Income Tax

On April 17, 2012, EVERTEC Group and Holdings were converted from a Puerto Rico corporation into Puerto Rico limited liability companies to benefit from changes to the Puerto Rico Income Tax Code allowing limited liability companies to be treated as partnerships that are pass-through entities for Puerto Rico tax purposes. As a result of these conversions and subsequent elections to be treated as partnerships, EVERTEC Group’s and Holding’s taxable income flows through 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 expense (benefit) consisted of the following:



	Years ended December 31,
(Dollar amounts in thousands)	2017			2016			2015
Current tax provision (benefit)	$	9,086		$	12,865		$	(245	)
Deferred tax benefit	(4,306		)	(4,594		)	(3,090		)
Income tax expense (benefit)	$	4,780		$	8,271		$	(3,335	)

The Company conducts operations in Puerto Rico and certain countries throughout the Caribbean and Latin America. As a result, the income tax expense (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 expense (benefit) based on location of operations:



	Years ended December 31,
(Dollar amounts in thousands)	2017			2016			2015
Income before income tax provision
Puerto Rico	$	47,347		$	70,899		$	73,327
United States	3,089			2,670			1,879
Foreign countries	9,763			9,828			6,836
Total income before income tax provision	$	60,199		$	83,397		$	82,042
Current tax provision (benefit)
Puerto Rico	$	1,892		$	7,072		$	(3,500	)
United States	292			567			413
Foreign countries	6,902			5,226			2,842
Total current tax provision (benefit)	$	9,086		$	12,865		$	(245	)
Deferred tax benefit
Puerto Rico	$	(3,176	)	$	(2,874	)	$	(2,169	)
United States	(184		)	(259		)	(114		)
Foreign countries	(946		)	(1,461		)	(807		)
Total deferred tax benefit	$	(4,306	)	$	(4,594	)	$	(3,090	)

Taxes payable to foreign countries by EVERTEC’s subsidiaries will be paid by such subsidiary and the corresponding liability and expense will be presented in EVERTEC’s consolidated financial statements.

As of December 31, 2017, the Company has $35.3 million of unremitted earnings from foreign subsidiaries. The Company has not recognized a deferred tax liability on undistributed earnings for the Company’s foreign subsidiaries because these earnings are intended to be indefinitely 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 June 27, 2017 the Company received a one-time repatriation of cash from a foreign subsidiary of $8.9 million to partially fund the acquisition of PayGroup. This distribution was subject to withholding at source of 15% in the country of origin and accordingly the Company recognized current foreign income tax expense of $1.3 million. No Puerto Rico income tax expense was recorded in connection with this distribution because of the availability to credit foreign taxes paid. The Company believes that this one time repatriation of existing funds from a foreign subsidiary does not prohibit applying the indefinite reinvestment exception to the remaining undistributed earnings because Management has sufficient evidence of specific plans to continue reinvesting the foreign subsidiary’s undistributed earnings.

On October 19, 2012, EVERTEC Group was granted 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 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, (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); and (iii) 80% of EVERTEC Group employees must be residents of Puerto Rico. 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.

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. The Company filed an application for extension of the grant together with the required supplementary documentation with the Puerto Rico Industrial Development Company in November of 2017.

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



	December 31,
(Dollar amounts in thousands)	2017			2016
Deferred tax assets (“DTA”)
Allowance for doubtful accounts	$	195		$	265
Unearned income	3,136			2,023
Investment in equity subsidiary	447			385
Alternative minimum tax	51			176
Share-based compensation	1,208			697
Debt Issuance Costs	69			127
General Reserves	505			474
Derivative Liability	—			172
Accrual of contract maintenance cost	472			—
Impairment of asset	425			—
Other temporary assets	1,754			704
Total gross deferred tax assets	8,262			5,023
Deferred tax liabilities (“DTL”)
Deferred compensation	1,617			1,458
Difference between the assigned values and the tax basis of assets and liabilities recognized in purchase	19,124			17,738
Other temporary liabilities	353			—
Total gross deferred tax liabilities	21,094			19,196
Deferred tax liability, net	$	(12,832	)	$	(14,173	)

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. Act 72 of May 29, 2015, limited the amount of NOLs deduction to 80% for regular tax and 70% for AMT for the taxable year ended December 31, 2017. At December 31, 2017, the Company no longer has NOL carryforwards for tax purposes.

The Company recognizes the benefit of uncertain tax positions ("UTPs") only if it is more likely than not that the tax position will be sustained on examination by taxing authorities, based on the technical merits of the position. The tax benefits recognized in the financial statements from such a position are measured based on the largest benefit that has a greater than fifty percent likelihood of being realized upon ultimate settlement. During the third quarter of 2017, the Company decreased a previously recorded potential liability for uncertain tax positions by $4.5 million, as a result of the expiration of the statute of limitations.

The following is a tabular reconciliation of the total amounts of UTPs:



	Years ended December 31,
(Dollar amounts in thousands)	2017			2016			2015
Balance, beginning of year	$	12,219		$	12,847		$	19,859
Gross increases—tax positions in prior period	—			—			53
Gross decreases—tax positions in prior period	—			(345		)	—
Lapse of statute of limitations	(3,071		)	(283		)	(7,065		)
Balance, end of year	$	9,148		$	12,219		$	12,847

As of December 31, 2017, 2016 and 2015, approximately $9.1 million, $12.2 million and $12.2 million, respectively, would affect the Company’s effective income tax rate, if recognized.

The Company recognizes interest and penalties related to UTB as part of income tax expense. During the years ended December 31, 2017, 2016 and 2015, the Company recognized an income tax benefit of $0.8 million, an income tax expense of $0.7 million and an income tax benefit of $2.0 million, respectively, related to interest and penalties. The amount accrued for interest and penalties at December 31, 2017 and 2016 was $1.2 million, and $2.0 million, respectively. The Company anticipates changes to the UTBs within the next 12 months to be primarily related to interest. The Company believes it has sufficient accruals for contingent tax liabilities.

In connection with tax return examinations, contingencies can arise that generally result from different interpretations of tax laws and regulations as they pertain to the amount, timing or inclusion of revenues and expenses in taxable income, or the ability to utilize tax credits to reduce income taxes payable. While it is probable, based on the potential outcome of the Company’s Puerto Rico and foreign tax examinations or the expiration of the statute of limitations for specific jurisdictions, that the liability for UTBs may increase or decrease within the next twelve months, the Company does not expect any such change would have a material effect on our financial condition, results of operations or cash flow.

The Company and its subsidiaries are subject to Puerto Rico income tax as well as income tax of multiple foreign jurisdictions. A significant majority of the income tax is from Puerto Rico with a statute of limitations of four years after filing the income tax returns; therefore, the income tax returns for 2013, 2014, 2015, and 2016 are currently open for examination.

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



	Years ended December 31,
(Dollar amounts in thousands)	2017			2016			2015
Computed income tax at statutory rates	$	23,477		$	32,525		$	31,996
Benefit of net tax-exempt interest income	(56		)	(52		)	(284		)
Differences in tax rates due to multiple jurisdictions	2,353			32			37
Tax (benefit) expense due to a change in estimate	(334		)	258			(201		)
Effect of income subject to tax-exemption grant	(16,832		)	(24,866		)	(23,375		)
Unrecognized tax (benefit) expense	(3,828		)	373			(11,626		)
Effect of disallowed operating losses in foreign entities	—			—			103
Other	—			1			15
Income tax expense (benefit)	$	4,780		$	8,271		$	(3,335	)