Income taxes

12 Months Ended

Dec. 31, 2016

Note 40 – Income taxes

The components of income tax expense (benefit) for the years ended December 31, are summarized in the following table.

(In thousands)		2016		2015		2014
Current income tax expense:
Puerto Rico	$	11,031	$	16,675	$	7,814
Federal and States		7,059		7,281		6,953
Subtotal		18,090		23,956		14,767
Deferred income tax expense (benefit):
Puerto Rico		36,423		63,808		12,569
Federal and States		24,271		(582,936)		2,861
Valuation allowance - Initial recognition		-		-		8,034
Adjustment for enacted changes in income tax laws		-		-		20,048
Subtotal		60,694		(519,128)		43,512
Total income tax expense (benefit)	$	78,784	$	(495,172)	$	58,279

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

			2016				2015				2014
(In thousands)			Amount	% of pre-tax income			Amount	% of pre-tax income			Amount	% of pre-tax income
Computed income tax at statutory rates		$	114,792	39	%	$	155,542	39	%		(51,570)	39	%
Benefit of net tax exempt interest income			(63,053)	(22)			(60,049)	(15)			(67,636)	51
Effect of income subject to preferential
	tax rate [1]		11,155	4			(10,010)	(3)			(21,909)	18
Deferred tax asset valuation allowance			16,585	6			(586,159)	(147)			(4,281)	3
Non-deductible expenses [2]			-	-			-	-			178,219	(135)
Difference in tax rates due to multiple
	jurisdictions		(4,092)	(1)			(3,008)	(1)			(2,403)	2
Initial adjustment in deferred tax due to
	change in tax rate		-	-			-	-			20,048	(16)
Unrecognized tax benefits			(4,442)	(2)			-	-			(3,601)	3
State and local taxes			9,081	3			4,543	1			6,248	(5)
Others			(1,242)	-			3,969	1			5,164	(4)
Income tax expense (benefit)		$	78,784	27	%	$	(495,172)	(125)	%	$	58,279	(44)	%

[1] Includes the impact of the Closing Agreement with the P.R. Treasury signed in June 2014.

[2] For the year ended December 31, 2014, includes approximately $161.5 million of amortization of the discount and deferred cost associated with the TARP funds, which are not deductible.

The results for the year ended December 31, 2015, reflect a tax benefit of $589 million as a result of the partial reversal of the valuation allowance on the Corporation’s deferred tax asset from the U.S. operation as further explain below.

During the third quarter of 2016, a reversal of $4.4 million in the reserve for uncertain tax positions, including interest was recognized due to the expiration of the statute of limitation in the P.R. operations.

During the year ended December 31, 2014, the Corporation recognized an income tax expense of $20.0 million mainly related to the deferred tax liability associated with the portfolio acquired from Westernbank, as a result of the increase in the income tax for capital gains from 15% to 20%. Additionally, during the second quarter of 2014 the Corporation entered into a Closing Agreement with the Puerto Rico Department of the Treasury. The Agreement, among other matters, was related to the income tax treatment of certain charge-offs related to the loans acquired from Westernbank as part of the FDIC assisted transaction in the year 2010. As a result of the Agreement, the Corporation recorded a tax benefit of $23.4 million due to a reduction in the deferred tax liability associated with Westernbank loan portfolio.

Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and their tax bases. Significant components of the Corporation’s deferred tax assets and liabilities at December 31 were as follows:

(In thousands)			December 31, 2016		December 31, 2015
Deferred tax assets:
Tax credits available for carryforward		$	18,510	$	13,651
Net operating loss and other carryforward available			1,238,222		1,262,197
Postretirement and pension benefits			94,741		116,036
Deferred loan origination fees			6,622		6,420
Allowance for loan losses			649,107		670,592
Deferred gains			4,884		5,966
Accelerated depreciation			9,828		8,335
Intercompany deferred gains			2,496		2,743
Differences between the assigned values and the tax basis of assets and liabilities
	recognized in purchase business combinations		13,160		12,684
Other temporary differences			31,127		29,208
	Total gross deferred tax assets		2,068,697		2,127,832
Deferred tax liabilities:
FDIC-assisted transaction			58,363		90,778
Indefinite-lived intangibles			73,974		63,573
Unrealized net gain on trading and available-for-sale securities			21,335		22,281
Other temporary differences			8,477		6,670
	Total gross deferred tax liabilities		162,149		183,302
Valuation allowance			664,287		642,727
Net deferred tax asset		$	1,242,261	$	1,301,803

The net deferred tax asset shown in the table above at December 31, 2016 is reflected in the consolidated statements of financial condition as $1.2 billion in net deferred tax assets (in the “other assets” caption) (2015 - $1.3 billion in deferred tax asset in the “other assets” caption) and $1.4 million in deferred tax liabilities (in the “other liabilities” caption) (2015 - $649 thousand in deferred tax liabilities in the “other liabilities” caption), reflecting the aggregate deferred tax assets or liabilities of individual tax-paying subsidiaries of the Corporation.

Included as part of the other carryforwards available are $44.2 million related to contributions to BPPR’s qualified pension plan and $30.4 million of other net operating loss carryforwards (“NOLs”) primarily related to the loss on sale of non-performing assets that have no expiration date since they were realize through a single member limited liability company with partnership election. Additionally, the deferred tax asset related to the NOLs outstanding at December 31, 2016 expires as follows:

(In thousands)
2018	$	5,116
2019		1,080
2021		108
2022		2,071
2023		1,444
2024		9,548
2025		14,057
2026		13,359
2027		42,062
2028		504,976
2029		170,691
2030		171,897
2031		134,106
2032		25,043
2033		1,757
2034		66,268
	$	1,163,583

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 December 31, 2016 the net deferred tax asset of the U.S. operations amounted to $1.1 billion with a valuation allowance of approximately $617 million, for a net deferred tax asset after valuation allowance of approximately $525 million. During the year ended December 31, 2015, after weighting all positive and negative evidence, the Corporation concluded that it is more likely than not that a portion of the total deferred tax asset from the U.S. operations, comprised mainly of net operating losses, will be realized. The Corporation based this determination on its estimated earnings for the remaining carryforward period of eighteen years beginning with the 2016 fiscal year, available to utilize the deferred tax asset, to reduce its income tax obligations. The historical level of book income adjusted by permanent differences, together with the estimated earnings after the reorganization of the U.S. operations and additional estimated earnings from the Doral Bank Transaction were objective positive evidence considered by the Corporation. As of December 31, 2015 the U.S. operations were not in a three year loss cumulative position, taking into account taxable income exclusive of reversing temporary differences. All of these factors led management to conclude that it is more likely than not that a portion of the deferred tax asset from its U.S. operations will be realized. Accordingly, the Corporation recorded a partial reversal of the valuation allowance on the deferred tax asset from the U.S. operations amounting to approximately $589 million. As of December 31, 2016, 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 $525 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 December 31, 2016, the Corporation’s net deferred tax assets related to its Puerto Rico operations amounted to $718 million.

The Corporation’s Puerto Rico Banking operation is not in a cumulative loss position and has sustained profitability for the three year period ended December 31, 2016. 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 in a cumulative loss position, taking into account taxable income exclusive of reversing temporary differences, for the three years period ending December 31, 2016 Management expect these losses will be a trend in future years. This objectively verifiable negative evidence 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, the Corporation has maintained a full valuation allowance on the deferred tax asset of $47 million as of December 2016.

Under the Puerto Rico Internal Revenue Code, the Corporation and its subsidiaries are treated as separate taxable entities and are not entitled to file consolidated tax returns. The Code provides a dividends-received deduction of 100% on dividends received from “controlled” subsidiaries subject to taxation in Puerto Rico and 85% on dividends received from other taxable domestic corporations.

The Corporation’s subsidiaries in the United States file a consolidated federal income tax return. The intercompany settlement of taxes paid is based on tax sharing agreements which generally allocate taxes to each entity based on a separate return basis.

The following table presents a reconciliation of unrecognized tax benefits.

(In millions)
Balance at January 1, 2015	$	8.0
Additions for tax positions related to 2015		1.5
Reduction as a result of settlements		(0.5)
Balance at December 31, 2015	$	9.0
Additions for tax positions related to 2016		1.1
Additions for tax positions taken in prior years		0.3
Reduction as a result of lapse of statute of limitations		(3.0)
Balance at December 31, 2016	$	7.4

At December 31, 2016, the total amount of interest recognized in the statement of financial condition approximated $2.9 million (2015 - $3.2 million). The total interest expense recognized during 2016 was $1.2 million (2015 - $57 thousand), which is net of the reversal of $1.4 million due to the expiration of the statute of limitations. Management determined that, as of December 31, 2016 and 2015, 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 $9.0 million at December 31, 2016 (2015 - $11.2 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 statute of limitations, 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. As of December 31, 2016, the following years remain subject to examination: U.S. Federal jurisdiction – 2013 through 2016 and Puerto Rico – 2012 through 2016. The Corporation anticipates a reduction in the total amount of unrecognized tax benefits within the next 12 months, which could amount to approximately $4.8 million.