Like Global Depository Receipts (GDR’s) & American Depository Shares (ADS’s), IDR are the derivative instrument with parent companies shares as the underlying asset, they allow foreign companies to raise money in India. An IDR holder acquires the same rights as a shareholder, except that he/she can neither attend the AGM nor vote on resolutions. NRI’s can trade in the IDR’s.
The biggest question doing the rounds is – what could be the tax implications for the Indian IDR holder? The good news is that IDR does not come under the purview of Securities Transaction Tax. But the IDR holder will have to pay tax on the dividend income earned. It is not yet clear whether the tax payable would be equal to the Dividend Distribution Tax which for the current fiscal stands at 16.61%. So tax seems sure but the rate is yet unsure.
Then there is the question of short and long term capital gains tax?
Currently, Long term gains made from Indian Stock Exchanges (stock held for more than 12 months) is completely exempted from tax while Short term capital gains tax (held less than 12 months) stands at 15%. But the IDR does not fall under the STT, so maybe it will not enjoy the same benefits as the shares listed on the Indian Exchanges enjoys. So this means that IDR’s will be taxed like any other asset –long term tax- held for over 36 months would be around 20%. Short term tax, when asset is held for less than a year, will be like regular income earned, at 30.9%.
There is no real clarity yet on this treatment of tax but surely, the Govt will have to bring a notification soon. A quick resolution on the tax angle is urgent and imperative or else it could undermine the very lure of this IDR.
According to the red-herring prospectus, the legal regime for IDR’s is still to be tested; investors in IDR’s may not get the benefits of a bonus issue or a rights issue; Even dividend income on IDR’s will be taxed in the hands of the investors and long-term capital gains tax will be another additional burden. Standard Chartered Bank has said whenever the company and/or the depository is unable to make bonus issues or rights issues available to the IDR holders, the depository will try and sell the deposited property that is the subject of the distribution on behalf of the IDR holders and distribute the net proceeds thereof as a cash distribution to the IDR holders.
Standard Chartered said it has agreed that for all corporate actions including voting, rights issues, the payment of dividends and other distributions, it will treat IDR holders on an equitable basis vis-à-vis other holders of shares in the home country (the UK). However, it pointed out that in circumstances where certain corporate actions, which are available to the holders of shares in the home country of the company and other jurisdictions where its shares are listed, are not permitted by Indian laws to be offered to IDR holders.
There is also a term called "Fungibility", now what does this means & how it relates to IDR/ADRS ?
The actual meaning of the word fungible is the ability to substitute one unit of a financial instrument for another unit of the same financial instrument. However, in trading, fungibility usually implies the ability to buy or sell the same financial instrument on a different market with the same end result.
Its a financial instrument (i.e. individual stock, futures contract, options contract, etc.) is considered fungible if it can be bought or sold on one market or exchange, and then sold or bought on another market or exchange.
For example, if one hundred shares of an individual stock can be bought on the NASDAQ in the US , and the same one hundred shares of the same individual stock can be sold on the London Stock Exchange in the UK
Fungible financial instruments are often used in arbitrage trades, because the difference in the price (the arbitrage part) often comes from a difference in location (the fungible part). For example, if the Euro to US Dollar exchange rate was 1.2500 in the US and 1.2505 in the UK, an arbitrage trader could buy Euros in the US, and then immediately sell Euros in the UK, making a profit of 0.0005 per Euro (or $5 per €10,000), because Euros are a fungible financial instrument. Similarly it implies to Stocks IDRs etc.
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A year after the listing of India’s first depository receipt (IDR), the Securities Exchange Board of India (SEBI) released a circular on 3 JUNE 2011,allowing redemption of illiquid Indian Depository Receipts (IDRs),investors can now convert IDRS issued in India into shares of the parent company. However, SEBI has permitted the interchangeability of IDRS into the underlying shares only after the expiry of the one-year period from the date of the issue of the IDRs.
IDRS with a turnover of less than 5% can be termed as illiquid. Currently, Stanchart is the only listed IDR in the country. Bankers say, “This may not have a significant impact on Stanchart because it is a liquid. The Stanchart IDR is extremely liquid or frequently traded in the market.”
Meanwhile, bankers see this move as an investor protection mechanism because it will guarantee maximum returns from liquid IDRs instead of getting it converted into shares of the parent company. “Regulators could be affected or fear any sort of forex inflows, outflows because of any sort conversion that could happen in the IDR,” they added.
Recently, RBI also came out with a guideline on IDRs. The central bank said that no bank can lend against IDRs or give loans for subscribing to the IDRs.