflected in the consolidated statements of financial condition as $758 million in net deferred tax assets in the “Other assets” caption (December 31, 2013 - $762 million) and $36 million in deferred tax liabilities in the “Other liabilities” caption (December 31, 2013 - $2 million), reflecting the aggregate deferred tax assets or liabilities of individual tax-paying subsidiaries of the Corporation.

A deferred tax asset should be reduced by a valuation allowance if based on the weight of all available evidence, it is more likely than not (a likelihood of more than 50%) that some portion or the entire deferred tax asset will not be realized. The valuation allowance should be sufficient to reduce the deferred tax asset to the amount that is more likely than not to be realized. The determination of whether a deferred tax asset is realizable is based on weighting all available evidence, including both positive and negative evidence. The realization of deferred tax assets, including carryforwards and deductible temporary differences, depends upon the existence of sufficient taxable income of the same character during the carryback or carryforward period. The analysis considers all sources of taxable income available to realize the deferred tax asset, including the future reversal of existing taxable temporary differences, future taxable income exclusive of reversing temporary differences and carryforwards, taxable income in prior carryback years and tax-planning strategies.

The Corporation recorded a valuation allowance in the year 2008 since in consideration of the requirement of ASC 740 management considered that it is more likely than not that all of the U.S. operation deferred tax asset will not be realized. For purposes of assessing the realization of the deferred tax assets in the U.S. mainland management evaluates and weights all available positive and negative evidence. The Corporation's U.S. mainland operations is not in a cumulative loss position for the three-year period ended September 30, 2014 taking into account taxable income exclusive of reversing temporary differences (“adjusted book income”). This represents positive evidence within management's evaluation. However, the book income for 2013 and the first nine months of 2014 was significantly impacted by a reversal of the loan loss provision due to the improved credit quality of the loan portfolios. In addition, the U.S. mainland operations did not report taxable income for the years 2011, 2012 and 2013, although it currently reflects taxable income for the nine months ended September 30, 2014. Future realization of the deferred tax assets ultimately depends on the existence of sufficient taxable income of the appropriate character within the carryforward period available under the tax law. The lack of taxable income together with the fact that historic book income has been positively impacted by a reversal of loan loss provision that is not expected to be a continuing condition and the uncertainties regarding future performance represents strong negative evidence within management's evaluation. After weighting of all positive and negative evidence management concluded, as of the reporting date, that it is more likely than not that the Corporation will not be able to realize any portion of the deferred tax assets related to the U.S. mainland operations, considering the criteria of ASC Topic 740. This determination is updated each quarter and adjusted as any changes arise.

At September 30, 2014, the Corporation's net deferred tax asset related to its Puerto Rico operations amounted to $755 million net of the valuation allowance of $14.1 million recorded in the Holding Company.

The Corporation's Puerto Rico Banking operation is not in a cumulative loss position and has sustained profitability for the three year period ended September 30, 2014, exclusive of the loss generated on the sales of non-performing assets that took place in 2013 which is not a continuing condition of the operations. This is considered a strong piece of objectively verifiable positive evidence that out weights any negative evidence considered by management in the evaluation of the realization of the deferred tax asset. Based on this evidence and management's estimate of future taxable income, the Corporation has concluded that it is more likely than not that such net deferred tax asset of the Puerto Rico Banking operations will be realized.

The Holding Company operation is not in a cumulative loss position for the three year period ended September 30, 2014. However, after the payment of TARP, the interest expense that will be paid on the newly issued $450 million subordinated notes, bearing interest at 7%, will be tax deductible, contrary to the interest expense payable on the note issued to the U.S. Treasury under TARP. Based on this new fact pattern the Holding Company is expecting to have losses for income tax purposes exclusive of reversing temporary differences. Since as required by ASC 740 the historical information should be supplemented by all currently available information about future years, the expected losses in future years is considered by management a strong negative evidence that will suggest that income in future years will be insufficient to support the realization of all deferred tax asset. After weighting of all positive and negative evidence management concluded, as of the reporting date, that it is more likely than not that the Holding Company will not be able to realize any portion of the deferred tax assets, considering the criteria of ASC Topic 740. Accordingly, a valuation allowance on the deferred tax asset of $14.1 million was recorded during the year 2014.

The reconciliation of unrecognized tax benefits was as follows:

(In millions) 2014  2013
Balance at January 1$ 9.8 $ 13.4
Additions for tax positions - January through March   0.3   0.2
Balance at March 31$ 10.1 $ 13.6
Additions for tax positions - April through June  0.2   0.3
Balance at June 30$ 10.3 $ 13.9
Additions for tax positions - July through September  0.3   0.3
Reduction as a result of lapse of statute of limitations - July through September  (2.5)   (5.7)
Balance at September 30$ 8.1 $ 8.5

At September 30, 2014, the total amount of interest recognized in the statement of financial condition approximated $3.0 million (December 31, 2013 - $3.6 million). The total interest expense recognized at September 2014 was $452 thousand (December 31, 2013 - $1.4 million). Management determined that at September 30, 2014 and December 31, 2013 there was no need to accrue for the payment of penalties. The Corporation's policy is to report interest related to unrecognized tax benefits in income tax expense, while the penalties, if any, are reported in other operating expenses in the consolidated statements of operations.

After consideration of the effect on U.S. federal tax of unrecognized U.S. state tax benefits, the total amount of unrecognized tax benefits, including U.S. and Puerto Rico, that if recognized, would affect the Corporation's effective tax rate, was approximately $9.7 million at September 30, 2014 (December 31, 2013 - $11.9 million).

The amount of unrecognized tax benefits may increase or decrease in the future for various reasons including adding amounts for current tax year positions, expiration of open income tax returns due to the statutes of limitation, changes in management's judgment about the level of uncertainty, status of examinations, litigation and legislative activity and the addition or elimination of uncertain tax positions.

The Corporation and its subsidiaries file income tax returns in Puerto Rico, the U.S. federal jurisdiction, various U.S. states and political subdivisions, and foreign jurisdictions. At September 30, 2014, the following years remain subject to examination in the U.S. Federal jurisdiction: 2011 and thereafter; and in the Puerto Rico jurisdiction, 2010 and thereafter. The Corporation anticipates a reduction in the total amount of unrecognized tax benefits within the next 12 months, which could amount to approximately $7.1 million.

 

  Quarters ended 
  September 30, 2014   September 30, 2013 
(In thousands) Amount % of pre-tax income    Amount% of pre-tax income 
Computed income tax expense at statutory rates $ 23,198 39% $ 94,880 39%
Net benefit of tax exempt interest income  (12,663) (21)    (7,608) (3) 
Deferred tax asset valuation allowance  (3,120) (5)    (2,399) (1) 
Non-deductible expenses  90 -    8,085 3 
Difference in tax rates due to multiple jurisdictions  (2,240) (4)    (2,348) (1) 
Initial adjustment in deferred tax due to change in tax rate  20,048 34    - - 
Effect of income subject to preferential tax rate  (3,385) (6)    (57,565) (24) 
Unrecognized tax benefits  (3,601) (6)    (7,727) (3) 
Others  8,340 14   (7,550) (3) 
Income tax expense$ 26,667 45% $ 17,768 7%

  Nine months ended 
  September 30, 2014   September 30, 2013 
(In thousands) Amount % of pre-tax income    Amount% of pre-tax income 
Computed income tax expense (benefit) at statutory rates $ (71,939) 39% $ 51,149 39%
Net benefit of tax exempt interest income  (37,607) 21    (27,484) (21) 
Deferred tax asset valuation allowance  (17,303) 9    (5,374) (4) 
Non-deductible expenses  178,219 (97)    23,844 18 
Difference in tax rates due to multiple jurisdictions  (12,728) 7    (8,296) (6) 
Initial adjustment in deferred tax due to change in tax rate  20,048 (11)    (197,467) (151) 
Effect of income subject to preferential tax rate[1]  (21,940) 12    (102,878) (78) 
Unrecognized tax benefits  (3,601) 2    (7,727) (6) 
Others  12,658 (7)    (2,256) (2) 
Income tax expense (benefit) $ 45,807 (25)% $ (276,489) (211)%
[1] For 2014, includes the impact of the Closing Agreement with the P.R. Treasury signed in June 2014.