Note 17—Income Tax

On April 17, 2012, EVERTEC Group was converted from a Puerto Rico corporation into a Puerto Rico limited liability company in order to take advantage of recent changes to the PR Code that allow limited liability companies to be treated as partnerships that are pass-through entities for Puerto Rico tax purposes. As a result of the Conversion, EVERTEC Group’s taxable income from its Puerto Rico operations flows through to its direct parent company and therefore to EVERTEC, Inc.

EVERTEC Group, Holdings and EVERTEC, Inc. entered into a Tax Payment Agreement pursuant to which EVERTEC Group is obligated to make certain payments to Holdings or EVERTEC, Inc. for taxable periods or portions thereof occurring on or after April 17, 2012 (the “Effective Date”). Under the Tax Payment Agreement, EVERTEC Group will make payments with respect to any and all taxes (including estimated taxes) imposed under the laws of Puerto Rico, the United States of America and any other jurisdiction or any political (including municipal) subdivision or authority or agency in Puerto Rico, the United States of America or such other jurisdiction, that would have been imposed on EVERTEC Group if EVERTEC Group had been a corporation for tax purposes of that jurisdiction, together with all interest and penalties with respect thereto (“Taxes”), reduced by taking into account any applicable net operating losses or other tax attributes of Holdings or EVERTEC, Inc. that reduce Holdings’ or EVERTEC, Inc.’s taxes in such period. The Tax Payment Agreement provides that the payments thereunder shall not exceed the net amount of Taxes that Holdings and EVERTEC, Inc. actually owe to the appropriate taxing authority for a taxable period. Further, the Tax Payment Agreement provides that if Holdings or EVERTEC, Inc. receives a tax refund attributable to any taxable period or portion thereof occurring on or after the Effective Date, EVERTEC, Inc. shall be required to recalculate the payment for such period required to be made by EVERTEC Group to Holdings or EVERTEC, Inc. If the payment, as recalculated, is less than the amount of the payment EVERTEC Group already made to Holdings or EVERTEC, Inc. in respect of such period, Holdings or EVERTEC, Inc. shall promptly make a payment to EVERTEC Group in the amount of such difference.

The components of income tax benefit consisted of the following:


	Years ended December 31,
(Dollar amounts in thousands)	2013			2012			2011
Current tax provision (benefit)	$	3,712		$	6,910		$	(7,144	)
Deferred tax benefit		(5,702	)		(66,568	)		(22,083	)

Income tax benefit	$	(1,990	)	$	(59,658	)	$	(29,227	)

For the year ended December 31, 2012, the Company recognized a reduction of $66.4 million of its deferred tax liability as a result of a tax grant received from the Government of Puerto Rico that reduced the Company’s marginal corporate income tax rate from 30% to 4% on industrial development income.

For the year ended December 31, 2011, the Company recognized a reduction in its deferred tax liability of $27.6 million as a result of the approval in January 2011 of the new Puerto Rico Internal Revenue Code, which provides for a reduction in the statutory tax rates from 39% to 30%.

The Company conducts operations in Puerto Rico and certain countries throughout the Caribbean and Latin America. As a result, the income tax benefit includes the effect of taxes paid to the Puerto Rico government as well as foreign jurisdictions. The following table presents the segregation of income tax benefit based on location of operations:


	Years ended December 31,
(Dollar amounts in thousands)	2013			2012			2011
Current tax provision (benefit)
Puerto Rico	$	913		$	4,661		$	(9,521	)
United States		753			622			385
Foreign countries		2,046			1,627			1,992

Total currrent tax provision (benefit)	$	3,712		$	6,910		$	(7,144	)

Deferred tax benefit
Puerto Rico	$	(5,094	)	$	(65,822	)	$	(21,479	)
United States		(5	)		(38	)		—
Foreign countries		(603	)		(708	)		(604	)

Total deferred tax benefit	$	(5,702	)	$	(66,568	)	$	(22,083	)

EVERTEC’s subsidiaries will pay applicable local taxes in foreign countries and the corresponding liability and expense will be presented in EVERTEC’s consolidated financial statements.

On June 30, 2013, the Governor of Puerto Rico signed into law Act 40, effective as of January 1, 2013, which increased the maximum corporate income tax rate from 30% to 39%. This rate increase is only applicable to the fully taxable operations of EVERTEC in Puerto Rico. As a result of this tax rate increase, the deferred taxes were revalued resulting in the Company recognizing additional non-cash income tax expense of $1.4 million for the first half of 2013. In addition, Act 40 established a national gross receipts tax based on gross revenues that is included as part of the alternative minimum tax calculation.

As of December 31, 2013, the Company has reported $9.0 million of unremitted earnings for foreign subsidiaries in the consolidated balance sheet. The Company had not recognized a deferred tax liability on undistributed earnings for the Company’s foreign subsidiaries, because these earnings are intended to be permanently reinvested. The amount of the unrecognized deferred tax liability depends on judgment required to analyze the withholding tax due, the applicable tax law and factual circumstances in effect at the time of any such distributions, therefore, EVERTEC believes it is not practicable at this time to reliably determine the amount of unrecognized deferred tax liability related to the Company’s undistributed earnings. If circumstances change and it becomes apparent that some or all of the undistributed earnings of a subsidiary will be remitted and income taxes have not been recognized by the parent entity, the parent entity shall accrue as an expense of the current period income taxes attributable to that remittance.

On October 19, 2012, EVERTEC Group was granted with an additional tax exemption under the Tax Incentive Act No. 73 of 2008. Under this grant, EVERTEC Group will benefit from a preferential income tax rate on industrial development income, as well as from tax exemptions with respect to its municipal and property tax obligations for certain activities derived from its data processing operations in Puerto Rico. The grant has a term of 15 years effective as of January 1, 2012 with respect to income tax obligations and January 1, 2013 with respect to municipal and property tax obligations.

The grant establishes a base taxable income amount with respect to EVERTEC Group’s industrial development income, which amount will continue to be subject to the ordinary income tax rate under existing law. Applicable taxable income in excess of the established base taxable income amount will be subject to a preferential rate of 4%. The base taxable income amount will be ratably reduced to zero by the fourth taxable year at which point all of EVERTEC Group’s applicable industrial development income will be taxed at the preferential rate of 4% for the remaining period of the grant. The grant also establishes a 90% exemption on certain real and property taxes and a 60% exemption on municipal taxes, in each case imposed on EVERTEC Group. In addition, distributions to stockholders by EVERTEC, Inc. of the industrial development income will not be subject to Puerto Rico tollgate taxes.

The grant contains customary commitments, conditions and representations that EVERTEC Group will be required to comply with in order to maintain the grant. The more significant commitments include: (i) maintaining at least 750 employees in EVERTEC Group’s Puerto Rico data processing operations during 2012 and at least 700 employees for the remaining years of the grant; and (ii) investing at least $200.0 million in building, machinery, equipment or computer programs to be used in Puerto Rico during the effective term of the grant (to be made over four year capital investment cycles in $50.0 million increments). Failure to meet the requirements could result, among other things, in reductions in the benefits of the grant or revocation of the grant in its entirety, which could result in EVERTEC, Inc. paying additional taxes or other payments relative to what such parties would be required to pay if the full benefits of the grant are available. In addition, the protection from Puerto Rican tollgate taxes on distributions to stockholders may be lost.

On October 11, 2011, the Puerto Rico Government approved a grant under Tax Incentive Law No. 73 of 2008, retroactively to December 1, 2009. Under this grant, activities derived from consulting and data processing services provided outside Puerto Rico are subject to a preferred rate that declines gradually from 7% to 4% by December 1, 2013. After this date, the rate remains at 4% until its expiration in November 1, 2024.

In addition, EVERTEC Group has a base tax rate of 7% on income derived from certain development and installation service in excess of a determined income for a 10-year period from January 1, 2008. No income was subject to the exemption for years prior to 2012 since the income covered by the decree did not exceed the determined base income amount.

The following table presents the components of the Company’s deferred tax assets and liabilities:


	December 31,
(Dollar amounts in thousands)	2013			2012
Deferred tax assets (“DTA”)
Allowance for doubtful accounts	$	330		$	307
Net operating loss		11,306			7,141
Other temporary assets		1,845			399

Total gross deferred tax assets		13,481			7,847

Deferred tax liabilities (“DTL”)
Deferred compensation	$	993		$	768
Difference between the assigned values and the tax basis of assets and liabilities recognized in purchase		28,849			28,871
Debt issue cost		1,680			2,353
Other temporary liabilities		177			(333	)

Total gross deferred tax liabilities		31,699			31,659

Deferred tax liability, net	$	(18,218	)	$	(23,812	)

Pursuant to the provision of the PR Code, net operating losses (“NOL”) can be carried forward for a period of seven, ten or twelve taxable years, depending on the taxable year generated. The Company incurred in NOLs during 2010, which will expire in 2022, and in 2013, that will expire in 2023. At December 31, 2013 the recorded value of the Company’s NOL carryforwards was $11.3 million. The recorded value of the Company’s NOL carryforwards is approximately $7.4 million lower than the total NOL carryforwards available to EVERTEC due to a windfall tax benefit. The windfall tax benefit is available to offset future taxable income and is considered an off-balance sheet item until the deduction reduces taxes payable. This windfall tax benefit results from tax deductions in excess of previously recorded compensation expense due to the difference in fair value of stock options at the time of the grant as compared to when they were exercised. The total gross NOL carryforwards available to EVERTEC, including the windfall tax benefit, was $84.4 million as of December 31, 2013.

The Company recognizes in its financial statements the benefits of tax return positions if it is more likely than not to be sustained on audit based on its technical merits. On a quarterly basis, EVERTEC evaluates its tax positions and revises its estimates accordingly. The Company records accrued interest, if any, to unrecognized tax benefits in income tax expense, while the penalties, if any reported in operating costs and expenses. For the years ended December 31, 2012 and 2011, the Company accrued $25,000 and $0.3 million for potential payment of interest based on an average 10% interest rate, respectively, none in 2013. As of December 31, 2010, the Company had not accrued any amount for potential payment of penalties and interest. At December 31, 2013, the Company had no liability for unrecognized tax benefits. At December 31, 2012 and 2011, EVERTEC had a liability for unrecognized tax benefits of $0.8 million and $1.5 million, respectively, which, if recognized in the future, would impact EVERTEC’s effective tax rate.

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


(Dollar amounts in thousands)
Balance as of December 31, 2010	$	1,222
Accrued estimated interest		281

Balance as of December 31, 2011		1,503
Foreign currency translation adjustment		7
Reversal of tax uncertainties reserve		(707	)
Accrued estimated interest		25

Balance as of December 31, 2012		828
Foreign currency translation adjustment		18
Expiration of statute of limitations		(846	)

Balance as of December 31, 2013	$	—

The income tax benefit differs from the amount computed by applying the Puerto Rico statutory income tax rate to the (loss) income before income taxes as a result of the following:


	Years ended December 31,
(Dollar amounts in thousands)	2013			2012			2011
Computed income tax at statutory rates	$	(10,378	)	$	5,313		$	(1,504	)
Benefit of net tax-exempt interest income		(180	)		(13	)		(23	)
Benefit of net tax-exempt dividend income		—			—			(620	)
Non taxable loss on settlement of derivative asset		—			—			420
Tax expense (benefit) due to a change in estimate		83			320			(2,416	)
Adjustment to deferred taxes due to changes in enacted tax rate and tax grant		1,441			(66,423	)		(23,813	)
Effect of disallowed net operating losses in foreign entities		93			1,012			—
Differences in tax rates due to multiple jurisdictions		577			720			285
Effect of income subject to tax-exemption grant		7,164			(58	)		(1,737	)
Reversal of tax uncertainties reserve		(846	)		(707	)		—
Fair value adjustment of indemnification assets		—			340			(288	)
Tax expense CONTADO dividend		—			—			81
Tax uncertainties reserve		—			—			250
Other		56			(162	)		138

Income tax benefit	$	(1,990	)	$	(59,658	)	$	(29,227	)

There are no open uncertain tax positions as of December 31, 2013.