Income taxes

3 Months Ended

Mar. 31, 2018

Note 31 – Income taxes

The reason for the difference between the income tax expense applicable to income before provision for income taxes and the amount computed by applying the statutory tax rate in Puerto Rico, were as follows:

		Quarters ended
		March 31, 2018				March 31, 2017
(In thousands)		Amount	% of pre-tax income			Amount	% of pre-tax income
Computed income tax expense at statutory rates	$	44,257	39	%	$	49,121	39	%
Net benefit of tax exempt interest income		(22,993)	(20)			(18,004)	(14)
Deferred tax asset valuation allowance		7,226	6			5,056	4
Difference in tax rates due to multiple jurisdictions		(2,959)	(2)			(959)	(1)
Effect of income subject to preferential tax rate		(3,048)	(3)			(3,019)	(3)
Adjustments in net deferred tax due to change in tax law		(5,133)	(4)			-	-
State and local taxes		1,363	1			1,279	1
Others		3,442	3			(468)	-
Income tax (benefit) expense	$	22,155	20	%	$	33,006	26	%

Income tax expense amounted to $22.2 million for the quarter ended March 31, 2018, compared with an income tax expense of $33.0 million for the same quarter of 2017. The reduction in income tax expense was primarily due to lower taxable income before tax and higher tax benefit on net exempt interest income.

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

			March 31, 2018
(In thousands)			PR		US		Total
Deferred tax assets:
Tax credits available for carryforward		$	16,069	$	7,859	$	23,928
Net operating loss and other carryforward available			120,973		705,651		826,624
Postretirement and pension benefits			84,204		-		84,204
Deferred loan origination fees			3,210		593		3,803
Allowance for loan losses			596,211		21,053		617,264
Deferred gains			-		2,596		2,596
Accelerated depreciation			1,300		7,213		8,513
Intercompany deferred (loss) gains			1,324		-		1,324
Difference in outside basis from pass-through entities			27,034		-		27,034
Other temporary differences			27,293		6,678		33,971
	Total gross deferred tax assets		877,618		751,643		1,629,261
Deferred tax liabilities:
FDIC-assisted transaction			60,406		-		60,406
Indefinite-lived intangibles			32,848		34,135		66,983
Unrealized net gain (loss) on trading and available-for-sale securities			19,457		(13,951)		5,506
Other temporary differences			10,199		386		10,585
	Total gross deferred tax liabilities		122,910		20,570		143,480
Valuation allowance			74,489		381,451		455,940
Net deferred tax asset		$	680,219	$	349,622	$	1,029,841

			December 31, 2017
(In thousands)			PR		US		Total
Deferred tax assets:
Tax credits available for carryforward		$	16,069	$	7,979	$	24,048
Net operating loss and other carryforward available			115,512		708,158		823,670
Postretirement and pension benefits			85,488		-		85,488
Deferred loan origination fees			3,669		958		4,627
Allowance for loan losses			603,462		20,708		624,170
Deferred gains			-		2,670		2,670
Accelerated depreciation			1,300		7,083		8,383
Intercompany deferred (loss) gains			224		-		224
Difference in outside basis from pass-through entities			30,424		-		30,424
Other temporary differences			25,084		6,901		31,985
	Total gross deferred tax assets		881,232		754,457		1,635,689
Deferred tax liabilities:
FDIC-assisted transaction			60,402		-		60,402
Indefinite-lived intangibles			31,973		33,009		64,982
Unrealized net gain (loss) on trading and available-for-sale securities			26,364		(7,961)		18,403
Other temporary differences			9,876		386		10,262
	Total gross deferred tax liabilities		128,615		25,434		154,049
Valuation allowance			67,263		380,561		447,824
Net deferred tax asset		$	685,354	$	348,462	$	1,033,816

The net deferred tax asset shown in the table above at March 31, 2018 is reflected in the consolidated statements of financial condition as $1.0 billion in net deferred tax assets in the “Other assets” caption (December 31, 2017 - $1.0 billion) and $1.5 million in deferred tax liabilities in the “Other liabilities” caption (December 31, 2017 - $1.3 million), reflecting the aggregate deferred tax assets or liabilities of individual tax-paying subsidiaries of the Corporation in their respective tax jurisdiction, Puerto Rico or the United States.

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.

At March 31, 2018 the net deferred tax asset of the U.S. operations amounted to $731 million with a valuation allowance of approximately $381 million, for a net deferred tax asset of approximately $350 million. As of March 31, 2018, management estimated that the U.S. operations would earn enough pre-tax Income during the carryover period to realize the total amount of net deferred tax asset after valuation allowance. After weighting all available positive and negative evidence, management concluded that is more likely than not that a portion of the deferred tax asset from the U.S. operation, amounting to approximately $350 million, will be realized. Management will continue to evaluate the realization of the deferred tax asset each quarter and adjust as any changes arises.

At March 31, 2018, the Corporation’s net deferred tax assets related to its Puerto Rico operations amounted to $680 million.

The Corporation’s Puerto Rico Banking operation is not in a cumulative three year loss position and has sustained profitability for the three year period ended March 31, 2018. This is considered a strong piece of objectively verifiable positive evidence that outweights 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 Popular, Inc., holding company (“PIHC”) operation is in a cumulative loss position taking into account taxable income exclusive of reversing temporary differences, for the three year period ended March 31, 2018. Management expects these losses will be a trend in future years. This objectively verifiable negative evidence is considered by management as 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 PIHC will not be able to realize any portion of the deferred tax assets, considering the criteria of ASC Topic 740. Accordingly, a valuation allowance is recorded on the deferred tax asset at the PIHC, which amounted to $74 million as of March 31, 2018.

The reconciliation of unrecognized tax benefits, excluding interest, was as follows:

(In millions)		2018		2017
Balance at January 1	$	7.3	$	7.4
Additions for tax positions -January through March		0.2		0.2
Balance at March 31	$	7.5	$	7.6

At March 31, 2018, the total amount of interest recognized in the statement of financial condition approximated $2.8 million (December 31, 2017 - $2.7 million). The total interest expense recognized at March 31, 2018 was $151 thousand (March 31, 2017 - $145 thousand). Management determined that at March 31, 2018 and December 31, 2017 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 $9.2 million at March 31, 2018 (December 31, 2017 - $9.0 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 March 31, 2018, the following years remain subject to examination in the U.S. Federal jurisdiction: 2014 and thereafter; and in the Puerto Rico jurisdiction, 2013 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 $4.6 million.