Over the last three or four decades, many Indians have migrated to the USA, first as students and then to work and settle in America. They have ultimately gotten a green card or US citizenship. However, their ties with the homeland remain strong. They are OCI cardholders as well, that is Overseas Citizens of India. Many come back and temporarily settle in India and work in India or from here. Naturally, this also leads them to make various investments in India in an effort to save o taxes here. Many Indian Americans while resident in the USA, may still choose to invest in India to maintain ties with their homeland or to support families in India. No matter what the reason behind the investments maybe, a good portion of Indian Americans have invested in Indian mutual Funds. What many US taxpayers are not aware of is the fact that foreign mutual funds attract complex PFIC tax and reporting regulations.
A PFIC is a passive foreign investment company. Without going into the complexities of defining PFIC, suffice it to say that most non-US mutual funds fall into this category. The PFIC rules came into existence in 1986 but started attracting attention only lately because now the financial transparency requirements between countries make it possible for the IRS to trace and track these investments by US Citizens. It is now easier for the tax authorities to implement the PFIC regulations. Currently, a lack of disclosure of PFIC investments would mean additional tax, penalties, and interest for a US taxpayer.
The tax treatment of PFICs as compared to American mutual funds is not beneficial. For example, a US Citizen who invests in a US incorporated mutual fund would pay a long-term capital gains tax rate of 0% to 20% (depending upon his tax bracket). However, a US citizen and holder of a foreign mutual fund would be subject to the top rate of 37% under the PFIC rules. In other words, all PFIC income including capital gains is treated as ordinary income. The other disadvantage, of course, is the reporting requirements on Form 8621. Post FATCA, Form 8621 must be filed for every PFIC held by the taxpayer.
So, should PFICs be totally ignored as an investment? Not necessarily. The decision to invest in a PFIC must be made only after taking all factors into consideration. So long as relevant disclosures are made, the decision to invest in PFICs or not must be decided based on financial and tax factors. A thorough analysis of the tax, cost, and reporting requirements of foreign investments must form the basis for any decision by a US citizen to invest in foreign mutual funds.