United States: IRS re-emphasizes sponsored ADRs' withholding obligations

Tax News and Developments April 2023

In brief

On 24 February 2023, the IRS released Advice Memorandum 2023-001 ("Advice") concluding that payments, regardless of their structure, made by US depositary institutions (DIs) to foreign corporate issuers ("Issuers") of stock in exchange for the rights to a sponsored American depositary receipts (ADR) program are subject to 30% US withholding tax under section 1442 unless treaty benefits apply.


In more detail

ADR programs generally allow issuers access to US capital markets. The advice addresses only sponsored ADR programs, which provide exclusive arrangements between issuers and DI's. An issuer establishes a sponsored ADR program by entering into a deposit agreement with and appointing a DI (usually a US bank or trust company) as the exclusive depositary and agent for the issuance and other activities in respect of ADR for the issuer's stock in the United States. The DI generally serves three main functions, which are:

  • To assist brokers by issuing and cancelling ADR that trade in the US capital markets
  • To serve as the issuer's transfer agent in the United States (e.g., maintaining ADR holder records, disbursing dividend payments to ADR holders, and sending out proxy notices to ADR holders, etc.)
  • To act as an administrator for the issuer by promoting ADR in the US capital markets. 

As an inducement to grant an exclusive arrangement for a sponsored ADR program, the DI generally offers to reimburse a portion of the expenses the issuer will incur in setting up the program or to revenue-share ADR fees with the issuer of the underlying stock (i.e., to pay the issuer a percentage of fees collected from ADR holders) ("ADR Program Payments").

Under section 881, a foreign corporation may be taxed at a flat 30% rate on gross income from US sources that is fixed or determinable annual or periodical (FDAP) income. Examples of FDAP income generally include interest, dividends, rents, salaries, wages, premiums, annuities, compensations, remunerations, emoluments and other similar items. Section 861(a)(4) provides that rentals or royalties from property located in the United States or from any interest in such property, including royalties for the use of or for the privilege of using in the US patents, copyright, secret processes and formulas, goodwill, trademarks, trade brands, franchises, and other like property are treated as income from sources within the United States. Section 1442 requires any person making a payment of US source FDAP income to a foreign corporation to withhold from the payment a tax equal to 30%, unless such withholding rate is reduced or exempted under the Code or an income tax treaty or the income is effectively connected with the conduct of a US trade or business.

In determining whether the ADR program payments constitute FDAP income from sources within the United States that are subject to 30% withholding, the IRS first noted that the ADR program payments are remunerations to the issuer for providing the DI with the right to conduct business activities related to the ADR program in the United States. Next, the IRS noted that it is proper to treat the ADR program payments as having the character of payments for the use of property rights within the United States, because the ADR program, similar to franchise or other like property under section 861(a)(4), grants the DI exclusive right to establish, control, and exploit the trading of the issuer's ADR in the United States. Finally, the IRS noted that the United States is the place of use in this case and therefore is the source of the ADR program payments because the DI profits from holders trading in the US capital markets. Accordingly, the IRS concluded that the ADR program payments constitute FDAP income from sources within the United States, and, therefore, such payments are subject to 30% withholding under section 1441 unless treaty benefits apply.

However, in a previous advice memorandum (AM 2013-003), the IRS concluded that ADR program payments are not "royalties" under the narrow definition used in the US and OECD Model Treaties. Based on that analysis, the ADR program payments governed by a provision corresponding to either such Model Treaty would be treated as "Other Income." Therefore, if the issuer is eligible to claim the benefits of an income tax treaty with an "Other Income" provision and otherwise satisfies the requirements of any applicable "Limitation on Benefits" provision, no withholding is required on the ADR program payments. For instance, the Other Income provision (Article 22) of the US-UK Income Tax Treaty ("UK Treaty") is beneficial in that it provides that other income may only be taxed in the payee's (here, the issuer's) country of residence. Therefore, the ADR program payments are not subject to 30% withholding if the issuer is a UK resident and can also satisfy the requirements of the "Limitation on Benefits" provision of the UK Treaty. On the other hand, some treaties have unfavorable Other Income provisions. For example, the Other Income provision (Article 23) of the US-India Income Tax Treaty provides income earned in the US by a person resident in the other treaty jurisdiction that is not specifically addressed in the treaty may be taxed by the United States.

We recommend that DIs that act as ADR administrators assess their US withholding tax obligations if the counterparty issuers are not entitled to treaty benefits as mentioned above. Furthermore, the IRS could make similar arguments as those underlying the advice to assert withholding tax obligations in other cross-border expense reimbursement arrangements. Accordingly, US withholding agents should review their reimbursement agreements and policies to assess any potential exposure.

Contact Information
Eric Min
Associate at BakerMcKenzie
New York
Read my Bio

Copyright © 2024 Baker & McKenzie. All rights reserved. Ownership: This documentation and content (Content) is a proprietary resource owned exclusively by Baker McKenzie (meaning Baker & McKenzie International and its member firms). The Content is protected under international copyright conventions. Use of this Content does not of itself create a contractual relationship, nor any attorney/client relationship, between Baker McKenzie and any person. Non-reliance and exclusion: All Content is for informational purposes only and may not reflect the most current legal and regulatory developments. All summaries of the laws, regulations and practice are subject to change. The Content is not offered as legal or professional advice for any specific matter. It is not intended to be a substitute for reference to (and compliance with) the detailed provisions of applicable laws, rules, regulations or forms. Legal advice should always be sought before taking any action or refraining from taking any action based on any Content. Baker McKenzie and the editors and the contributing authors do not guarantee the accuracy of the Content and expressly disclaim any and all liability to any person in respect of the consequences of anything done or permitted to be done or omitted to be done wholly or partly in reliance upon the whole or any part of the Content. The Content may contain links to external websites and external websites may link to the Content. Baker McKenzie is not responsible for the content or operation of any such external sites and disclaims all liability, howsoever occurring, in respect of the content or operation of any such external websites. Attorney Advertising: This Content may qualify as “Attorney Advertising” requiring notice in some jurisdictions. To the extent that this Content may qualify as Attorney Advertising, PRIOR RESULTS DO NOT GUARANTEE A SIMILAR OUTCOME. Reproduction: Reproduction of reasonable portions of the Content is permitted provided that (i) such reproductions are made available free of charge and for non-commercial purposes, (ii) such reproductions are properly attributed to Baker McKenzie, (iii) the portion of the Content being reproduced is not altered or made available in a manner that modifies the Content or presents the Content being reproduced in a false light and (iv) notice is made to the disclaimers included on the Content. The permission to re-copy does not allow for incorporation of any substantial portion of the Content in any work or publication, whether in hard copy, electronic or any other form or for commercial purposes.