Foreign taxes are not withheld before interest and dividends are passed through to the ADR holder. True False
The correct answer and explanation is:
The correct answer is True.
Explanation:
American Depositary Receipts (ADRs) are financial instruments that represent shares of a foreign company, traded on U.S. stock exchanges. When a foreign company pays dividends or interest on the underlying shares, these payments go through the ADR process before reaching the U.S. investor holding the ADR.
Foreign taxes on dividends or interest paid by the foreign company are generally not withheld before the payments reach the ADR holder. Instead, the foreign tax authorities often require that taxes be withheld at the source, meaning the foreign company or its paying agent deducts the applicable foreign withholding tax before passing the payment to the depositary bank, which issues the ADRs.
The depositary bank then distributes the net amount (after foreign tax withholding) to the ADR holders in U.S. dollars. Therefore, the foreign taxes are withheld by the foreign entity or intermediary before the dividends or interest reach the depositary bank, not at the level of the ADR holder.
For the ADR holder, this means that the dividends or interest received have already been reduced by foreign tax withholdings. However, the U.S. investor may be eligible to claim a foreign tax credit or deduction on their U.S. tax return to offset these foreign taxes paid. This credit helps avoid double taxation on the same income by both the foreign country and the U.S.
In summary, foreign taxes are withheld at the foreign company or intermediary level before the dividend or interest reaches the depositary bank, and the ADR holder receives the payment net of these foreign taxes. Therefore, foreign taxes are not withheld directly from the ADR holder but before the payment is passed through to them. This process ensures compliance with foreign tax laws and allows ADR holders to manage foreign tax effects through U.S. tax mechanisms.