Big India Returns, Bigger Tax Shock: Why Nris Are Losing Money on Investments

(SAN FRANCISCO) — The single most important distinction for NRIs investing in India while living in the U.S. is this: many Indian mutual funds are treated by the US IRS as PFICs, which can turn a “good” rupee return into a harsh U.S. tax result.

For tax year 2026 (returns filed in 2027), that PFIC label can push gains into ordinary income rates up to 37%, plus a PFIC interest charge in many cases. At the same time, selling Indian property as an NRI can trigger high Indian TDS under Section 195, temporarily freezing a large share of your sale proceeds.

Put together, NRIs can see steep “tax erosion” and cash-flow hits, even when the underlying investment performed well. This is common among investor-visa families too. EB-5 investors, E-2 treaty investors, and H-1B professionals often keep Indian portfolios.

Many only learn about PFICs and cross-border reporting after receiving a U.S. notice, or when a property buyer demands a lower-TDS certificate.

NRI tax friction: PFICs vs. Indian TDS (what hurts, and how)

Two issues drive most of the pain:

1. U.S. PFIC rules on Indian pooled funds
   Many India-domiciled mutual funds are “foreign corporations” for U.S. tax purposes. If they meet PFIC tests, special rules apply under Internal Revenue Code §§ 1291–1298, reported on Form 8621.
2. Indian TDS and compliance on NRI property sales
   Under Indian law, buyers often must withhold tax on payments to NRIs under Section 195, and the rate can be far higher than the resident regime under Section 194-IA. The result is often a liquidity crunch.

Side-by-side comparison: Indian mutual funds (PFIC) vs. Indian property sale (TDS)

Criteria checklist: when each regime applies

You are in the PFIC danger zone if:

• You are a U.S. tax resident under the Green Card Test or Substantial Presence Test. See IRS Publication 519 at https://www.irs.gov/pub/irs-pdf/p519.pdf.
• You hold India-domiciled mutual funds or similar pooled funds that may be PFICs.
• You did not track annual statements, distributions, and cost basis in U.S.-ready format.

You are in the India TDS liquidity trap if:

• You are an NRI seller of Indian property.
• The buyer must withhold under Section 195, often on gross consideration when thresholds apply.
• You did not apply early for a lower/nil certificate (Form 13 under Section 197).

PFIC impact on mutual fund gains: a case with real numbers

A commonly cited NRI scenario shows why PFICs terrify cross-border filers.

Case example (from the scenario provided): An NRI in San Francisco invests ₹45 lakh in Indian mutual funds and earns a ₹12 lakh profit. Under PFIC rules, the U.S. tax bill can be nearly $18,000 (about ₹15 lakh).

That can happen when gains are treated like ordinary income up to 37%, plus a PFIC interest charge. Meanwhile, Indian tax on comparable gains can look modest. The example notes an Indian tax of about ₹62,500 on a ₹5 lakh gain in one scenario.

Yet the U.S. side could still rise sharply. The example suggests it could climb to about ₹2.1 lakh of U.S. liability in another case, wiping out over 40% of profits after cross-border interaction.

• U.S. character mismatch: India may treat certain fund gains as long-term. The U.S. PFIC regime can deny expected U.S. capital gain treatment.
• Compliance load: Many filers discover they need Form 8621 for each PFIC each year. This can multiply costs and errors.

⚠️ Warning: PFIC reporting is one of the most error-prone areas for immigrants. Missing Form 8621 can leave your return incomplete and increase audit risk.

For official starting points, use the IRS international portal at https://www.irs.gov/individuals/international-taxpayers and the forms library at https://www.irs.gov/forms-pubs.

Property sale dynamics: TDS under Section 195 and the liquidity squeeze

NRIs often expect withholding to work like it does for resident sellers. It usually does not.

Under the scenario provided, when an NRI sells property and the transaction is above ₹50 lakh, the buyer may need to withhold under Section 195 at the seller’s applicable rate, including surcharge and cess. 5% to 31.2% withholding range until the seller files and claims a refund, if due.

Residents, by contrast, may see 1% TDS under Section 194-IA in many cases. That difference is why NRI deals can fall apart at closing.

There is also a buyer-side compliance burden:

• Buyer often must obtain a TAN
• Deposit withheld tax
• File quarterly e-TDS returns

Divya Baweja of Deloitte India, cited in the scenario, points to a common solution: apply for a lower or nil withholding certificate using Form 13 under Section 197. That application requires careful capital gains calculations, indexation where relevant, and exemption analysis (often under Sections 54 or 54F).

FEMA restrictions: don’t add a compliance violation to a tax problem

Tax is only half the story for NRIs. FEMA restrictions can block certain investments and create penalties.

The scenario highlights that NRIs generally cannot invest in several small-savings products, including:

• PPF (new accounts)
• NSCs, KVP, post office schemes
• Chit funds and Nidhi companies

It also notes restrictions on agricultural and plantation land, plus caps on listed company holdings: 5% per issuer (and 10% aggregate, up to 24% with approval).

Penalties described can be severe: up to three times the amount involved, ₹2 lakh when the amount is not quantifiable, or ₹5,000 per day for continuing violations.

Reporting to the US IRS: don’t ignore FBAR and FATCA alongside PFICs

PFIC filers are often also foreign-account filers. If your non-U.S. financial accounts exceed $10,000 in aggregate at any time, you must file FBAR (FinCEN Form 114). FBAR is not filed with the IRS, but it is part of U.S. compliance.

If your foreign financial assets exceed FATCA thresholds, you may need Form 8938.

📅 Deadline Alert: For tax year 2026, individual returns are generally due April 15, 2027. FBAR is due April 15, 2027, with an automatic extension to October 15, 2027.

Regulatory outlook: India’s Budget 2026 and the new Income Tax Act, 2025

Ahead of India’s Union Budget 2026 on February 1, 2026, there are calls to simplify NRI property-sale TDS and related compliance. No specific relief is confirmed in the scenario.

The scenario also notes India’s Income Tax Act, 2025, effective April 1, 2026. It modernizes structure and language, but it reportedly does not change NRI investment rules directly.

For NRIs, the practical message is that the U.S. side remains the bigger “hidden” exposure. PFIC rules are U.S. law. They do not depend on Indian simplification.

Common mistakes (and how to avoid them)

• Mistake: Assuming Indian mutual funds are “just like U.S. mutual funds.”
  Avoid it: Ask whether the holding is a PFIC and whether Form 8621 is required.
• Mistake: Only planning for Indian tax, not US IRS tax.
  Avoid it: Model both countries before you invest or redeem.
• Mistake: Selling property without a lower-TDS certificate plan.
  Avoid it: Start the Form 13 / Section 197 process early.
• Mistake: Ignoring FBAR/Form 8938 while focusing on PFICs.
  Avoid it: Track peak balances and account ownership from January through December.

You are “in PFIC territory” if…

You are a U.S. tax resident for 2026, and you own India-domiciled mutual funds or pooled funds that meet PFIC rules, requiring Form 8621.

You are “in the Section 195 squeeze” if…

You are an NRI selling Indian property, and the buyer must withhold under Section 195 on gross consideration, often far above the 1% resident TDS framework.

Action items for tax year 2026 (filed in 2027)

• Inventory India holdings and identify any likely PFICs before you file.
• Confirm whether you must file Form 8621, FBAR (FinCEN 114), and Form 8938.
• If selling Indian property, plan early for Form 13 (Section 197) to reduce withholding.
• For complex portfolios, use a cross-border CPA familiar with NRIs, PFICs, and U.S. international forms.