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Review of American Depository Receipts and Taxes

    Although ADR certificates are issued by US banks, they still represent shares in a foreign company. In essence, you are investing in a non-US asset, and the taxation involved can become a bit complicated. Since the actual shares of the company that you’re buying through an ADR are being held by a bank native to the stock, you’re subject to that country’s tax laws as well as your own.

    Taxed Dividends on ADRs

    Just like US stocks, dividends paid on ADR shares are generally taxable. There are a number of other variables that depend on the situation, including the possibility that the company’s local government will withhold taxes on your dividends – sometimes to the extent that this revenue is negated completely.

    This is why it’s important to thoroughly examine the tax scenario on a particular ADR before you invest.

    When in doubt, consult a tax advisor.

    There are some circumstances where local taxes withheld can be applied as a credit to your US taxes, and sometimes you can take advantage of a tax reclaim opportunity. Again, this is why the counsel of a tax professional is often worth its weight in gold.

    Avoiding Double Taxation

    You might be catching wind of a little Catch-22 in this whole process: namely, double taxation. This isn’t something that the IRS wants to subject you to, believe it or not, and therefore there are some safeguards in place.

    The IRS has a system in place through which investors can take a tax credit or a tax deduction to avoid being taxed twice.

    I can tell you this much: tax deductions are easier to figure out, but they’re usually not the best option. A tax credit will have a direct dollar-value impact on your tax liabilities, whereas a deduction is subject to a percentage-based calculus that will often leave you holding the short end of the stick.

    Filing a Form 1116 for Foreign Tax Credits:

    Think of it as a difference between elimination and mitigation. The credit will eliminate the burden of foreign taxation, while a deduction will usually only mitigate the same burden. Which would you choose? Most likely, you’ll be reaching for that Form 1116, despite the fact that it can get complicated.

    ADR Foreign Tax Withholding

    A company that wants to raise capital and go public will issue stock that can be sold on a stock exchange. For example, an American company will normally sell stock on either the NASDAQ or NYSE…New York Stock Exchange.

    Foreign countries will often have their own stock exchanges, but sometimes companies want to seek a larger investment base by attracting American and Canadian investors. To do this they use American Depository Receipts, which are traded like American stocks that represent shares of a foreign company.

    An American bank will hold a certain number of shares from the foreign company and divide those shares into American Depository Receipts, which then get traded on the American stock exchanges.  These receipts are typically bought by American and Canadian investors.

    It is much easier to buy an ADR on these American exchanges relative to the complexity of buying the stock on a foreign exchange where there could be different languages, taxation and purchasing barriers.

    If an American or Canadian investor makes dividend income while holding the ADR investment, they will owe federal taxes. Often investors from Canada and the United States will have taxes automatically deducted by the foreign country of the ADR.  This is called a withholding tax and the rate varies depending on the country in which it is incorporated.  Usually there are tax credits for paying that tax and there are usually tax friendly options that the ADR itself will offer.

    If the ADR is contained in a government Registered account, you would not receive a tax credit for the the foreign tax paid. From a tax perspective, ADRs are considered foreign equity.  In Canada, they are not eligible for the dividend tax credit.

    Christopher - BSc, MBA

    With over two decades of combined Big 5 Banking and Agency experience, Christopher launched Underbanked® to cut through the noise and complexity of financial information. Christopher has an MBA degree from McMaster University and BSc. from Western University in Canada.

    Christopher - BSc, MBA

    Christopher - BSc, MBA

    With over two decades of combined Big 5 Banking and Agency experience, Christopher launched Underbanked® to cut through the noise and complexity of financial information. Christopher has an MBA degree from McMaster University and BSc. from Western University in Canada.