What are American Depository Receipts or ADRs?

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oi-Roshni

By Roshni Agarwal

Published: Thursday, September 19, 2013, 10:12 [IST]

ADRs are negotiable instruments facilitating purchase of shares in a foreign company that trades on the US exchange. Such certificates indicating a fixed number of shares or a single share in dollar denomination are issued by the bank in the US and are referred to as American depository shares (ADSs).

This way, ADRs provide a route to several non-US entities to trade on the American exchanges. Traded as usual stocks, ADRs generate dividends for investors in dollars. ADR for the first time was launched for a UK-based retailer Selfridges by J.P Morgan.

Pros

1. Enable investment in shares of foreign company by domestic investors. Thus, ADRs provide an investment option for investors to diversify their portfolio. So, investment in ADRs prove to be a good bet in case of downturn in the domestic economy. As, a result creation of ADRs makes foreign companies' shares more accessible.

2. Trading similar to usual stocks and over-the-counter ADRs can only be traded during the extended hours. Investors are hence able to avoid the problems of foreign brokerage account.

3. Helps in reducing administrative as well as duty cost that would otherwise be charged

4. Favourable currency conversion for dividends and other pay-outs: Investors can realize gains through easy and favorable currency conversion both for dividend as well as other cash-pay-outs. Say for instance, if Britain pound is stronger than dollar then dividend return will be more rewarding as dividend is offered in dollar terms.

5. Underlying shares of the foreign company can also be procured by the investor instead of the depository receipt. However, individuals prefer holding depository receipt over the underlying securities on account of convenience that the former offers.

6. ADRs do not carry risk or inconvenience associated with cross-currency or currency-border transactions.

Cons

1. Do not eliminate economic and currency risks in relation to the stocks held in a foreign nation.

2. Creation of ADRs results in the levy of stamp duty reserve tax by certain government. For eg: UK-based companies producing ADRs to be traded in the US markets attract some tax amount that is imposed by the UK government.

3. ADRs can confront some issues that are not relevant or appropriate in respect of domestic stock markets.

4. ADRs similar to other domestic stocks face credit and inflation risk.

Tax Treatment for ADRs

ADRs are treated for tax purposes in a manner similar to other domestic investments. Tax rates for dividend distribution tax as well as dividend tax are same for ADRs. In some cases, nations withhold dividend distribution tax paid on dividends.

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