Why a non-US fund is a PFIC

A US person who holds a pooled investment fund organised outside the United States almost certainly holds a Passive Foreign Investment Company. The rules that follow are punitive by design, and they are invisible until the position is sold — at which point the bill is calculated backwards through every year it was held.

The test is about the fund, not about you

A foreign corporation is a PFIC if 75% or more of its gross income is passive, or if 50% or more of its assets produce passive income. A pooled fund holding securities meets both without trying. Nothing about the investor's intent, size of holding, or country of residence changes the answer — a US taxpayer holding one unit is inside the regime.

This is why the problem is so widespread among people who moved. Money invested perfectly sensibly before emigrating, or invested at home on a visit, becomes a reporting and taxation problem the day the holder becomes a US person, and usually nobody mentions it.

The default regime, and why time is the penalty

Absent an election, disposition is taxed under the excess-distribution method. The gain is spread ratably across every day of the holding period. The slice falling in the year of sale is ordinary income at your own rate. Every earlier slice is taxed at the highest ordinary rate in force for that year — not your bracket, and not today's rate — and each one carries an interest charge running from that year's filing deadline, as though the tax had been underpaid ever since.

Three consequences follow, and all three are counter-intuitive:

• Long-term holding, which is rewarded almost everywhere else in the tax code, is the thing being penalised here.
• There is no preferential capital-gain rate. The entire gain is ordinary income, in slices.
• On a long enough holding period the tax and interest together can exceed the gain itself — you can sell for several times what you paid and end up with less than you put in.

The PFIC exposure calculator shows the year-by-year allocation, including which rate applied to which year.

The two elections, and why they usually are not available

A Qualified Electing Fund election taxes you annually on your share of the fund's ordinary earnings and net capital gain as they arise, and the eventual disposition is then an ordinary capital gain. It requires an annual information statement from the fund, in a form the US rules recognise. Many non-US funds have no reason to produce one and do not.

A mark-to-market election includes unrealised appreciation each year as ordinary income. It requires the holding to be marketable stock within the meaning of the regulations, which is a real constraint on pooled vehicles that are not exchange-traded.

Both generally had to be in place for the first year of the holding period. Making one later usually requires a purging election, which has its own cost. So the comparison between the three regimes is best read as a measure of what the default is costing — not as a menu.

The part that is not arithmetic

Holding one of these carries annual reporting obligations of its own, separate from the tax. Those are filing questions rather than calculation questions, and they have their own deadlines and their own consequences for lateness.

What a calculator can tell you is the size of the position and the shape of the charge. What to do about it — the order, the year, the forms — is a question for a licensed CPA or enrolled agent, and for a SEBI-registered adviser on the Indian side of the same decision.