American depositary receipts are U.S.-source income subject to withholding.

• Author: Chang, Anne

In July, the IRS Office of Chief Counsel (OCC) released a memorandum (AM 2013-003) to address the character and source of payments by a domestic depositary institution made to, or on behalf of, a foreign corporation in consideration for a grant of the exclusive right to offer American depositary receipts (ADRs), and whether those payments are subject to withholding under Sec. 1442. In this memo, the IRS concluded that the payment is fixed or determinable, annual or periodical (FDAP) income sourced within the United States and, therefore, is subject to Sec. 1442 withholding. The withholding rate is 30% unless the foreign corporation is entitled to treaty benefits. To apply treaty benefits, the character of the payment is "other income" in the model tax treaties of the Organisation for Economic Co-operation and Development (OECD) and the United States.

American Depositary Receipt Programs

Foreign corporations (issuers) that want to make their stock more accessible to investors in the United States may enter into an agreement with a U.S. financial institution to offer the stock in an ADR program. The issuer places the stock with a U.S. depositary institution (DI). The DI offers interests in the issuer's stock in the form of ADRs to investors in the U.S. market. ADRs can be traded on U.S. stock exchanges and over-the-counter markets. They are subject to SEC oversight. ADRs are priced in U.S. dollars. The DI makes dividend-equivalent payments in U.S. dollars to the investors based on dividends paid in foreign currency by the issuer to the DI.

An ADR program can be sponsored or unsponsored. In an unsponsored program, the issuer does not agree to use an exclusive DI. Any DI can acquire the issuer's stock and offer ADRs to U.S. investors. In 'a sponsored program, the issuer and the DI enter into an agreement that the DI has the exclusive right to offer ADRs for a period. This memorandum pertains solely to payments by a U.S. DI on behalf of an issuer made in consideration for a grant of the right to be the exclusive DI, i.e., a sponsored program.

Various costs are associated with ADR programs. An issuer incurs legal fees, accounting fees, SEC registration costs, marketing expenses, expenses for participating in investor conventions, costs for acquiring and maintaining electronic communications systems, exchange and listing fees, filing fees, underwriting fees, mailing and printing costs in connection with sending out financial reports, annual...