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Income Taxes

12 Months Ended

Dec. 31, 2020

NOTE 19 — INCOME TAXES

Oriental is subject to the provisions of the PR Code. For 2020, the PR Code imposed a maximum statutory corporate tax rate of 37.5%. Oriental has operations in the U.S. through its wholly owned subsidiary OPC, a retirement plan administration based in Florida; also in March 2019, Oriental formed a new subsidiary, OFG Ventures, based in Missouri. In addition, in October 2017, Oriental expanded its operations in U.S. through the Bank's wholly owned subsidiary OFG USA. These subsidiaries are subject to state and federal taxes. OPC is subject to Florida state taxes, OFG Ventures is subject to Missouri state taxes and OFG USA is subject to North Carolina state taxes. OFG Ventures and OFG USA elected to be classified as a corporation for federal income tax purposes.

Under the PR Code, all companies are treated as separate taxable entities and are not entitled to file consolidated tax returns. Oriental and its subsidiaries are subject to Puerto Rico regular income tax or the alternative minimum tax (“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.

The components of income tax expense for the years ended December 31, 2020, 2019, and 2018 are as follows:

	Year Ended December 31,
	2020		2019			2018
	(In thousands)
Current income tax (benefit) expense	$	(7,347)	$	25,477	$	33,618
Deferred income tax expense (benefit)		27,846		(4,068)		14,772
Total income tax expense	$	20,499	$	21,409	$	48,390

In relation to the exempt income level, the Bank’s investment securities portfolio and loans portfolio generated net tax-exempt interest income of $15.2 million at 2020, $11.8 million at 2019 and $11.0 million at 2018. OIB generated exempt income of $4.1 million, $10.3 million and $5.3 million for 2020, 2019, and 2018, respectively.

Oriental maintained an effective tax rate lower than statutory rate for the year ended December 31, 2020, mainly by investing in tax-exempt obligations, doing business through its international banking entities and by expanding its subsidiary operations in the U.S., which are taxed at a lower rate.

Oriental’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,
	2020			2019			2018
	Amount		Rate	Amount		Rate	Amount		Rate
	(Dollars in thousands)
Income tax expense at statutory rates	$	35,567	37.51%	$	28,219	37.50%	$	51,792	39.00%
Tax of exempt income, net		(7,272)	-7.67%		(8,728)	-11.60%		(6,645)	-5.01%
Disallowed net operating loss carryover		202	0.21%		384	0.51%		269	0.20%
Change in valuation allowance		2,267	2.39%		1,217	1.62%		1,504	1.13%
Unrecognized tax benefits, net		(1,941)	-2.05%		1,794	2.38%		(386)	-0.29%
Capital gain at preferential rate		(450)	-0.47%		(265)	-0.35%		(20)	-0.02%
Effect of change in tax rate		-	0.00%		-	0.00%		4,069	3.06%
Tax rate difference (ordinary vs capital)		(4,218)	-4.45%		-	0.00%		-	0.00%
Bargain purchase gain		(2,751)	-2.90%		(118)	-0.16%		-	0.00%
Other items, net		(905)	-0.95%		(1,094)	-1.44%		(2,193)	-1.63%
Income tax expense	$	20,499	21.60%	$	21,409	28.50%	$	48,390	36.40%

Oriental’s effective tax rate for the year ended December 31, 2020 was 21.62%, and it was mainly affected by several items pertaining to the year 2020, and not expected to reoccur on future years, such as the bargain purchase gain and tax rate differentials. For the years ended December 31, 2019 and 2018, the effective tax rate was 28.46% and 36.44%, respectively. On December 10, 2018, the Puerto Rico government enacted No. Act 257-2018 introducing several amendments to the PR Code. Some of the most relevant income tax changes include: a reduction of the maximum corporate income tax rate to 37.5%, from 39%, and a restriction of the use of partnership gains to offset current and accumulated operating losses generated by a corporate partner.

Oriental classifies unrecognized tax benefits in other liabilities. These gross unrecognized tax benefits would affect the effective tax rate if realized. At December 31, 2020, the amount of unrecognized tax benefits was $728 thousands (December 31, 2019 - $2.7 million). Oriental had accrued $50 thousand at December 31, 2020 (December 31, 2019 - $51 thousand) for the payment of interest and penalties relating to unrecognized tax benefits and released $2.0 million due to expiration of statute of limitation.

The following table presents a reconciliation of unrecognized tax benefits:

	Year Ended December 31,
	2020		2019		2018
	(In thousands)
Balance at beginning of year	$	2,668	$	875	$	1,260
Additions for tax positions of prior years		50		51		81
Additions due to new tax positions		-		2,181		-
Reduction for tax positions as a result of lapse of statute of limitations or new information resulting in a change in assessment		(1,990)		(439)		(466)
Balance at end of year	$	728	$	2,668	$	875

Oriental 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 of 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. The amount of unrecognized tax benefits may increase or decrease in the future due to new or current tax year positions, expiration of open income tax returns, changes in management’s judgment about the level of uncertainty, status of examinations, litigations and legislative activity. For 2020 there was a net decrease in unrecognized tax benefit of $1.9 million.

The statute of limitations under the PR Code is four years and the statute of limitations for federal tax purposes is three years, after a tax return is due or filed, whichever is later. Oriental is potentially subject to income tax audits in the Commonwealth of Puerto Rico for taxable years 2016 to 2019, until the applicable statute of limitations expires. In addition, Oriental’s US subsidiaries are potentially subject to income tax audits by the IRS for taxable years 2017 to 2019. Tax audits by their nature are often complex and can require several years to complete.

The determination of the deferred tax expense or benefit is generally based on changes in the carrying amounts of assets and liabilities that generate temporary differences. The carrying value of Oriental’s net deferred tax assets assumes that Oriental will be able to generate sufficient future taxable income based on estimates and assumptions. If these estimates and related assumptions change in the future, Oriental may be required to record valuation allowances against its deferred tax assets resulting in additional income tax expense in the consolidated statements of operations. Significant components of Oriental’s deferred tax assets and liabilities as of December 31, 2020, and 2019 were as follows:

	December 31,
	2020		2019
	(In thousands)
Deferred tax asset:
Allowance for loan and lease losses and other reserves	$	83,578	$	75,747
Scotiabank PR discount		5,461	$	15,499
Loans and other real estate valuation adjustment		5,769		6,874
Deferred loan charge-offs		140,445		144,799
Net operating loss carry forwards		7,947		7,785
Alternative minimum tax		15,513		25,123
Unrealized net loss included in other comprehensive income		642		340
Deferred loan origination income, net		5,147		11,303
Goodwill		23,927		30,408
Acquired portfolio		52,301		51,079
Other assets allowances		525		457
Other deferred tax assets		24,767		23,506
Total gross deferred tax asset		366,022		392,920
Less: valuation allowance		(8,842)		(6,585)
Net gross deferred tax assets		357,180		386,335
Deferred tax liability:
Acquired loans tax basis		(135,816)		(146,496)
FDIC-assisted Eurobank acquisition, net		(9,171)		(14,004)
Customer deposit and customer relationship intangibles		(13,823)		(17,838)
Building valuation adjustment		(7,412)		(7,848)
Unrealized net gain on available-for-sale securities		(2,106)		(82)
Servicing asset		(14,682)		(15,988)
Other deferred tax liabilities		(11,692)		(7,339)
Total gross deferred tax liabilities		(194,702)		(209,595)
Net deferred tax asset	$	162,478	$	176,740

As of December 31, 2020 and 2019, Oriental's net deferred tax asset, net of a valuation allowance of $8.8 million and $6.6 million, respectively, amounted to $162.5 million and $176.7 million, respectively. The deferred tax assets as of December 31, 2019 include acquisition related deferred tax assets of $59.9 million. The acquisition of SBPR was a nontaxable transaction where the historical tax bases of the acquired business carries over to the acquirer; the historical tax bases include a tax-deductible goodwill from prior acquisitions of SBPR with a deferred tax asset of $30.4 million. Also, as part of the acquisition of Scotiabank, certain closing agreements were transferred to Oriental in connection with the preferential tax treatment, and other provisions, applicable to a loan portfolio formerly acquired by SBPR. The increase in valuation allowance of $2.3 million was mainly related to the realizability of the Holding company’s deferred tax assets. 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 income during the periods in which those temporary differences become deductible. Management considers the scheduled reversal of deferred tax liabilities, projected future income, and tax planning strategies in making this assessment. Based upon the assessment of positive and negative evidence, the level of historical taxable income, projections for future taxable income over the periods in which the deferred tax asset are deductible, and provisions of certain closing agreements, management believes it is more likely than not that Oriental will realize the benefits of these deductible differences, net of the existing valuation allowances, at December 31, 2020. 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.

- 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.

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