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Income taxes | 9 Months Ended
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Sep. 30, 2020
Income Tax Disclosure |
Income Taxes | Note 31 – 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, 2020 |  |  |  | September 30, 2019 |
(In thousands) |  | Amount | % of pre-tax income |  |  |  | Amount | % of pre-tax income |
Computed income tax expense at statutory rates | $ | 78,594 | 38 | % |  | $ | 77,508 | 38 | %
Net benefit of tax exempt interest income |  | (31,177) | (15) |  |  |  | (38,103) | (18) |
Deferred tax asset valuation allowance |  | 2,185 | 1 |  |  |  | 3,170 | 1 |
Difference in tax rates due to multiple jurisdictions |  | (2,584) | (1) |  |  |  | (4,233) | (2) |
Effect of income subject to preferential tax rate |  | (3,095) | (2) |  |  |  | (2,243) | (1) |
Unrecognized tax benefits |  | (2,163) | (1) |  |  |  | - | - |
Adjustment due to estimate on the annual effective rate |  | (4,030) | (2) |  |  |  | 2,711 | 1 |
State and local taxes |  | 3,748 | 2 |  |  |  | 2,180 | 1 |
Others |  | (310) | - |  |  |  | 380 | - |
Income tax expense | $ | 41,168 | 20 | % |  | $ | 41,370 | 20 | %
|  |  | Nine months ended |
|  |  | September 30, 2020 |  |  |  | September 30, 2019 |
(In thousands) |  | Amount | % of pre-tax income |  |  |  | Amount | % of pre-tax income |
Computed income tax expense at statutory rates | $ | 149,715 | 38 | % |  | $ | 238,602 | 38 | %
Net benefit of tax exempt interest income |  | (93,497) | (24) |  |  |  | (95,986) | (15) |
Deferred tax asset valuation allowance |  | 10,333 | 3 |  |  |  | 9,915 | 2 |
Difference in tax rates due to multiple jurisdictions |  | 2,081 | 1 |  |  |  | (9,851) | (2) |
Effect of income subject to preferential tax rate |  | (7,722) | (2) |  |  |  | (7,458) | (1) |
Adjustment due to estimate on the annual effective rate |  | 2,821 | 1 |  |  |  | - | - |
Unrecognized tax benefits |  | (2,163) | (1) |  |  |  | - | - |
State and local taxes |  | 5,807 | 1 |  |  |  | 5,535 | 1 |
Others |  | 1,518 | - |  |  |  | (8,834) | (2) |
Income tax expense | $ | 68,893 | 17 | % |  | $ | 131,923 | 21 | %
For the nine months period ended September 30, 2020, the Corporation recorded an income tax expense of $68.9 million, compared to $131.9 million for the nine months period ended September 30, 2019. The reduction in income tax expense reflects the impact of lower pre-tax income, resulting primarily from a higher provision for credit losses and the impact of the COVID-19 pandemic. The following table presents a breakdown of the significant components of the Corporation’s deferred tax assets and liabilities.
|  |  | September 30, 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 |  | 121,842 |  | 701,733 |  | 823,575
Postretirement and pension benefits |  | 78,175 |  | - |  | 78,175
Deferred loan origination fees |  | 15,410 |  | (2,453) |  | 12,957
Allowance for credit losses |  | 405,681 |  | 42,452 |  | 448,133
Accelerated depreciation |  | 3,439 |  | 4,989 |  | 8,428
FDIC-assisted transaction |  | 82,994 |  | - |  | 82,994
Intercompany deferred gains |  | 1,453 |  | - |  | 1,453
Lease liability |  | 23,350 |  | 21,287 |  | 44,637
Difference in outside basis from pass-through entities |  | 59,348 |  | - |  | 59,348
Other temporary differences |  | 37,883 |  | 7,901 |  | 45,784
| Total gross deferred tax assets |  | 832,578 |  | 781,178 |  | 1,613,756
Deferred tax liabilities: |  |  |  |  |  |
Indefinite-lived intangibles |  | 39,908 |  | 37,662 |  | 77,570
Unrealized net gain (loss) on trading and available-for-sale securities |  | 74,101 |  | 8,793 |  | 82,894
Right of use assets |  | 21,266 |  | 19,412 |  | 40,678
Other temporary differences |  | 13,473 |  | 1,182 |  | 14,655
| Total gross deferred tax liabilities |  | 148,748 |  | 67,049 |  | 215,797
Valuation allowance |  | 110,435 |  | 406,590 |  | 517,025
Net deferred tax asset | $ | 573,395 | $ | 307,539 | $ | 880,934
|  |  | December 31, 2019
(In thousands) |  | PR |  | US |  | Total
Deferred tax assets: |  |  |  |  |  |
Tax credits available for carryforward | $ | 2,368 | $ | 5,269 | $ | 7,637
Net operating loss and other carryforward available |  | 112,803 |  | 716,796 |  | 829,599
Postretirement and pension benefits |  | 82,623 |  | - |  | 82,623
Deferred loan origination fees |  | 2,519 |  | (2,759) |  | (240)
Allowance for loan losses |  | 405,475 |  | 10,981 |  | 416,456
Accelerated depreciation |  | 3,439 |  | 4,914 |  | 8,353
FDIC-assisted transaction |  | 82,684 |  | - |  | 82,684
Intercompany deferred gains |  | 1,604 |  | - |  | 1,604
Lease liability |  | 22,694 |  | 23,387 |  | 46,081
Difference in outside basis from pass-through entities |  | 21,670 |  | - |  | 21,670
Other temporary differences |  | 26,554 |  | 7,460 |  | 34,014
| Total gross deferred tax assets |  | 764,433 |  | 766,048 |  | 1,530,481
Deferred tax liabilities: |  |  |  |  |  |
Indefinite-lived intangibles |  | 37,411 |  | 36,058 |  | 73,469
Unrealized net gain (loss) on trading and available-for-sale securities |  | 15,635 |  | 432 |  | 16,067
Right of use assets |  | 20,598 |  | 21,430 |  | 42,028
Other temporary differences |  | 12,778 |  | 1,179 |  | 13,957
| Total gross deferred tax liabilities |  | 86,422 |  | 59,099 |  | 145,521
Valuation allowance |  | 100,175 |  | 399,800 |  | 499,975
Net deferred tax asset | $ | 577,836 | $ | 307,149 | $ | 884,985
The net deferred tax asset shown in the table above at September 30, 2020 is reflected in the consolidated statements of financial condition as $0.9 billion in net deferred tax assets in the “Other assets” caption (December 31, 2019 - $0.9 billion) and $1.3 million in deferred tax liabilities in the “Other liabilities” caption (December 31, 2019 - $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 negative and positive 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, mainly the future reversal of existing taxable temporary differences and future taxable income exclusive of reversing temporary differences and carryforwards. At September 30, 2020, the deferred tax asset net of deferred tax liabilities of the U.S. operations amounted to $715 million, mainly related to net operating losses expiring between 2017 and 2033, with a valuation allowance of approximately $407 million, for a net deferred tax asset of approximately $308 million. Management evaluates the realization of the deferred tax asset by taxing jurisdiction. The U.S. mainland operations are evaluated, as a whole, since a consolidated income tax return is filed. As of September 30, 2020, the U.S. operation is not in a cumulative three-years loss position. During 2020, two additional pieces of negative evidence arose: further reduction in interest rates combined with a lower expectation of rate increases in the near future and the economic uncertainty around COVID-19 pandemic. This economic disruption was the principal driver of the significant increase in our provision for credit losses during the first quarter of 2020, although net charge-offs for the first three quarters of 2020 and early credit indicators such as NPL inflows were stable in our U.S. operations. Due to the economic uncertainty, at this time, the additional negative evidence related to the economic disruption is not enough to overcome the positive evidence of recent historical operating performance such as sustained loan growth, the early success of new business initiatives and stable credit metrics, in combination with the length of the expiration of the NOLs. The Corporation believes that this objectively verified positive evidence places the U.S. operations in a good position to continue executing its business plan once the economic environment stabilizes after the current pandemic turmoil. As a result, as of September 30, 2020, management estimates 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. 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 DTA. Management will closely monitor factors like, net income versus forecast, targeted loan growth, net interest income margin, allowance for credit losses, charge offs, NPLs inflows and NPA balances. If such factors worsen during future periods, they could constitute sufficient objectively verifiable negative evidence to overcome the positive evidence that currently exists, and could require additional amounts of valuation allowance to be registered on the DTA. Any increases to the valuation allowance would be reflected as an income tax expense, reducing the Corporation’s earnings. At September 30, 2020, the Corporation’s net deferred tax assets related to its Puerto Rico operations amounted to $573 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, 2020. 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, 2020. 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, 2020. 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 negative and positive 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. Accordingly, a valuation allowance is recorded on the deferred tax asset at the PIHC, which amounted to $110 million as of September 30, 2020. The extent to which the COVID-19 pandemic further impacts our business, results of operations and financial condition, as well as the operations of our clients, customers, service providers and suppliers, will depend on future developments, which are highly uncertain and cannot be predicted, including the scope and duration of the pandemic and actions taken by governmental authorities and other third parties in response thereto. To the extent that the COVID-19 pandemic results in the continued closure of businesses and a reduction in economic activity, and interest rates, the Corporation and its subsidiaries will be further impacted in the form of reduced revenues, additional expenses and higher credit losses and could result in further impairment or reduction in the assessment of the realizability of our DTA in our Puerto Rico and U.S. operations. The reconciliation of unrecognized tax benefits, excluding interest, was as follows:
(In millions) |  | 2020 |  |  | 2019
Balance at January 1 | $ | 16.3 |  | $ | 7.2
Additions for tax positions - January through March |  | - |  |  | 0.3
Balance at March 31 | $ | 16.3 |  | $ | 7.5
Additions for tax positions - April through June |  | - |  |  | 0.2
Balance at June 30 | $ | 16.3 |  | $ | 7.7
Reduction as a result of lapse of statute of limitations - July through September |  | (1.5) |  |  | -
Balance at September 30 | $ | 14.8 |  | $ | 7.7
At September 30, 2020, the total amount of accrued interest recognized in the statement of financial condition approximated $4.5 million (December 31, 2019 - $3.5 million). The total interest expense recognized at September 30, 2020 was $1.6 million, net of the reduction of $645 thousand due to the expiration of the statute of limitation (September 30, 2019 - $317 thousand). Management determined that at September 30, 2020 and December 31, 2019 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 $9.8 million at September 30, 2020 (December 31, 2019 - $10.5 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, 2020, the following years remain subject to examination in the U.S. Federal jurisdiction: 2016 and thereafter; and in the Puerto Rico jurisdiction, 2014 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 $3.2 million.

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- Definition The entire disclosure for income taxes. Disclosures may include net deferred tax liability or asset recognized in an enterprise's statement of financial position, net change during the year in the total valuation allowance, approximate tax effect of each type of temporary difference and carryforward that gives rise to a significant portion of deferred tax liabilities and deferred tax assets, utilization of a tax carryback, and tax uncertainties information. + References Reference 1: http://fasb.org/us-gaap/role/ref/legacyRef -Publisher FASB -Name Accounting Standards Codification -Topic 740 -URI http://asc.fasb.org/topic&trid=2144680 + Details
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