Income taxes

9 Months Ended

Sep. 30, 2021

Income Tax Disclosure

Income Taxes

Note 30 – 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, 2021				September 30, 2020
(In thousands)		Amount	% of pre-tax income			Amount	% of pre-tax income
Computed income tax expense at statutory rates	$	124,370	38	%	$	78,594	38	%
Net benefit of tax exempt interest income		(34,294)	(10)			(31,177)	(15)
Deferred tax asset valuation allowance		3,529	1			2,185	1
Difference in tax rates due to multiple jurisdictions		(9,600)	(3)			(2,584)	(1)
Effect of income subject to preferential tax rate		(5,441)	(2)			(3,095)	(2)
Unrecognized tax benefits		(5,484)	(2)			(2,163)	(1)
Adjustment due to estimate on the annual effective rate		4,001	1			(4,030)	(2)
State and local taxes		6,352	2			3,748	2
Others		109	-			(310)	-
Income tax expense	$	83,542	25	%	$	41,168	20	%

		Nine months ended
		September 30, 2021				September 30, 2020
(In thousands)		Amount	% of pre-tax income			Amount	% of pre-tax income
Computed income tax expense at statutory rates	$	360,859	38	%	$	149,715	38	%
Net benefit of tax exempt interest income		(105,297)	(11)			(93,497)	(24)
Deferred tax asset valuation allowance		19,682	2			10,333	3
Difference in tax rates due to multiple jurisdictions		(25,429)	(3)			2,081	1
Effect of income subject to preferential tax rate		(10,175)	(1)			(7,722)	(2)
Adjustment due to estimate on the annual effective rate		(6,732)	(1)			2,821	1
Unrecognized tax benefits		(5,484)	(1)			(2,163)	(1)
State and local taxes		8,943	1			5,807	1
Others		(2,901)	-			1,518	-
Income tax expense	$	233,466	24	%	$	68,893	17	%

For the quarter and nine months ended September 30, 2021, the Corporation recorded an income tax expense of $83.5 million and $233.5 million, respectively, compared to $41.2 million and $68.9 million for the respective period of 2020. The increase in income tax expense was primarily due to higher pre-tax income resulting primarily from a lower provision for credit losses partially offset by higher net exempt interest income and higher income from the U.S. operations subject to lower statutory tax rate.

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

			September 30, 2021
(In thousands)			PR		US		Total
Deferred tax assets:
Tax credits available for carryforward		$	3,718	$	2,781	$	6,499
Net operating loss and other carryforward available			106,024		682,305		788,329
Postretirement and pension benefits			73,189		-		73,189
Deferred loan origination fees			11,251		(3,997)		7,254
Allowance for credit losses			254,120		32,493		286,613
Accelerated depreciation			4,400		7,325		11,725
FDIC-assisted transaction			152,665		-		152,665
Intercompany deferred gains			1,458		-		1,458
Lease liability			27,670		24,757		52,427
Difference in outside basis from pass-through entities			56,358		-		56,358
Other temporary differences			40,689		8,443		49,132
	Total gross deferred tax assets		731,542		754,107		1,485,649
Deferred tax liabilities:
Indefinite-lived intangibles			75,803		50,562		126,365
Unrealized net gain (loss) on trading and available-for-sale securities			35,095		5,882		40,977
Right of use assets			25,564		21,065		46,629
Other temporary differences			52,623		1,507		54,130
	Total gross deferred tax liabilities		189,085		79,016		268,101
Valuation allowance			124,351		417,013		541,364
Net deferred tax asset		$	418,106	$	258,078	$	676,184
			December 31, 2020
(In thousands)			PR		US		Total
Deferred tax assets:
Tax credits available for carryforward		$	3,003	$	5,269	$	8,272
Net operating loss and other carryforward available			124,355		698,842		823,197
Postretirement and pension benefits			80,179		-		80,179
Deferred loan origination fees			12,079		(2,652)		9,427
Allowance for credit losses			373,010		38,606		411,616
Accelerated depreciation			3,439		5,390		8,829
FDIC-assisted transaction			152,665		-		152,665
Intercompany deferred gains			1,728		-		1,728
Lease liability			22,790		18,850		41,640
Difference in outside basis from pass-through entities			61,222		-		61,222
Other temporary differences			38,954		7,344		46,298
	Total gross deferred tax assets		873,424		771,649		1,645,073
Deferred tax liabilities:
Indefinite-lived intangibles			73,305		37,745		111,050
Unrealized net gain (loss) on trading and available-for-sale securities			67,003		8,595		75,598
Right of use assets			20,708		15,510		36,218
Other temporary differences			50,247		1,169		51,416
	Total gross deferred tax liabilities		211,263		63,019		274,282
Valuation allowance			112,871		407,225		520,096
Net deferred tax asset		$	549,290	$	301,405	$	850,695

The net deferred tax asset shown in the table above at September 30, 2021 is reflected in the consolidated statements of financial condition as $0.7 billion in net deferred tax assets in the “Other assets” caption (December 31, 2020 - $0.9 billion) and $869 thousand in deferred tax liabilities in the “Other liabilities” caption (December 31, 2020 - $897 thousand), 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.

At September 30, 2021 the net deferred tax asset of the U.S. operations amounted to $675 million with a valuation allowance of approximately $417 million, for a net deferred tax asset after valuation allowance of approximately $258 million. The Corporation evaluates the realization of the deferred tax asset by taxing jurisdiction. The U.S. operation is not in a cumulative three-year loss position and had sustained profitability for the three-year period ended September 30, 2021 with strong pre-tax income for the first three quarters of 2021. This objectively verifiable positive evidence, together with the positive evidence of stable credit metrics, in combination with the length of the expiration of the NOLs are enough to overcome any negative evidence related to the COVID-19 pandemic and the uncertainty created by new variants. As of September 30, 2021, after weighting all positive and negative evidence, the Corporation concluded that it is more likely than not that approximately $258 million of the 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 available to realize the deferred tax asset for the remaining carryforward period, together with the historical level of book income adjusted by permanent differences. Management will continue to monitor and review the U.S. operation’s results and the pre-tax earnings forecast on a quarterly basis to assess the future realization of the deferred tax asset. Management will closely monitor factors, including, net income versus forecast, targeted loan growth, net interest income margin, allowance for credit losses, charge offs, NPLs inflows and NPA balances.

At September 30, 2021, the Corporation’s net deferred tax assets related to its Puerto Rico operations amounted to $418 million net of valuation allowance pertaining to the Holding Company operation.

The Corporation’s Puerto Rico Banking operation is not in a cumulative three-year loss position and had sustained profitability for the three-year period ended September 30, 2021. This is considered a strong piece of objectively verifiable positive evidence that outweighs 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 as of September 30, 2021.

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 September 30, 2021. Management expects 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 valuation allowance on the deferred tax asset of $124 million as of September 30, 2021.

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

(In millions)		2021		2020
Balance at January 1	$	14.8	$	16.3
Balance at March 31	$	14.8	$	16.3
Balance at June 30	$	14.8	$	16.3
Reduction as a result of lapse of statute of limitations - July through September		(11.3)		(1.5)
Balance at September 30	$	3.5	$	14.8

At September 30, 2021, the total amount of accrued interest recognized in the statement of financial condition approximated $2.6 million (December 31, 2020 - $4.8 million). The total interest expense recognized at September 30, 2021 was $810 thousand, net of the reduction of $2.9 million due to the expiration of the statute of limitation (September 30, 2020 - $1.6 million) net of the reduction of $645 thousand due to the expiration of the statute of limitation). Management determined that at September 30, 2021 and

December 31, 2020 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 $5.4 million at September 30, 2021 (December 31, 2020 - $10.2 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 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, 2021, the following years remain subject to examination in the U.S. Federal jurisdiction: 2018 and thereafter; and in the Puerto Rico jurisdiction, 2017 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 $1.4 million, including interest.