Indian mutual funds and PFIC: what a US tax resident actually owes

Is this you? This guide is for US tax residents holding Indian mutual funds. Indian shares you own directly aren't PFICs. ULIPs have their own rules: see Indian life insurance and ULIPs for US residents. Not a US tax resident yet? Selling first keeps the gain out of US tax.

This assumes you're a non-resident for the whole tax year. Moving back this year? Check your residency status first, because the answer can change.

What the US does to an Indian mutual fund

To the IRS, an Indian mutual fund is a foreign company that earns almost nothing but dividends, interest and gains. That makes it a passive foreign investment company (PFIC), a category written to stop Americans deferring tax through offshore funds. The rules apply to you once you’re a US person: a citizen, a green card holder, or someone who meets the substantial presence test.

There are three ways the US can tax a PFIC. Which one applies depends on what you elect, and when.

US None of these is the ordinary long-term capital gains rate you’d pay on a US fund. That’s the real cost of a PFIC, and it’s why so many advisers tell new arrivals to stop buying Indian funds.

The default: spread the gain, charge interest

If you make no election, the gain on selling is treated as an “excess distribution”. The IRS divides it evenly over every day of your holding period, as if the fund had paid you a little each day and you had hidden it. The part that falls in the year you sell is ordinary income, taxed at your normal rate. The part for each earlier year is taxed at the highest individual rate in force that year, whatever your actual bracket was, and interest is charged on that tax from the due date of that year’s return to the due date of the return for the year you sell.

The interest is at the IRS underpayment rate, 7% this quarter, compounded daily. On a fund held for ten years, the oldest year’s share can carry almost as much interest as tax. A loss, on the other hand, gets no special treatment: it’s a capital loss, and there’s no PFIC tax to pay.

Two things surprise people. First, a quick gain is caught too: sell in March what you bought the previous July, and the share that fell in the first calendar year is taxed at the top rate with a year’s interest. Second, it doesn’t matter when the fund actually rose. A fund that doubled in your first year and then went flat is taxed as if it grew evenly.

Mark-to-market: pay as you go, at your own rate

Under a mark-to-market election, you treat the fund as sold at its value on 31 December each year. Any rise over your adjusted cost is ordinary income that year, taxed at your own rate, with no interest. If it falls, the drop is deductible, but only up to the MTM gains you’ve reported and not yet reversed. When you finally sell, the gain is ordinary income, and a loss is ordinary up to those unreversed gains and a capital loss beyond them.

The election is for “marketable stock”. Regulations extend that to a foreign fund whose units are redeemable at net asset value, if it’s widely held, open to the general public with a low minimum investment, quotes its price at least weekly in a widely available medium, is audited each year, is supervised by a regulator such as SEBI, issues no senior securities, and is almost entirely passive in its income and assets. Most open-ended Indian funds seem to fit, which is why MTM is the usual election for them. Your CPA should still check each scheme, especially one that won’t accept money from US investors.

Timing matters. You make the election on Form 8621, filed with your return by its due date, including extensions. If you make it in the first year you hold the fund as a US person, every later year is clean. If you make it later, the growth up to the end of the election year is first taxed under the default method, interest and all, and only after that does MTM take over.

QEF: the election you usually can’t make

A qualified electing fund election would be the gentlest: you’d pay each year on your share of the fund’s earnings, with long-term capital gains keeping their lower rate. But it only works if the fund gives you a PFIC annual information statement showing that share, worked out under US rules. Indian fund houses generally don’t produce one, so for most Indian funds QEF isn’t an option.

What India takes on the same sale

India India taxes the gain first, because the fund is Indian. As a non-resident of India, you pay Indian capital gains tax like anyone else, and the fund house deducts tax at source before paying you, at the rates below plus surcharge and cess. For long-term equity fund gains, the rates for tax deducted from a non-resident apply only to the gain above the yearly exemption.

Surcharge and cess go on top of these rates. The details of long-term capital gains in India, and how exemptions work for non-residents, belong to the Indian return, which you file if you have a taxable gain or want TDS back. The US doesn’t care about any of this except as a possible credit.

Step by step

1. List every fund and every lotGet a consolidated account statement from CAMS or KFintech showing each purchase date, amount and folio. Each SIP instalment is a separate lot with its own dates. Convert each purchase to dollars at that day’s exchange rate.
   US
2. Record the value each 31 DecemberYou need it for the MTM election, for the annual PFIC report and for the foreign account thresholds. Keep the fund house’s statement for that date.
3. Decide on an election for each fundMark-to-market works best elected in the first year you’re a US person holding the fund. Deciding this is the main thing a CPA does for you here.
   With your first US return
4. File Form 8621 for each fundAttach it to your US return every year you have to: when you sell or redeem at a gain, when you make or keep an election, and whenever your PFIC holdings are above the exception described below.
   With your US return
5. Report the accountsYour folios and any demat account go on the FBAR if your foreign accounts pass USD 10,000 together, and count towards Form 8938.
6. When you sell, file in India tooReport the gain in your Indian return and claim the TDS; our guide to filing an Indian return from abroad covers the forms. Keep the Indian return and TDS certificates; your US credit rests on the tax India finally kept.
   July 31, 2027

Worked example

With no election, Rohan’s tax and interest come to around half of his gain, even though his own bracket is lower than the top rate. The interest on the early years is the part that stings, and it keeps running until the due date of his 2026 return. Had he elected mark-to-market in 2017, he’d have paid along the way at his own rate, and less in total, but in years like 2021 and 2024 he’d have owed tax on growth he hadn’t touched.

The Indian tax on his gain is a separate bill, and only part of it may be creditable in the US, as explained below. To see where your own funds land, estimate your PFIC cost with your purchase and sale figures; the full estimator also takes year-end values and the Indian tax you can credit.

Try your own numbers

Paying less, legitimately

Sell before you become a US tax resident

A non-resident alien isn’t taxed by the US on gains from selling foreign fund units. If you know you’re moving, selling Indian funds before your US residency starts means the growth so far is only India’s to tax.

Once you’re a US person, selling brings the whole gain into US tax. The days you held the units before you became a US person still count in the holding period, but the regulations (Treas. Reg. §1.1291-9(j)(1)) say the fund isn’t a PFIC for those days. So their share of the gain is generally ordinary income in the year you sell, at your own rate, with no top rate and no interest. That definition sits in a regulation written for a different election, but most advisers read it this way; confirm it with your CPA. Growth from before you arrived is still taxed by the US when you sell as a resident, just not at the PFIC top rate. The full PFIC estimator takes the date your US residence began and works it out this way.

Elect mark-to-market early

If you’ll keep the funds, the first US return on which you hold them is the moment to elect MTM. Each year you wait adds another year that will later be taxed at the top rate with interest.

Stop adding Indian fund units

Every new SIP instalment is a new PFIC lot. Indian shares held directly in a demat account aren’t PFICs, and neither are US-listed funds that invest in India. Both avoid the problem, though they have other trade-offs your adviser can go through with you.

Use the Indian tax as a credit, where you can

The US lets you credit Indian income tax on Form 1116, but only against US tax on foreign-source income. A US resident’s gain on selling shares is normally US-source, so on its own it creates no room for a credit. The treaty with India treats income India may tax as arising in India for this purpose, but subject to the US source rules for limiting the credit. Whether that leaves room for the credit isn’t settled. Some advisers use a rule in the tax code (section 865(h)) that treats a gain the treaty sources to India as foreign income in its own credit category, so the Indian tax can offset the US tax on this gain. Others read the treaty’s wording as ruling this out, in which case how much you can use depends on your other foreign income. Ask your CPA which applies. Our guide to how tax treaties work for NRIs covers the treaty side.

With no election, the special PFIC rule that spreads foreign tax over the holding period covers only tax withheld on distributions, not tax on a sale. The Indian tax on the gain is claimed for the year you sell, under the normal limits. Whether it can reduce the deferred tax and interest as well as your ordinary tax that year is a point to settle with your CPA. Under MTM, the Indian tax also falls in the year of sale, while most of the US tax was paid in earlier years, so it can only help against that year’s US tax (or be carried back one year and forward ten, within the same credit category).

Forms, documents and deadlines

You don’t need to file Form 8621 for a fund in a year when it had no election in effect, you had no gain on selling it and no excess distribution from it, and all your PFIC holdings were worth USD 25,000 or less on the last day of the year (USD 50,000 on a joint return). A fund you sell at a gain, or one under a mark-to-market election, needs its own form whatever the total. Above that total, every fund needs one. Funds you report on Form 8621 aren’t listed again on Form 8938, but they still count towards its threshold. Our guide to FBAR and FATCA reporting for Indian accounts goes through both reports line by line.