Volume 8 | Issue 1 | November 2012

Many Non Resident Indians (“NRIs”) find mutual fund investment in India a great wealth creation opportunity. The reasons are:

This is a default method unless you find an exception. The basic rules are that you pay no tax until you sell your investment. This is for people who did not make any election on their PFICs and throughout the holding period, did not fill up Form 8621. The way the gain would be calculated and reported is as follows:

This method allows the investor to declare notional gains as income by taking the difference between the fair market value of the shares at the beginning of the year and the fair market value of the shares at the end of the year. The income will be treated as ordinary income.

Subsequent year, you will start with an adjusted basis (mostly, the market value at the beginning of the year).

In the year of sale of investment, you will be taxed long term capital gains only on the portion of the gains that has not been taxed previously as ordinary income.

There are some requirements that must be met by the fund:There are some requirements that must be met by the fund:

Fund prices must be readily available Fund cannot require a minimum investment of more than $10,000, etc.

If the PFIC meets certain accounting and reporting requirements, only then the investor can elect this option. It is practically impossible for a foreign mutual fund to keep US books and tax records and provide US tax information to their investors.

All income and gains would be taxed at the highest ordinary income tax rate (currently 35%)You have to assume that all gains at the time of sale are earned ratably over the time the the investment was held (immaterial if you had loss in the initial years). Interest charges has to be paid (compounded annually) on the deferred tax (of each year).

A US tax payer can choose one of the following three methods:

Dividends are tax freeShort term capital gains on equity funds are taxed @15%Long term capital gains on equity funds are tax freeLong term capital gains on debt funds are taxed @ 20% if indexation is taken or taxed @10% if indexation benefit is not taken

derives at least 75% of its gross income from passive activities orderives passive income from at least 50% of its assets which are held for the production of passive income.

However, Internal Revenue Services (“IRS”) is treating foreign mutual funds as Passive Foreign Investment Companies (“PFIC”).

Mutual Fund structure in India

Definition of PFIC

So, how are PFICs taxed in US?

Excess Distributions Method

Qualified Electing Fund Method

Mark-to-Market Method

Penalties

Conclusion

As per US Internal Revenue Code 1297, a PFIC is any foreign company that:

Failure to file Form 8621 can result in a $10,000 fine.

With the introduction of the new Form 8938, you are required to check (in part IV) whether you

have filed Form 8621.

As of the date of this newsletter, IRS is in the process of introducing a newer version of the Form

8621 (currently in draft form).

The rules of PFIC and the tax Form 8621 associated with it are very complex. The complexity

further increases if the investment are purchased and sold in the same year (short term

investments). Non compliance penalties are also very high.

WeWe recommend consulting cross-border tax advisory firm before you take any decision on your

current and future investments.

US Persons investments in Indian MutualFunds are treated as PFICs

NS Global is an advisory firm founded by certified professionals from USA & India to provide international tax solutions to individuals having asset and / or an income base in India and USA.

We at NS Global, provide you tailored cross border tax solutions. Our in-house tax veterans have a profound understanding of U.S. and Indian Tax laws to address complexities arising out of multiple jurisdictions.

View Previous SUBSCRIBE NOW for our free monthly newsletterShare This:

Connect With Uswww.nsglobal.com Unsubscribe