Programs that make foreign issuers’ stock available in domestic markets are known as American Depositary Receipt (ADR) programs. In an ADR program, an issuer’s stock is placed with and maintained and controlled by a depository institution (DI). The DI, a domestic financial institution, then offers interests in the issuer’s stock, in the form of ADRs, to investors in domestic markets. U.S. investors can trade ADRs on U.S. exchanges and OTC markets, as they do shares of domestic companies.
An ADR program may be either unsponsored or sponsored. An unsponsored ADR is issued without the involvement of the foreign issuer whose stock underlies the ADR. In a sponsored program, the issuer registers with the Securities and Exchange Commission and chooses an exclusive DI. As an inducement to grant an exclusive arrangement for a sponsored ADR program, DIs commonly offer to pay part of the expenses the issuer will incur in setting up the program.
The expenses typically paid by the DI include legal, accounting fees, SEC registration costs, marketing expenses, expenses for participating in investor conventions, and exchange and listing fees. They also include filing and underwriting fees, mailing and printing costs, and other administrative costs. The Internal Revenue Service has ruled that the issuer realizes gross income in an amount equal to the expenses paid by the DI on the issuer’s behalf (see AM 2010-006, December 8, 2010).
It is, the IRS noted, “well-established” that the payment of the expenses of a taxpayer by someone else is includible in the taxpayer’s gross income (see Old Colony Trust v. Commissioner, 279 US 716 (1929)). The payments are includible regardless of whether they are made directly to the taxpayer or to a third party on his or her behalf.
A taxpayer does not have gross income when it pays the expenses of another person and receives a reimbursement of its payments. When, however, a person pays someone else’s expenses mainly to advance the business interests of the person making the payments, the payments are not includible in the gross income of the recipient, notwithstanding any incidental or indirect economic benefit to the recipient. (See United States v. Gotcher, 401 F.2d 118 (5th Cir. 1968); Rev. Rul. 63-77, 1963-1 C.B. 177; and Rev. Rul. 80-348, 1980-2 C.B. 31. In all three instances, the expenditures were primarily for the benefit of the payer.)
Here, though, the expenses paid by the DI are unequivocally those of the issuer in that (1) the payments are for expenses any issuer would expect to incur to sell its stock in the United States; (2) the DI does not have a preexisting obligation to incur these expenses, the source of its obligation being solely by virtue of its agreement with the issuer; (3) the issuer has discretion over which vendor to use in instituting its DI program when it incurs the expenses; and (4) the DI does not pay all the expenses necessary to set up the ADR program, but only up to an agreed amount.