Is the Special Tax Rate on Dividends applicable for ADRs?

To begin with let us understand what precisely an ADR is and then go on to understand where it stands as regards to the Special Tax Rate on dividends. American Depository Receipts or ADRs for short are certificates given as proof of ownership of American Depository Shares or ADSs. You might very often find that the terms ADR and ADS are used to imply the same thing.

The ADSs are shares belonging to a foreign company and are held by a custodian Bank in America on deposit. The advantage of ADRs is that as an US investor you can invest in foreign stocks easily by going through your US broker at lesser transactional costs and minimum difficulty - you need not buy a foreign company’s stock through the stock exchange in the company’s home nation.

Coming to the Special Tax Rate on Dividends, according to the Jobs and Growth Tax Relief Reconciliation Act (2003) the tax rate on certain dividends has been reduced to the lower rate which is applicable to capital gains. This rate is normally pegged at 15% but if you are a tax payer in the lower tax brackets, your rate would be just 5%. This provision applies to dividends declared from domestic American corporations and QFCs or Qualified Foreign Corporations.

When does a corporation get the status of QFC? - When it pays out dividend on its stocks which are readily tradable on an established securities market in the United States. ADRs qualify as QFCs as they meet the above mentioned criteria. Only when the dividend distribution is made from earnings & profits, it is regarded as a Qualifying dividend from the US income tax point of view and the concerned security must be an equity security and not debt. ADRs satisfy these criteria too.

In order to be eligible for the special, reduced tax rates, there are also the holding period criteria to be met. There are different holding period conditions for common stock and preferred stock and only when these are met, your ADR is qualified for lower tax at the rates reserved for capital gains. The test is very much dependent on the time period in which the ADRs were sold and at what price.

In case your ADRs do not meet the holding period test, you will have to pay the same tax like what you pay on your regular, ordinary income. In simple terms, if you got the dividend and held the ADRs for over sixty days, you should pass the holding period requirement.

An ADR’s qualifying dividends would be mentioned in Box 1b of the 1099-DIV form which your investment account manager or your broker forwards to you. One point to note here is even if your ADRs have been mentioned in Box 1b, they might still not qualify for reduced tax rates if the holding period test is not passed. Therefore it would be a good idea for you to consider the date of selling of your ADR so that you meet the holding period test to your benefit.

[posted by : OFP on Feb. 25, 2012]

TAGS: tax, dividends, ADR, taxes

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