Indian Mutual Funds and PFIC Rules

A mutual fund looks simple: you buy units, receive dividends and sell later. For U.S. taxpayers, a fund set up outside the United States, which includes most Indian mutual funds, is often a "passive foreign investment company," or PFIC. Congress wrote the PFIC rules to stop people from deferring U.S. tax on offshore investments, and the default rules are far less friendly than the usual treatment of dividends and capital gains. This page explains how they work and what Form 8621 involves.

Why Indian funds are usually PFICs

Funds hold stocks, bonds and similar assets, so almost all of their income and assets are passive. That is why equity, debt and hybrid funds from Indian fund houses are commonly treated as PFICs. U.S.-based mutual funds that invest in India are not PFICs, and shares of an operating Indian company are generally not PFICs either, because the income is mostly from business activity rather than passive sources. The IRS also lists foreign mutual funds as reportable on both the FBAR and Form 8938.

The default rules: excess distributions

Unless you make an election, the fund is a "section 1291 fund." An excess distribution is the part of a payout in the current year that is more than 125% of the average payouts over the three previous years. Nothing you receive in your first year of holding is an excess distribution. The whole gain when you sell or redeem the units is treated as an excess distribution.

An excess distribution is spread over each day you held the units. The share for the current year, and for any years before the fund became a PFIC, is taxed as ordinary income. The share for earlier years is not added to income. Instead, it is taxed at the highest individual rate for each of those years (37% for 2018 through 2025), plus interest as if the tax had been due then.

The two elections

• Qualified electing fund (QEF). You include your share of the fund's ordinary earnings and net capital gain each year, whether or not it is paid out. It needs a separate election for each PFIC, and the fund must give you the data to compute your share. Ask the fund house whether it provides this information; if it does not, the election is not workable.
• Mark-to-market. For "marketable stock" only, which the instructions describe as stock regularly traded on a national securities exchange registered with the SEC, or on a qualifying foreign exchange, plus certain other PFICs. Each year you report the increase in value as ordinary income, and you may deduct a decrease only up to earlier inclusions. Whether a given Indian fund or exchange-traded fund qualifies needs fund-by-fund review.

Special rules apply in the first year you start using either method, so talk to a preparer before you sell.

Form 8621

You file a separate Form 8621 for each PFIC in which you hold stock directly or indirectly. It is required when you:

• receive certain distributions,
• have a gain on a sale or redemption,
• report income under a QEF or mark-to-market election or make an election, or
• must file the annual report under section 1298(f).

You attach it to your return and file by the return's due date, including extensions. The instructions revised in December 2025 add lines for the currency code and a dollar conversion, which matters for rupee-denominated funds.

Small-holding exception. Under the instructions revised in December 2025, you do not have to complete Part I for a fund if the total value of your PFIC stock on the last day of the year is $25,000 or less ($50,000 on a joint return), and you received no excess distribution and had no gain on a sale. An indirect holding of $5,000 or less has a similar exception. This does not remove your FBAR or Form 8938 duties.

Tax paid in India

Indian tax withheld on a distribution may qualify for the foreign tax credit if it is a creditable income tax. The Form 8621 instructions explain how to apply it. See foreign tax credit on India income. Indian rules on funds, switches and tax deducted at source are governed by Indian law and are handled with your Indian CA.

Planning before you sell or switch

Under U.S. rules, redeeming units, or switching from one scheme to another, is generally a taxable disposition that can trigger the excess distribution calculation. Review your holdings and elections before you move money, and ideally before you become a U.S. tax resident.

How we can help

We review each Indian fund, work out whether an election is possible, prepare Form 8621 with your return and compare your Indian CA's records to the U.S. figures. See international tax services.

Frequently asked questions

General information only, not tax, legal or accounting advice for your situation. Rules, limits and deadlines change; confirm the current rules with the official source or a qualified professional before you act. Reading this page does not create a professional relationship with CPA Tax Payroll and Accounting Corp.