Are you a US resident or citizen holding Indian mutual funds? You could be triggering unexpected tax liabilities under the IRS PFIC rules. Here’s a complete guide on how Indian mutual fund investments are taxed in the USA, what the PFIC rules mean for you, and the actions you need to take to avoid heavy penalties and interest.

Why NRIs and Indian Americans Need to Understand US Taxation of Indian Mutual Funds

While Indian mutual funds are a popular investment avenue, especially for NRIs and OCIs, the tax treatment of these funds in the USA is starkly different. In India:

• Dividends are tax-free (in the hands of the investor)
• Long-term capital gains on equity funds are either tax-free or lightly taxed

However, if you’re a US person for tax purposes—including Green Card holders, US citizens, and tax residents—the IRS expects you to report and pay tax on your global income, including gains from Indian mutual funds.

The catch? Most Indian mutual funds are considered PFICs (Passive Foreign Investment Companies) under US tax law, which come with strict compliance requirements and potentially punitive tax treatment.

What Is a PFIC and Why Indian Mutual Funds Fall Under It?

The IRS uses the PFIC classification to deter US taxpayers from investing in offshore funds that don't distribute income regularly (thus deferring taxes). Indian mutual funds generally meet the PFIC criteria:

• 75% or more of their income is passive
• 50% or more of their assets produce passive income

Once classified as PFIC, your Indian mutual fund investments are subject to special tax treatment, and Form 8621 must be filed each year for every PFIC investment you hold.

Form 8621 Filing: Your Reporting Requirement for Indian Mutual Funds

Form 8621 is the IRS disclosure form for each PFIC holding. If you invest in Indian mutual funds while living in the US, you're required to submit this form annually—regardless of whether you've made any gains or received distributions.

Depending on your choice of election, you’ll be taxed in one of three ways:

Option 1: Mark-to-Market Election – The Most Practical for Indian Mutual Funds

This is the most commonly used and IRS-compliant method for reporting PFICs like Indian mutual funds.

• Each year, you report notional (unrealized) gains as ordinary income, even if you haven’t sold your units.
• Losses can be offset against previous PFIC gains but not against other income.
• On final sale, any previously unrecognized gain is taxed as capital gain.

Key Benefit: Spreads your tax burden over time and avoids the painful default method.

Best used when you become a US tax resident—make this election in your first US tax return to lock in favorable treatment.

Option 2: Qualified Electing Fund (QEF) Election

Under this option, your Indian mutual fund is treated like a US partnership—you report your proportionate share of earnings and gains each year.

However, this requires cooperation from the Indian fund house, which must provide annual statements showing your income. Since most Indian AMC platforms don’t provide QEF data, this option is rare for Indian mutual funds.

Option 3: Default Taxation (Excess Distribution Method)

If you don’t make an election, the IRS taxes you using the most punitive PFIC method:

• Your entire gain is spread over the holding period
• Each year’s share is taxed at the highest possible rate
• Interest is levied for late tax payment on each of those years

For example: You held Indian mutual funds for 10 years and sold for a $100 gain. IRS will treat it as $10/year gain, tax each year at top rates, and charge interest on unpaid taxes—creating a massive tax liability.

Are You Temporarily in the US? Should You Still Report PFICs?

If you're in the US for only a couple of years on a temporary assignment, and you plan not to redeem your Indian mutual fund units, you might think skipping Form 8621 is safe.

However, the IRS has proposed a new rule: if a person holding PFICs gives up US residency or citizenship, they are deemed to have sold all PFIC holdings on their final day as a US person—triggering full tax liability retroactively.

Translation: Even if you plan to leave the US, the IRS may tax you as if you sold your Indian mutual funds before you left.

Key Takeaways: What NRIs and US Residents Holding Indian Mutual Funds Must Do

• Do not ignore PFIC reporting – You must file Form 8621 for each Indian mutual fund every year.
• Make the Mark-to-Market Election in your first US tax return for the most efficient outcome.
• Avoid the default method, which leads to backdated taxes, penalties, and interest.
• Plan ahead if you’re moving to the US or planning to return to India soon.

Need Help Navigating PFIC Rules or Filing Form 8621?

At Dinesh Aarjav & Associates, we specialize in:

• Cross-border taxation
• US tax filing for NRIs and Indian Americans
• Global mobility advisory
• FATCA, FBAR, PFIC, and Form 8621 compliance

Whether you’re newly moved to the US, planning to relocate, or reviewing your India-based investments for US tax impact—our experts can help you stay compliant while optimizing your tax exposure through specialized NRI advisory services.

Reach out to us for a consultation on your PFIC reporting obligations and US tax return filing services involving Indian mutual funds.