Skip to main content
KCM Consultants LLC
US Tax

PFIC Tax on Indian Mutual Funds for US-Based NRIs

A US tax resident who redeems an Indian mutual fund is taxed as if the gain had been earned evenly every year, at 37% a year, plus interest. On a ten-year hold that is about 52% of the gain before any Indian tax.

By Suril Mehta, CA, Partner, K C Mehta & Co LLP | KCM Consultants LLC, Dubai and Vasu Patel, Deputy Manager, M&A

Published 11 November 202610 min

Key Takeaways

  • Every Indian mutual fund scheme is a Passive Foreign Investment Company (PFIC) for a US citizen, green card holder or other US tax resident. So are most AIFs and GIFT City funds.
  • Nothing is taxed while you hold. On redemption the default rule (IRC section 1291) spreads the gain over every year held, taxes each year’s share at the top rate (37%) and adds interest. Our recomputation gives 43%, 52% and 63% of the gain for 5, 10 and 15 years.
  • The two escapes, the QEF election (section 1295) and the mark-to-market election (section 1296), rarely work for Indian funds.
  • Form 8621 is due for each fund, each year, once you are above a small threshold or have any redemption.
  • For US residents, the simple rule is: buy the stock, not the fund.

Introduction

An NRI in the US running a SIP in Indian mutual funds is exposed to one of the harshest regimes in the US tax code. Directly held Indian shares are taxed at the 20% long-term capital gains rate. The same gain realised through a fund routinely passes 50%. This article shows where those numbers come from.

Why an Indian mutual fund is a PFIC

A foreign corporation is a PFIC if 75% or more of its gross income is passive, or at least half of its assets produce or are held to produce passive income (IRC section 1297(a)). A pooled fund earns dividends, interest and gains, so it meets the test. Under section 1298(b)(1), stock that was a PFIC at any point in your holding period stays PFIC stock for you unless you have made a QEF election or a purging election.

Equity, debt, hybrid, index, ELSS and fund-of-funds schemes, Indian ETFs, most AIFs, GIFT City funds and India funds based in Mauritius, Singapore or Luxembourg are generally PFICs. A vehicle structured as an LLP or trust needs its US entity classification checked. A fund set up in the US, including a US-listed India ETF, is not a PFIC.

How the default tax works

Under section 1291, a gain on redemption is an “excess distribution”. It is treated as earned ratably over each day of your holding period (section 1291(a)(1)). The share for the current year and any pre-PFIC period is ordinary income. The share for each earlier year is taxed at the highest rate in effect for that year (section 1291(c)(2)), whatever your actual bracket, and interest is charged from the due date of that year’s return to the due date of the return for the year of sale, at the section 6621 underpayment rate (section 1291(c)(3)). Losses are ignored under section 1291, so a loss on one scheme does not shelter the gain on another.

Rates in force (checked 6 November 2026). The top individual rate is 37% for 2026 (it applies above US$640,600 single and US$768,700 joint). Long-term capital gains are taxed at 0%, 15% or 20%. The IRS underpayment rate for the fourth quarter of 2026 is 7% a year, compounded daily (IR-2026-98). The rate is reset every quarter. The 3.8% net investment income tax (IRC section 1411) applies on top, in either route, and is left out of every figure below.

Worked example: where 43%, 52% and 63% come from

Assumptions: US$100,000 is invested on day one of year 1 and redeemed at the end of year N. It grows at 12% a year. The gain is spread equally over N years. The investor is at 37% in every year. Interest runs at 7% compounded daily (an effective 7.25% a year) for every year, and each earlier year carries interest for the number of years from its return due date to the due date of the sale-year return. Indian tax is ignored in this table.

Holding period Gain (US$) Tax at 37% (US$) Interest (US$) Total US tax (US$) Share of gain Direct shares at 20% (US$)
5 years 76,234 28,207 4,397 32,604 42.8% 15,247
10 years 210,585 77,916 31,017 108,933 51.7% 42,117
15 years 447,357 165,522 117,173 282,694 63.2% 89,471

The tax part is always 37% of the gain. Only the interest grows with the holding period.

Arithmetic for the 10-year row. Gain = 100,000 x 1.12^10 – 100,000 = 210,585. Each year’s share = 21,058. Tax per year = 21,058 x 37% = 7,792. Interest on year k = 7,792 x (1.0725^(10-k) – 1).

Year of holding Years of interest Tax at 37% (US$) Interest (US$)
1 9 7,792 6,837
2 8 7,792 5,848
3 7 7,792 4,926
4 6 7,792 4,066
5 5 7,792 3,265
6 4 7,792 2,517
7 3 7,792 1,821
8 2 7,792 1,171
9 1 7,792 565
10 (sale year) 0 7,792 0
Total 77,916 31,017

The total is 77,916 + 31,017 = 108,933, or 51.7% of the gain. Individual rows are rounded, so they add to within US$1 of the total. These figures are illustrative. Real results depend on the IRS rate in each year (it was lower in some earlier years), the top rate in each earlier year (39.6% for 2013 to 2017), SIP instalment dates and rupee movements.

Indian tax and the credit

India taxes the redemption too. Under section 198 of the Income-tax Act 2025 (section 112A of the 1961 Act), long-term gains on equity shares and units of equity-oriented funds are taxed at 12.5% on gains above Rs 1.25 lakh. The effective rate is about 13% to 15% with surcharge and cess. For the 10-year example we use 13% of the gain, US$27,376.

How the credit works. Section 1291(g) allocates creditable foreign tax ratably across the holding period, and the allocation to earlier years reduces that year’s tax increase, never below zero and never the interest. Form 8621 (instructions revised 12/2025) follows the same approach for withholding tax on the distribution.

10-year example (US$) US tax Indian tax Credit Combined tax Share of gain
Ratable credit under section 1291(g) 108,933 27,376 27,376 108,933 51.7%
Direct shares, for comparison 42,117 27,376 27,376 42,117 20.0%

The direct-shares row assumes the Indian tax is fully creditable against the US tax on the same gain.

Elections: QEF and mark-to-market

Default (section 1291) QEF (section 1295) Mark-to-market (section 1296)
How it taxes On exit, with spread-back and interest Each year, your share of the fund’s ordinary earnings and net capital gain, no interest Each year, the rise in value as ordinary income, losses limited to earlier inclusions
Needs Nothing A PFIC Annual Information Statement from the fund (Treas. Reg. 1.1295-1(g)) Marketable stock: regularly traded on a qualifying exchange, or NAV-redeemable and meeting eight conditions (Treas. Reg. 1.1296-2)
Indian funds Where most holders end up Not in practice Arguable, untested

Why QEF is usually unavailable. The election is honoured only if the fund gives you the annual statement showing your share of its ordinary earnings and net capital gain on US principles. Several Canadian fund houses publish it every year. Indian fund houses generally do not, and Indian schemes have no duty to produce one. Ask the fund house in writing before relying on QEF.

Why mark-to-market is uncertain. A listed Indian ETF may qualify if its exchange meets the supervision and trading tests in Treas. Reg. 1.1296-2(c). An open-ended scheme must meet all eight conditions in 1.1296-2(d), one of which bars senior securities, including debt beyond de minimis amounts. SEBI lets schemes borrow within limits, so each fund needs testing. The election also taxes paper gains every year at up to 37% while India taxes only on exit, which weakens the credit. If made after the first year of ownership, the first election year runs the default tax on the earlier gain (Treas. Reg. 1.1296-1(i)).

Form 8621 and reporting

A US shareholder files a separate Form 8621 for each PFIC for each year in which they receive an excess distribution, recognise gain, make an election or are required to report under section 1298(f). Five schemes mean five forms. Part I need not be completed if the total value of your PFIC stock at year end is US$25,000 or less (US$50,000 on a joint return), you have no excess distribution or gain treated as one, and you have made no QEF election (Treas. Reg. 1.1298-1(c)(2)). The year you redeem is therefore always a filing year. Missing the form keeps the limitation period open for the items concerned until the information is furnished (IRC section 6501(c)(8)).

Foreign funds and accounts can also fall under the FBAR (aggregate above US$10,000 at any time in the year) and Form 8938 (for example above US$50,000 at year end for an unmarried US-resident filer). Assets reported on Form 8621 need not be repeated on Form 8938 but count towards its threshold.

What to do

  • Check PFIC status before you invest, and again for holdings you bring with you on moving to the US. See US Pre-Immigration Planning.
  • Prefer direct Indian equity, bonds, NRE / NRO deposits, a PMS that buys shares in your name, or a US-listed India ETF.
  • If you already hold Indian funds, model the exit before you redeem. Compare staying in, redeeming in stages and a purging election, which brings forward the tax on the old gain.
  • Keep scheme-wise gain and holding records each year for Form 8621, and plan the Indian tax credit with your adviser.

FAQ

Is a US-listed India ETF a PFIC? No. A fund organised in the US is not a PFIC, so it avoids these rules. An India ETF listed in India is a foreign fund and is a PFIC.

Is a GIFT City fund a PFIC? Generally yes, because it is a foreign fund holding passive assets. GIFT City is also not a way around US reporting. See GIFT City AIF vs offshore fund.

Does a PMS avoid PFIC? It does if the PMS buys shares and bonds directly in your demat account. If the PMS buys mutual fund units, those units are PFICs. A PMS is still reportable on Form 8938 and the FBAR where the thresholds are met.

Are NRE and NRO deposits PFICs? No. Bank deposits are not PFICs. The interest is taxable in the US and the accounts are reportable on the FBAR and, above the thresholds, Form 8938.

Do I owe tax while I hold the fund? Not under the default rule, except on a distribution above 125% of the prior three-year average (section 1291(b)). Otherwise the tax arises on redemption, so the exposure is easy to miss until you exit.

Related: The PFIC Tax Trap, US CFC rules, US Estate Tax Primer, US Estate and Gift Tax for Indian Families.

Talk to KCM’s US tax team about your Indian investments: contact us.

Sources and last checked: 6 November 2026

With the PFIC overview by Vasu Patel, KCM.

This is not to be construed as legal advice. The actual advice will depend upon the facts and will have to take into consideration the case-specific facts and the anti-abuse regulations.

← Back to Knowledge Hub