When calculating our taxes, the question arises about the possible deductions to make to pay less tax. One of the most common questions is whether ADR fees are tax deductible, but this is not a tax like a dividend withholding tax.
It means that ADR fees will not be tax deductible for most holders, so you will have to pay taxes on them. Non-U.S. companies issue ADRs and carry special risks inherent in all foreign investments.
One of the most common is exchange rate risk, which can occur when the currency in the issuing company’s country falls relative to the U.S. dollar. The charges are normally 2 cents per share and cover the cost of coordinating foreign investments.
How is an ADR taxed?
All dividends paid on ADRs are normally taxable, just like dividends on U.S. stocks. In addition, the local government may withhold taxes from the ADR company.
Depending on the circumstances, foreign taxes withheld may apply as a credit against U.S. taxes. Tax recapture opportunities may also be available.
How often are ADR fees charged?
Fees will normally be 2 cents per share and cover the cost of coordinating foreign investments. For ADRs that include this provision, the broker can apply the charge at any time. However, it cannot do it more than once a year.
However, it should note that ADRs are not direct shareholders of the issuer. For this reason, they do not entitle to vote on the shares underlying their ADRs because this right is reserved exclusively for ordinary shareholders.
How are ADRs taxed?
All dividends paid will always be subject to taxation, just like dividends on U.S. shares. As mentioned above, the local government may withhold taxes, so reviewing each case is important.
The payment made for the grant of the right to offer ADRs will represent compensation to the issuer in the United States. It means that it will constitute FDAP income from sources within the United States and will not treat as foreign income.
In some cases, ADR dividends are subject to double taxation in the U.S. and abroad. However, the IRS has a foreign tax credit that taxpayers can use to offset taxes paid to a foreign government.
On the other hand, banks that hold ADRs in custody will charge fees for the transfer of ADRs. These fees are to the companies and transferred to the client holding the ADR.
Why do companies issue depositary receipts?
A depositary receipt is a negotiable certificate issued by a bank representing the shares of a foreign company listed on the local stock exchange. It will allow investors to own shares in the capital of foreign countries, providing an alternative to trading in an international market.
The easiest way to find out if an ADR is to look for it in the official ADR listing. You must have the ticker or the name of the company to see if it is an ADR or not.
Fees charged to investors
The banks that have custody of this type of deposit charge a custody fee for the work performed on the ADR. These fees compensate custodian banks for inventorying the non-U.S. shares and performing registration, compliance, dividend payment, communication, and record-keeping services.
A common practice for collecting the fees is for the bank to subtract the fee amount from the gross dividends paid to ADR holders. These fees are to the Depository Trust Company or DTC, which will announce the gross and net dividend rate after the custodial fee.
However, several ADR issues will not pay periodic dividends and, therefore, cannot be collected in this manner. The fees will be passed directly to the clients holding their investments in these cases.
On the other hand, custodian banks may charge fees related to dividend distributions, foreign exchange, share voting, and other matters.
Fees vary between 1 and 3 cents per share, so total fees paid in a year can add up. We must itemize the expense on IRS Form 1040 Schedule A, line 21, if fees are deducted from taxes.
Deductions should be placed in this category as long as the total amount in this category exceeds 2% of adjusted gross income. This ADR fee may not be tax deductible for many investors.
Investing in ADRs has more expenses than investing in local stocks. But, many investors prefer to take the risk, to take advantage of the benefits of international diversification and the possible higher dividend yields. It will usually far outweigh the costs involved with ADR debt, including fees and taxes.
For years I have studied American finance regulations. All the information in this blog is sourced from official or contrasted sources from reliable sites.
Salesforce Certified SALES & SERVICE Cloud Consultant in February 2020, Salesforce Certified Administrator (ADM-201), and Master degree in “Business Analytics & Big Data Strategy” with more than 13 years of experience in IT consulting.