The Company is subject to the dispositions of the 2011 Internal Revenue Code of the New Puerto Rico, as amended (the Code). Among others, the Code imposes a maximum corporate tax rate of 39%. One of the Code's amendments is Act. 77-2014 known as “Ley de Ajustes al Sistema Contributivo” (Act of Adjustments to the Tax System). The main purpose of the Act is to increase government collections in order to alleviate the structural deficit. The most relevant provisions of the Act, as applicable to the Company, and effective for transactions held after June 30, 2014 are as follows: (1) the capital tax rate was increased from 15% to 20% and (2) for an asset to be considered long term capital asset, the holding period must be over a year, which before was defined with a holding period of over six months.

Other provisions applicable to tax years commencing after December 31, 2013 is the additional tax on gross income (“patente nacional”) is defined as a separate tax, rather than a component of the Alternative Minimum Tax (AMT) for non-financial institutions and, therefore is not longer accounted for under the provisions of ASC 740. For financial institutions, the additional tax on gross income remained mostly unaltered at a tax rate of 1% of its gross income of a taxable year, of which fifty percent (50%) may be claimed as a credit against the financial institution's applicable income tax of that year.

Currently, the House of Representatives' Bill 2329 known as “Ley de Transformación al Sistema Contributivo del Estado Libre Asociado de Puerto Rico” (Act of Transformation of the Tax System of the Commonwealth of Puerto Rico) is under consideration by the Legislature and will introduce a new Internal Revenue Tax Code. Among the proposed changes are: 1) the reduction of the maximum corporate income tax rate from 39% to 30%, 2) repeals the additional tax on gross income and 3) repeals preferential tax rates of capital gains and dividend income. Another significant change that the Bill introduces is the substitution of the Sales and Use Tax “Impuesto de Ventas y Uso” of 7%, with a broad base Value Added Tax of 16% with fewer exemptions.

Under Puerto Rico law, all companies are treated as separate taxable entities and are not entitled to file consolidated returns. The Company and its subsidiaries are subject to Puerto Rico regular income tax or AMT on income earned from all sources. The AMT is payable if it exceeds regular income tax. The excess of AMT over regular income tax paid in any one year may be used to offset regular income tax in future years, subject to certain limitations. As of December 31, 2014, the tax years that remain subject to examination by the Puerto Rico Treasury Department are 2011 and 2012.

The components of income tax expense (benefit) for the years ended December 31, 2014, 2013 and 2012 are as follows

The Company maintained an effective tax rate lower than the maximum marginal statutory rate of 39.00%, 39.00%, and 30.00% as of December 31, 2014, 2013 and 2012, respectively, mainly due to exempt income from investment securities and loans. For 2014, 2013 and 2012 the Bank's investment securities portfolio and loans portfolio generated tax-exempt interest income of $40.5 million, $11.7 million, and $6.2 million, respectively. For 2014, OIB generated $16.5 million in exempt income. For 2013 and 2012, OIB generated $12.1 million and $15.3 million in income taxable at a 5% income tax rate.

Pursuant to the Declaration of Fiscal Emergency and Plan for Economic Stabilization and Restoration of the Puerto Rico Credit Act of March 9, 2009, for the 2009 and 2010 taxable years every taxable corporation engaged in trade or business in Puerto Rico, including banks and insurance companies, was subject to an additional 5% surcharge on corporate income tax, increasing the maximum tax rate from 39% to 40.95%. Also, income earned by international banking entities, which was previously fully exempt, was subject to a 5% income tax for the 2012. These taxes were imposed on a temporary basis as a measure to generate additional revenue to address the fiscal crisis of the government of Puerto Rico.

The Company's income tax expense differs from amounts computed by applying the applicable statutory rate to income before income taxes as follows:

	Year Ended December 31,
	2014			2013			2012
	Amount		Rate	Amount		Rate	Amount		Rate
	(Dollars in thousands)
Tax at statutory rates	$	47,749	39.00%	$	34,997	39.00%	$	8,357	30.00%
Tax effect of exempt income, net		(10,002)	-26.85%		(4,652)	-4.90%		(3,461)	-12.42%
Effect of tax rate on capital loss carryforwards		-	0.00%		840	0.94%		(4,361)	-15.66%
Disallowed net operating loss carryover		8,289	22.25%		-	0.00%		-	0.00%
Change in valuation allowance		(958)	-2.57%		1,896	2.11%		(554)	-1.99%
Income tax contingencies provision (credit)		(1,093)	-2.94%		(1,559)	-1.57%		114	0.41%
Effect in deferred taxes due to increase in tax rates
from 30.00% to 39.00%		-	0.00%		(38,068)	-43.04%		-	0.00%
Loan tax basis change effect		(7,642)	-20.51%		-	0.00%		-	0.00%
Effect of change in tax of IBE		-	0.00%		148	0.17%		2,383	8.55%
Other items, net		909	2.00%		(2,311)	-2.58%		823	2.96%
Income tax expense (benefit)	$	37,252	10.82%	$	(8,709)	-9.70%	$	3,301	11.85%

The Company classifies unrecognized tax benefits in income taxes payable. These gross unrecognized tax benefits would affect the effective tax rate if realized. The balance of unrecognized tax benefits at December 31, 2014 was $2.6 million (December 31, 2013 - $4.0 million). The Company had accrued $470 thousand at December 31, 2014 (December 31, 2013 - $1.3 million) for the payment of interest and penalties relating to unrecognized tax benefits. Also, during this year the Company recorded a reversal of an income tax contingency of $1.0 million as a result of reviewing the positions of certain unrecognized tax benefits at the Bank. At December 31, 2014 there is also $694 thousand (December 31, 2013 - $752 thousand) in accrued payment of interest and penalties relating to unrecognized tax benefits from this acquisition.

	Year Ended December 31,
	2014		2013		2012
	(In thousands)
Balance at beginning of year	$	4,042	$	5,452	$	1,389
Additions for tax positions of prior years		187		287		114
Additions for tax positions related to BBVAPR Acquisition		-		-		3,949
Reduction for tax positions as a result of settlements		(1,388)		-		-
Reduction for tax positions as a result of lapse of statute of limitations		(281)		(1,697)		-
Balance at end of year	$	2,560	$	4,042	$	5,452

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.

Income tax expense was $37.3 million for the year ended December 31, 2014, compared to $8.7 million tax benefit for the year ended December 31, 2013. Effective July 1, 2014, capital gains tax rate was increased from 15% to 20% as explained above

The tax effect expected of the income earned by OIB is included in the “tax effect of exempt income, net” caption on the table above and amounted to $4.7 million and $4.7 million for the years ended December 31, 2014 and 2013, respectively.

The determination of deferred tax expense or benefit is based on changes in the carrying amounts of assets and liabilities that generate temporary differences. The carrying value of the Company's net deferred tax assets assumes that the Company will be able to generate sufficient future taxable income based on estimates and assumptions. If these estimates and related assumptions change in the future, the Company may be required to record valuation allowances against its deferred tax assets resulting in additional income tax expense in the consolidated statements of operations.

	December 31,
	2014		2013
	(In thousands)
Deferred tax asset:
Allowance for loan and lease losses and other reserves	$	90,090	$	87,248
Loans and other real estate valuation adjustment		9,295		3,955
Net capital and operating loss carry forwards		28,973		35,829
Alternative minimum tax		16,208		425
Deposit and borrowings valuation adjustment		390		2,251
Unrealized net loss included in other comprehensive income		3,273		4,229
S&P option contracts		1,882		7,329
Acquired portfolio		46,146		55,876
Other assets allowances		1,424		1,727
Acquired software related to BBVAPR Acquisition		-		3,011
Other deferred tax assets		6,262		9,270
Total gross deferred tax asset		203,943		211,150

Deferred tax liability:
FDIC shared-loss indemnification asset		(21,809)		(20,783)
FDIC-assisted acquisition		(40,740)		(15,021)
Customer deposit and customer relationship intangibles		(3,800)		(4,646)
Loans and building valuation adjustment		(11,656)		(17,425)
Unrealized net gain on available-for-sale securities		(3,799)		(1,454)
Servicing asset		(5,457)		(5,374)
Other deferred tax liabilities		(2,703)		(4,570)
Total gross deferred tax liabilities		(89,964)	$	(69,273)
Less: valuation allowance		(5,271)		(4,313)
Net deferred tax asset	$	108,708	$	137,564

In assessing the realizability of the deferred tax asset, management considers whether it is more likely than not that some portion or the entire deferred tax asset will not be realized. The ultimate realization of the deferred tax asset is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income, and tax planning strategies in making this assessment. Based upon the level of historical taxable income and projections for future taxable income over the periods in which the deferred tax asset are deductible, management believes it is more likely than not that the Company will realize the benefits of these deductible differences, net of the existing valuation allowances at December 31, 2014. The amount of the deferred tax asset considered realizable, however, could be reduced in the near term if estimates of future taxable income during the carry-forward period are reduced.

The Company and its subsidiaries have operating and capital loss carry-forwards for income tax purposes which are available to offset future taxable income and capital gains. Operating loss carry-forwards are available until December 2023 and capital loss carry-forwards are available until December 2018. The majority of these operating and capital loss carry-forwards are at the Bank amounting to approximately $41.8 million as of December 31, 2014.

The Company follows a two-step approach for recognizing and measuring uncertain tax positions. The first step is to evaluate the tax position for recognition by determining if the weight of available evidence indicates that it is more likely than not that the position will be sustained on audit, including resolution of related appeals or litigation processes, if any. The second step is to measure the tax benefit as the largest amount that is more than 50% likely to be realized upon ultimate settlement.