The Tax Man Cometh (For ADR Issuers)

Tax Collector Painting

A ruling from the US’ Internal Revenue Service (IRS) last month has some American depositary receipt (ADR) issuers in a tizzy over a bump in the cost of listing in the US.

ADR depositary banks are also busy grappling with an issue that cuts deeply into the way they compete for business.

The memo from the office of the chief counsel of the IRS (AM 2010-006, December 17) didn’t create any new rules; it just reiterated what has always been on the books. The problem is no one was complying – until a few years ago. 

The IRS is focusing on the reimbursements depositary banks pay to issuers for expenses related to their ADR programs. The taxman has declared these reimbursements or other similar contributions to be beneficial income and thus taxable. A technical explanation was posted last week on by Robert Willens, a tax expert formerly with Lehman Brothers’ equity research division.

Whatever amount an issuer has been getting back in reimbursements from its ADR bank could now be cut by 30 per cent to pay the income tax, unless the issuer is from a country with a double taxation treaty covering this kind of supposed income. Practically every nation in western Europe – including the UK, France and Germany – is exempt, but most Asian and Latin American countries lack tax treaties with the US or don’t have the type needed to avoid these taxes.

Root of it all
The tax issue surfaced when BNY Mellon, one of the four big depositary banks, began complying with the rule three years ago. On advice from counsel, it started withholding 30 per cent tax on reimbursements. To the consternation of the other ADR banks, BNY Mellon’s proactive approach drew the attention of the IRS.

‘This is a bit of a challenge. After all, no one likes paying more taxes,’ says Chris Kearns, global product manager for BNY Mellon Depositary Receipts. ‘But the reason we started doing this was in order to protect ourselves and our clients in an environment that was becoming more and more focused on fiscal and tax discipline.’
Once BNY Mellon had gone that route, observers point out, it was competitively hobbled. For an issuer shopping for an ADR depositary, one comparative factor is how much it will get reimbursed for expenses related to its US listing. Allowing for similar calculations in terms of liquidity and so on, BNY Mellon’s proposed funding agreements would probably fall short by around 30 per cent – the same amount as the tax.

The other depositary banks have been trying to hold back the new tax treatment. Tax attorneys representing the banks as well as corporate issuers from around the world have been deep in discussion with the IRS.

Kearns says it was simply good due diligence to start paying the tax. ‘Try Googling ‘IRS audit’ and you can see there’s now a great deal more focus on tax withholding issues,’ he says.

As a withholding agent, BNY Mellon has been withholding the 30 per cent tax at source before reimbursing issuers’ expenses. Kearns says the IRS ruling is good news in terms of transparency and levels the playing field for all depositaries, while reiterating that ‘nobody likes paying more taxes.’

He adds that the IRS ruling shouldn’t come as a big shock to the other ADR banks or their clients. ‘In fact, it should be settling to have clarity and a clear direction from the IRS,’ he says.
Another commentator with an interest in the situation says the final decision has not yet been made and is expected from the IRS within the next few weeks, although it is very likely to follow the December announcement. Some issuers are extremely upset, having only just found out about the tax at the beginning of the year and with expense reimbursements for 2010 still to be put through.

This might all seem an overreaction until you consider the magnitude of the reimbursements in question. In fact, few people outside the tight and competitive world of DR banks ever considered them, unless you count the executives and directors at foreign issuers who are offered the enticements when setting up sponsored ADR programs. Under a disclosure change announced in 2009, ADR issuers now have to report the reimbursements in their annual 20F filings (the equivalent of a 10K for a non-US issuer).

In an IR Web Report blog post on January 5, Dominic Jones mined 20F filings and uncovered reimbursements ranging from the low six figures for smaller companies up to $11.9 mn received by Brazil’s Banco Itaú. The 20Fs still to come from larger, more liquid programs are sure to include even bigger shocks. As Jones points out, the payments are ostensibly to help cover US-based IR activities but they overshadow even the richest IR budgets.

‘The numbers were mind-boggling,’ says a US-based IRO for a large foreign issuer, who does not want to be named. ‘Of course, these are large, liquid programs with big issuances, and some of them have raised capital in the past year, so maybe it makes sense for the ADR banks.’

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