Are these stock transactions tax-free?

Financial Planning Tax Strategies
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I recently transferred stocks held in a European brokerage account to a US broker (Interactive Brokers).

Some of those stocks are American companies (e.g. General Electric) that were purchased on a European stock exchange and are denominated in Euro, have a different ticker symbol than in the U.S. and can only be traded on a European exchange.

Another stock position is a European company, for which a corresponding ADR (American Depositary Receipt) exists.

  1. For the first case (U.S. companies) Interactive Brokers offers a so-called ā€œsector transferā€, which will convert a position from being denominated in Euro to one denominated in USD (with a corresponding change in the ticket symbol), so that the resulting position can be traded on a U.S. exchange.

E.g. 100 shares of General Electric would be converted from 100 shares of GCP (ISIN: US3696043013, currency: Euro) into 100 shares of GE (currency: USD).

Is this ā€œsector transferā€ a tax-free event? Or is it taxable (e.g. as if the original position was sold and then repurchased)?

  1. Another variant of this is that Interactive Brokers also offers an exchange for one of my British stocks (Diageo, symbol: DGE, currency: GBP) into the corresponding American Depositary Receipt (Diageo, symbol DEO, currency USD).

Once again I am wondering, if this exchange is tax-free, even though itā€™s not the identical security (but probably a substantially identical one)?

Naturally Iā€™d only consider doing those exchanges, if they were tax-free, so any advice is greatly appreciated.

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Once again I am wondering, if this exchange is tax-free, even though itā€™s not the identical security (but probably a substantially identical one)?

I would dispute your contention that they these are ā€˜probably substantially identicalā€™. From IBā€™s site on doing the conversions https://www.interactivebrokers.com/en/trading/adr-conversionā€¦

ADRs provide a convenient and cost-effective way to buy foreign shares without incurring foreign tax obligations on each transaction. While ADR prices tend to follow the price of the foreign underlying shares, it may be the case that these prices diverge to create an arbitrage opportunity.

The fact that they may diverge and create an arbitrage opportunity means that they are not ā€˜substantially identicalā€™. Therefore, I would say any sale of the euro-denominated stocks to buy dollar-denominated stocks is taxable. This would also be true for the reverse type of transaction with GCP and GE - since they could potentially diverge, creating an arbitrage opportunity.

AJ

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AJ,

Thanks so much for replying and sharing your thoughts on this matter. If I understand you correctly, both transactions are taxable in your opinion. I canā€™t dispute the conclusion, however I do not quite understand the way you got there.

I would dispute your contention that they these are ā€˜probably substantially identicalā€™. [ā€¦] The fact that they may diverge and create an arbitrage opportunity means that they are not ā€˜substantially identicalā€™.

The first thing I donā€™t understand is why the existence of an arbitrage opportunity means that the securities are not substantially identical. You can have an arbitrage opportunity with the identical security, e.g. buy GCP (General Electric)on XETRA and sell it in Berlin or Frankfurt. Of course these transactions would be taxable simply by the fact that a sale is involved. But it shows that the (substantial) identity between of a security (or two) cannot simply be defined by an arbitrage opportunity.

Another example: Thereā€™s an arbitrage opportunity between Berkshire Hathaway A-shares and B-shares, yet the conversion from A-shares to B-shares is apparently not a taxable event:

Therefore, I would say any sale of the euro-denominated stocks to buy dollar-denominated stocks is taxable. This would also be true for the reverse type of transaction with GCP and GE - since they could potentially diverge, creating an arbitrage opportunity.

But in these transactions there is no sale taking place. My understanding is that in the first case (GCP to GE) the stocks move from a European Transfer Agency/Registrar to a U.S. one. And in the 2nd case (Foreign Stock to ADR) the ADR issuer takes the foreign stocks in and issues the corresponding number of ADR certificates.

Again, Iā€™m not saying that these two events are non-taxable, Iā€™m just saying that I donā€™t follow your logic to come to the conclusion that they are taxable. (Though if I take Iraā€™s logic from the 14-year old old post on this post, Iā€™d be tempted to come to the conclusion that both are NOT taxable, since the ownership rights stay the same. But of course logic doesnā€™t always apply in tax law it seemsā€¦)

Thanks again so much for replying. This is an extremely helpful exchange to have.

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But in these transactions there is no sale taking place. My understanding is that in the first case (GCP to GE) the stocks move from a European Transfer Agency/Registrar to a U.S. one. And in the 2nd case (Foreign Stock to ADR) the ADR issuer takes the foreign stocks in and issues the corresponding number of ADR certificates.

Again, Iā€™m not saying that these two events are non-taxable, Iā€™m just saying that I donā€™t follow your logic to come to the conclusion that they are taxable. (Though if I take Iraā€™s logic from the 14-year old old post on this post, Iā€™d be tempted to come to the conclusion that both are NOT taxable, since the ownership rights stay the same. But of course logic doesnā€™t always apply in tax law it seemsā€¦)

Do the ownership rights remain the same? Do the GDRs of the US company and the US company shares have the same voting rights? And do the ADRs of the foreign company and the shares of the foreign company also have the same voting rights? If not, then the ownership rights donā€™t remain the same, so they arenā€™t substantially identical. This may vary by security, as I think some ADRs provide voting rights while others donā€™t. Iā€™m not sure if GDRs provide voting rights or not. That said, even if the voting rights remain the same, my (admittedly conservative) take would still be because they are issued in different currencies, which exposes you to currency risk (thus creating the arbitrage opportunity), they are not substantially identical.

You might want to ask if a 1099-B will be issued for the conversion.

AJ

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Do the ownership rights remain the same? Do the GDRs of the US company and the US company shares have the same voting rights?

My understanding is that my position of GCP is not a GDR of some sort, but rather the same common share of General Electric, just managed by a European Transfer Agent/Depositary. In fact when you enter the ISIN of General Electric, which is US3696043013, into the query here: https://stockmarketmba.com/lookupisinonopenfigi.php , it shows several different ticker symbols for different exchanges, among them GCP, which is used in German Stock Exchanges and GE (the U.S. ticker). Unfortunately U.S. brokers never straight list the ISIN of a stock, since in the U.S. they apparently use CUSIP.

So Iā€™d conclude from that fact that the ISIN stays the same, that it is literally the identical security.

And do the ADRs of the foreign company and the shares of the foreign company also have the same voting rights? If not, then the ownership rights donā€™t remain the same, so they arenā€™t substantially identical. This may vary by security, as I think some ADRs provide voting rights while others donā€™t.

Indeed, it may differ by ADR, but the ADRs I had did have the same voting rights (once you accounted for the fact that there isnā€™t always a 1:1 ratio between ADR and underlying common stock).

That said, even if the voting rights remain the same, my (admittedly conservative) take would still be because they are issued in different currencies, which exposes you to currency risk (thus creating the arbitrage opportunity), they are not substantially identical.

On a very tangentially related topic: If they were really not substantially identical, then that would be an excellent way to bypass the wash-sale rule: I could sell my GCP shares for a loss and buy GE shares. Or for a holder of GE, they could sell GE for a loss and purchase the same amount of GCP without running afoul of the wash-sale rule. Iā€™m not convinced that the IRS would accept this. A similar scenario would be between a stock and its corresponding ADR.

As a side note: There actually is very little to no currency risk in practice, because it is arbitraged away by the pros, once the disparity gets too big. So if you hold GCP and the Euro plummets, it just means that the stock price will go up relative to GE to account for the change in exchange rate. Of course this isnā€™t perfect, but is close enough.

You might want to ask if a 1099-B will be issued for the conversion.

An excellent idea. Iā€™ve created a ticket with them for both cases and will report back what they say.

Thanks again for engaging on this topic.