Income taxes

9 Months Ended

Sep. 30, 2017

Note 32 – 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
		September 30, 2017				September 30, 2016
(In thousands)		Amount	% of pre-tax income			Amount	% of pre-tax income
Computed income tax expense at statutory rates	$	272	39	%	$	24,434	39	%
Net benefit of tax exempt interest income		(19,563)	(2,803)			(15,620)	(25)
Deferred tax asset valuation allowance		5,142	737			5,698	9
Difference in tax rates due to multiple jurisdictions		189	27			(897)	(1)
Effect of income subject to preferential tax rate		(3,313)	(475)			6,364	10
Unrecognized tax benefits		(1,185)	(170)			(4,442)	(7)
State and local taxes		(64)	(9)			1,557	2
Others		(1,444)	(207)			(1,255)	(2)
Income tax (benefit) expense	$	(19,966)	(2,861)	%	$	15,839	25	%

		Nine months ended
		September 30, 2017				September 30, 2016
(In thousands)		Amount	% of pre-tax income			Amount	% of pre-tax income
Computed income tax expense at statutory rates	$	100,857	39	%	$	117,525	39	%
Net benefit of tax exempt interest income		(56,408)	(22)			(47,094)	(16)
Deferred tax asset valuation allowance		15,262	6			14,407	5
Difference in tax rates due to multiple jurisdictions		(1,601)	(1)			(2,874)	(1)
Effect of income subject to preferential tax rate		(9,825)	(4)			(1,772)	(1)
Unrecognized tax benefits		(1,185)	-			(4,442)	(1)
State and local taxes		2,800	1			6,642	2
Others		(1,128)	-			(1,842)	(1)
Income tax expense	$	48,772	19	%	$	80,550	26	%

Income tax benefit amounted to $20 million for the quarter ended September 30, 2017, compared with an income tax expense of $15.8 million for the same quarter of 2016. The reduction in income tax expense was primarily due to lower taxable income before tax and higher tax benefit on net exempt interest income.

For the nine months period ended September 30,2017, income tax expense amounted to $48.8 million compared to $80.5 million for the nine months period ended September 30,2016. The reduction in income tax expense was primarily due to lower 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.

			September 30, 2017
(In thousands)			PR		US		Total
Deferred tax assets:
Tax credits available for carryforward		$	16,069	$	1,958	$	18,027
Net operating loss and other carryforward available			117,273		1,106,550		1,223,823
Postretirement and pension benefits			83,925		-		83,925
Deferred loan origination fees			3,768		1,480		5,248
Allowance for loan losses			616,572		38,524		655,096
Deferred gains			-		4,262		4,262
Accelerated depreciation			1,325		10,280		11,605
Intercompany deferred (loss) gains			(31)		-		(31)
Difference between the assigned values and the tax basis of assets and
	liabilities recognized in purchase business combinations		17,107		-		17,107
Other temporary differences			22,750		13,512		36,262
	Total gross deferred tax assets		878,758		1,176,566		2,055,324
Deferred tax liabilities:
FDIC-assisted transaction			58,009		-		58,009
Indefinite-lived intangibles			31,083		48,414		79,497
Unrealized net gain on trading and available-for-sale securities			31,127		(7,537)		23,590
Other temporary differences			9,429		585		10,014
	Total gross deferred tax liabilities		129,648		41,462		171,110
Valuation allowance			62,213		615,873		678,086
Net deferred tax asset		$	686,897	$	519,231	$	1,206,128

			December 31, 2016
(In thousands)			PR		US		Total
Deferred tax assets:
Tax credits available for carryforward		$	16,552	$	1,958	$	18,510
Net operating loss and other carryforward available			112,929		1,125,293		1,238,222
Postretirement and pension benefits			94,741		-		94,741
Deferred loan origination fees			4,335		2,287		6,622
Allowance for loan losses			628,127		20,980		649,107
Deferred gains			-		4,884		4,884
Accelerated depreciation			605		9,223		9,828
Intercompany deferred (loss) gains			2,496		-		2,496
Difference between the assigned values and the tax basis of assets and
	liabilities recognized in purchase business combinations		13,160		-		13,160
Other temporary differences			16,417		14,710		31,127
	Total gross deferred tax assets		889,362		1,179,335		2,068,697
Deferred tax liabilities:
FDIC-assisted transaction			58,363		-		58,363
Indefinite-lived intangibles			28,412		45,562		73,974
Unrealized net gain on trading and available-for-sale securities			30,334		(8,999)		21,335
Other temporary differences			7,892		585		8,477
	Total gross deferred tax liabilities		125,001		37,148		162,149
Valuation allowance			46,951		617,336		664,287
Net deferred tax asset		$	717,410	$	524,851	$	1,242,261

The net deferred tax asset shown in the table above at September 30, 2017 is reflected in the consolidated statements of financial condition as $1.2 billion in net deferred tax assets in the “Other assets” caption (December 31, 2016 - $1.2 billion) and $1.4 million in deferred tax liabilities in the “Other liabilities” caption (December 31, 2016 - $1.4 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 September 30, 2017 the net deferred tax asset of the U.S. operations amounted to $1.1 billion with a valuation allowance of approximately $616 million, for a net deferred tax asset of approximately $519 million. As of September 30, 2017, 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 $519 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 September 30, 2017, the Corporation’s net deferred tax assets related to its Puerto Rico operations amounted to $687 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 September 30, 2017. 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 September 30, 2017. 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 full valuation allowance is recorded on the deferred tax asset at the PIHC, which amounted to $62 million as of September 30, 2017.

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

(In millions)		2017		2016
Balance at January 1	$	7.4	$	9.0
Additions for tax positions - January through March		0.2		0.2
Additions for tax positions taken in prior years - January through March		-		0.2
Balance at March 31	$	7.6	$	9.4
Additions for tax positions - April through June		0.3		0.3
Reduction as a result of settlements - April through June		(0.3)		-
Balance at June 30	$	7.6	$	9.7
Additions for tax positions - July through September		0.3		0.3
Additions for tax positions taken in prior years - July through September		-		0.1
Reduction as a result of lapse of statute of limitations - July through September		(0.9)		(3.0)
Balance at September 30	$	7.0	$	7.1

At September 30, 2017, the total amount of interest recognized in the statement of financial condition approximated $2.6 million (December 31, 2016 - $2.9 million). The total interest expense recognized at September 30, 2017 was $458 thousand net of a reduction of $505 thousand due to settlement and $353 thousand due to the expiration of the statute of limitation (December 31, 2016 - $1.2 million). Management determined that at September 30, 2017 and December 31, 2016 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, whiles 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 $8.5 million at September 30, 2017 (December 31, 2016 - $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 September 30, 2017, 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 $4.5 million.